CSCP - 2023 [5.1 ed.]

Table of contents :
APICS Certified Supply Chain Professional (CSCP) Learning System
Acknowledgments
Intellectual Property and Copyright Notice
Certified Supply Chain Professional Learning System
Module 1: Supply Chains, Demand Management, and Forecasting
Section A: Introduction to Supply Chains
Topic 1: Supply Chain Models
Basic Supply Chain
Vertical vs. Lateral Integration
Topic 2: Supply Chain Maturity and Complexity
Stages of Supply Chain Management Evolution
Supply Chain Examples
Section B: Demand Analysis and Patterns
Topic 1: Demand Analysis
Demand Analysis Road Map
SWOT Analysis
Market Research
Product Assessments
Topic 2: Demand Patterns
Demand Patterns Road Map
Macroeconomic Demand Patterns
Microeconomics
Short- to Medium-Term Demand Patterns
Section C: Demand Management
Topic 1: Demand Management
Demand Management Road Map
Planning Demand and Demand Plan
Communicating Demand
Topic 2: Influencing Demand
Plan-Do-Check-Action Model
Demand Influencing: Demand Generation
The Four Ps of Marketing and Demand Shaping
Product Life Cycle Stages
Product Life Cycle Management
Section D: Forecasting
Topic 1: Forecasting Principles and Process
Principles of Forecasting
Forecasting Process
Topic 2: Forecasting Methods
Qualitative and Combination Methods
Quantitative Methods: Time-Series Forecasting
Service-Sector Forecasting
Quantitative Methods: Associative Forecasting
Topic 3: Measures of Forecast Error
Forecast Error and Accuracy
Bias and Random Variation
Mean Absolute Deviation (MAD)
Tracking Signal
Standard Deviation
Mean Squared Error (MSE)
Mean Absolute Percentage Error (MAPE)
Section E: Supply and Demand Alignment
Topic 1: Supply and Demand Alignment
Supply and Demand Alignment Road Map
Strategic, Master, and Resource Planning
Topic 2: Sales and Operations Planning
S&OP Process
S&OP Inputs and Outputs
Reconciliation
Implementing S&OP
Demand Management and Prioritization
Index

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APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Certified Supply Chain Professional Learning System Welcome to the Certified Supply Chain Professional (CSCP) Learning System. This course is divided into eight modules that correspond to the eight domains of the 2022 v5.0 CSCP Exam Content Manual (ECM). The course has the following modules: Module 1: Supply Chains, Demand Management, and Forecasting. This module introduces supply chain management and addresses the demand management process, including forecasting and forecast error management. The operations planning and control process is illustrated, and then the module delves deeper into the consensus-building process of sales and operations planning. Module 2: Global Supply Chain Networks. This module helps supply chain managers design a supply chain network, including its IT strategy and tools and its methods of providing end-to-end connectivity and visibility. The module also addresses the importance of master data management and supply chain metrics.

Module 3: Sourcing Products and Services. This module shows how to align sourcing activities with demand, such as by the use of make-or-buy analysis. Category strategies show how categorizing various types of supply reveals the vital few categories to manage. The supplier selection and purchase order processes are covered. Module 4: Internal Operations and Inventory. This module covers master scheduling, material requirements planning, and capacity evaluations. Inventory management discussions include replenishment strategies, traceability, and inventory accuracy. Operational and inventory management metrics are reviewed. Module 5: Forward and Reverse Logistics. This module addresses warehouse and transportation strategy development. It covers distribution services such as shipping and receiving as well as transportation mode and provider selection. Trade considerations such as import/export regulations and Incoterms® are then described. The module also covers reverse logistics and the waste hierarchy. Module 6: Supply Chain Relationships. This module addresses the importance of customer and supplier relationship management. These methodologies (along with related software) help transform the supply chain into a cohesive system that can

provide real value from suppliers, through manufacturers, to customers (systems thinking). Module 7: Supply Chain Risk. This module represents the vital need of today’s supply chains to be proactive and resilient in how they identify, assess, and respond to risks. Module 8: Optimization, Sustainability, and Technology. This module shows how to optimize and redesign the supply chain. It also covers sustainable supply chains and reviews emerging technology trends. It closes with advice on implementing new technologies in a way that promotes their success.

Module 1: Supply Chains, Demand Management, and Forecasting The first module in this learning system starts with an overview of supply chain management. There is a discussion of the flows of product, information, and funds. Various levels of supply chain maturity are also addressed. After this introductory material, the module gets into the daily processes of supply chain management, which starts with the customer. Forecasting and managing customer demand requires analysis of the organization’s competitive environment using tools such as market research. Product assessments are then addressed, because it is important to validate that the right products and services are being offered given updated information from environmental scanning. The process of influencing demand through marketing activities is then reviewed, including a discussion of the four Ps (product, price, place, and promotion) as well as product life cycles and product life cycle management (PLM). Once these higher level planning processes are done, the next step is to build the forecast. Forecasting methods are reviewed so that

supply chain managers will be familiar with the various methods as well as how to fine-tune the methods and evaluate whether they are reliable enough from a forecast error perspective. Then the discussion turns to how to align supply with demand, which involves leveraging the sales and operations planning (S&OP) process. Since S&OP is one part of a larger process, this larger process, called operations planning and control, is also reviewed along with some of its subsets, such as master scheduling.

Section A: Introduction to Supply Chains This section is designed to Describe fundamental concepts of supply chains and supply chain management Define and illustrate the supply chain in terms of entities, structures, and flows Differentiate between vertical and horizontal (lateral) integration Describe the stages of supply chain evolution globally and within companies. Before getting into the details of supply chain management, it is important to take a step back and consider what a well-functioning supply chain should be able to accomplish for its constituents as well as to envision the lofty heights a superior supply chain can achieve.

Topic 1: Supply Chain Models Supply chain models are useful because they simplify complex realworld supply chains and help them become more understandable.

Here, we start with the most basic supply chain and then we discuss vertical versus lateral integration.

Basic Supply Chain An organization’s supply chain can have many forms. It can be a simple chain or a complex network or a structure that is somewhere between these two extremes. No matter whether it is a product or service chain, or what types of entities are involved, companies require their supply chains to guarantee a steady flow of supply at an acceptable cost. They can improve operating efficiency by employing the right supply chain structure. According to the APICS Dictionary, 16th edition, a supply chain is a global network used to deliver products and services from raw materials to end customers through an engineered flow of information, physical distribution, and cash. A supply chain, in this view, comprises a network of both entities and processes (the engineered flow). The massive chains that interest us in this course—the ones that run through corporations such as Walmart, Nestle, Boeing, Airbus, or Caterpillar—are decidedly global in scope. The Dictionary defines supply chain management as

the design, planning, execution, control, and monitoring of supply chain activities with the objective of creating net value, building a competitive infrastructure, leveraging worldwide logistics, synchronizing supply with demand, and measuring performance globally. (In this case, “globally” can mean either worldwide or the supply chain as a whole rather than to a particular entity within the chain.) Exhibit 1-1 illustrates a very basic supply chain with three entities—a producer with one supplier and one customer.

Exhibit 1-1: Basic Supply Chain for a Product

Three Entities and Four Flows The “entities” that perform the processes can be business or governmental organizations or individuals. They can also be departments or functional areas or individuals within a larger

organization; there are internal as well as external supply chains. For the most part the model applies to corporations. Most work on supply chains involves a manufacturing company in the middle (although service companies also have supply chains) with a supplier of materials or components on the upstream side and a customer on the downstream side. Technically, a supply chain needs only those three entities to exist; global supply chains have many more. The simplified chain in Exhibit 1-1 might be made up of these organizations: A supplier, a provider of goods or services or a seller with whom the buyer does business, as opposed to a vendor, which is a generic term referring to all sellers in the marketplace. The supplier provides materials, energy, services, or components for use in producing a product or service. These could include items as diverse as fabric, aircraft turbines, electrical power, or transportation services. A producer that receives services, materials, supplies, energy, and components to use in creating finished products, such as dress shirts, airplanes, electrical service, or delivered products. A customer that receives shipments of finished products to deliver to its customers, who wear the shirts, lease the planes, turn on the

lights, or receive the products. Four basic flows connect the supply chain entities together: The flow of information back and forth along the supply chain (also back and forth within the entities and between the chain and external entities, such as governments, markets, and competitors) The primary product flow, including physical materials and services from suppliers through the intermediate entities that transform them into consumable items for distribution to the final customer The primary flow of cash from the customer back upstream toward the raw material supplier The reverse flow of products returned for refund, replacement, repairs, recycling, remanufacturing, resale, or disposal. This is called the reverse supply chain, and it is handled by reverse logistics, which involves different arrangements than the forward logistics that carried materials and products in the other direction. The reverse chain, like the forward chain, comprises information flows and cash or credits. Reverse flows can also refer to the flow and disposition of manufacturing or service waste. The supply chain concept seems fairly solid when you consider the chain as linked organizations—supplier, producer, and customer connected by product, information, and payment flows. But the

supply chain is more accurately viewed as a set of linked processes that take place in the extraction of materials for transformation into products (or perhaps services) for distribution to customers. Those processes are carried out by the various functional areas within the organizations that constitute the supply chain. When considered as a set of processes rather than a succession of companies, the supply chain becomes just a little more difficult to conceptualize.

Funds Flows The flow of money in a supply chain goes upstream from customer to producer and from producer to supplier as intermediate or final products or services are paid for. This funds flow is not linear, since some upstream payments may occur long before the final good or service is even purchased. While the flow of funds is mandatory for a supply chain to exist, it is often an uncoordinated and suboptimized flow. Many mid-size and even some large corporations still work with paper invoices and checks. However, this practice appears to be declining given that many international transactions require the buyer to pay up front with a credit card, wire transfer, or letter of credit. Why is it critical to improve the flow of funds within a supply chain? There are several advantages to better flows:

The improved turnover of funds improves customer-supplier relationships through lower perceptions of risk, greater reliability, and better communications, which, in turn, tend to further improve the flow of funds. More prompt and consistent payments also tend to improve relationships, yielding a win-win situation throughout the supply chain. Improved cash flows tend to reduce imbalances between the larger and smaller players in the supply chain. Consistent rules for integrated cash flows across the supply chain help avoid the situation in which sizable retailers request more liberal payables terms from manufacturers and large manufacturers do the same with their smaller suppliers. The cash-to-cash cycle time (also called the cash conversion cycle) is a key metric for measuring the efficiency of the flow of funds. It basically measures how long it takes for an investment of cash into operations to be returned in the form of cash receipts from sales to customers. Supply chain innovations have reduced cycle times in many ways, as is addressed throughout this course. For example, cross-docking keeps inventory moving instead of putting it in storage.

Value and Balance Here are some other highlights of supply chain management.

Supply chain management is about creating net value. Early efforts at managing supply chains often focused only on cost reduction—on making the chain leaner. Unfortunately, these efforts sometimes reduced the ability to create value more than they reduced costs, for a net negative effect. As we’ll see, there’s more to creating value than simply squeezing costs out of the supply chain. There should be value-creating activities in the supply chain that transcend the activities of particular entities in the chain. Supply chains are generally organized by one strong company—a channel master or nucleus firm such as a manufacturer, a designer and patent owner, or a powerful retailer—which often manages the overarching value-creating activities. Nevertheless, the chain has to produce value for each stakeholder in addition to generating value for consumers or investors. (The APICS Dictionary, 16th edition, defines stakeholders as “people with a vested interest in a company, including managers, employees, stockholders, customers, suppliers, and others.”) Managing supply chains requires balancing competing interests. Given the complicated nature of group dynamics, this can be a challenging task, especially in global supply chains. Consider the rivalries that arise among the American states, the

nations in the European Union, and the diverse cultures around the globe.

Many Variations There are many variations on the basic supply chain model presented so far. Here are some basic points to keep in mind: A supply chain involves, directly or indirectly, everyone and everything required to extract or harvest materials, transform them into a product, and sell the product to a user. Supply chains include various entities, such as raw material extractors, service and component suppliers, a material product manufacturer or a producer of services, distributors, and end customers. Supply chain structures vary based on demand history, business focus, and needs for connectivity, technology, and equipment. Supply chains can be viewed in terms of processes, such as the gathering and processing of marketing data, distribution and payment of invoices, processing and shipping of materials, scheduling, fulfillment of orders, and so forth. Such functions cut across entities. Supply chains include various flows as well as various entities. Materials and services flow from suppliers toward customers; payment flows from customers toward suppliers; information flows both ways. Materials and funds also run in reverse.

Supply chain expertise is so important in today’s business world that Gartner conducts an annual survey to identify the top 25 supply chain leaders. Check the online Resource Center for a link to these survey results and to see which companies are top-ranked for their supply chain management expertise.

Vertical vs. Lateral Integration Companies have generally pursued one of two types of supply chain management, called vertical integration and lateral (or horizontal) integration.

Vertical Integration Vertical integration, or vertical supply chain management, refers to the practice of bringing the supply chain inside one organization. An example is a paper company that owns its land and trees, replanting for future harvests, owns the related equipment it uses, and manages all of its product processing, palletizing, and shipping. (The company purchases only its chemicals from an outside source.) A vertically integrated enterprise may grow from an entrepreneurial base by adding departments and layers of management to accommodate expansion, or it may be built through mergers and acquisitions to acquire more supply chain capabilities. In an attempt to create a self-sufficient enterprise, Henry Ford owned iron ore

mines, steel mills, and a fleet of ships as well as manufacturing plants and showrooms. Exhibit 1-2 illustrates the vertical integration of a supply chain.

Exhibit 1-2: Vertical Integration/Supply Chain Management of Henry Ford

The primary benefit of vertical integration is control. A department or wholly owned subsidiary with no independent presence in the marketplace can’t work with competitors. Its operations are completely visible to the parent company (at least in theory) and can be synchronized with other company functions by directives from the top. Its schedules, workforce policies, locations, amounts produced —all aspects of its business—are controlled by the overarching management.

By bringing many supply chain activities in-house and putting them under corporate management, vertical integration solves the problem of who will design, plan, execute, monitor, and control supply chain activities. It can also be used to address supply risks. For example, while McDonald’s doesn’t directly own its upstream supply chain, it has dedicated long-term supply contracts with numerous farms, processing facilities, and other suppliers to ensure availability of sufficient quality and quantity of supply at a fair price. Its supplier contracts use a “vested interest model” to ensure that the suppliers are motivated to create value for McDonald’s because doing so helps them profit appropriately themselves. Downstream, McDonald’s owns the land upon which all of its retail sites sit and operates as a landlord to what are primarily franchised facilities. This omits independent landlords and provides significant rent revenue. While it is not strictly a vertically integrated supply chain, McDonald’s has been heralded as a modern vertical integration success that can exercise a great deal of control over its supply chain partners and especially over control of processes. Ikea and Shell have similar partial vertical integration. While the vertical structure is still in use at least in some form for certain aspects of many supply chains, it is very challenging to be fully integrated end to end.

Lateral (Horizontal) Integration Exhibit 1-3 shows a lateral supply chain.

Exhibit 1-3: Lateral (Horizontal) Supply Chain

It’s difficult for one corporation to garner the expertise needed to excel in all elements of the supply chain, and it increases their risk, so corporations around the globe have turned to outsourcing those aspects of their business in which they judge themselves to be least effective. In this lateral integration, an organization specializes in its core competencies and relies on other specialists for the rest of the supply chain. Corporate ownership loses control of the outsourced activities and deals separately with members of the chain as suppliers or customers. Each will focus on their core competencies, such as extraction or production, and do business with each other through discrete transactions or longer-term contracts. For example, Ford divested itself of the production of many components, as Chrysler Corporation shed its Mopar (motor parts)

division and General Motors divested its component supplier as a separate organization, Delphi Corporation. The same organizations might then expand laterally, for example, by investing in their competencies or merging with direct competitors. Lateral integration has replaced vertical integration as the favored approach to managing complex supply chains. This horizontal approach is assumed in most supply chain illustrations, including the ones featured so far in this text. Lateral chains are now the way of the world and, therefore, the major focus of supply chain theory and application. Some Japanese companies favor an intermediate form of integration called keiretsu. The APICS Dictionary, 16th edition, defines keiretsu as A form of cooperative relationship among companies in Japan where the companies largely remain legally and economically independent, even though they work closely in various ways such as financial backing. A member of a keiretsu generally owns a limited amount of stock in other member companies. A keiretsu generally forms around a bank and a trading company, but “distribution” (supply chain) keiretsu alliances have been formed of companies ranging from raw material suppliers to retailers.

Among the reasons for relying on a lateral supply chain, the following stand out: To achieve economies of scale and scope. No matter how large the corporation, its internal supply chain functions lack economies of scale when compared with the potential capacity of an independent provider of the same product or service who can have numerous clients to support those larger economies of scale. Moreover, a specialist organization can increase its market share by internal growth or grow through lateral mergers with direct competitors or other organizations who have complementary core competencies. To improve business focus and expertise. Vertical integration, in a globally competitive market, multiplies the complexity of managing disparate businesses spread across international borders, time zones, and oceans. The independent company that focuses entirely on its particular business can develop more expertise than an in-house department, leading to more attractive pricing, higher quality, or both. To leverage communication and production competencies. Today many of the barriers to doing business at a distance have been reduced or minimized. Nearly instantaneous communication means that information can be shared simultaneously by

videoconference or in internal organization web boards or chat rooms. There are advantages to using already established companies that know their local markets. Many clothing companies in Europe, for example, work through Dutch logistics centers to take advantage of Holland’s central location and because a number of specialized companies exist there with welldeveloped capabilities in handling both the distribution and the return of clothing. Despite the benefits of the lateral supply chain, however, synchronizing the activities of a network of independent companies can be enormously challenging. What each company gains in scale, scope, and focus, it may lose in ability to see and understand the larger supply chain processes.

Topic 2: Supply Chain Maturity and Complexity Supply chain maturity refers to the level of integration and coordination with supply partners relative to those of competing supply chains. Organizations that want to create value from their supply chains need to determine their current state of supply chain maturity, their desired state, and how to close the gaps between the two. Understanding the possible levels of supply chain maturity will

help with this analysis. After presenting these discussions, some examples of supply chain complexity are addressed, starting from very simple supply chains and adding layers of complexity.

Stages of Supply Chain Management Evolution The advances made over the past few decades in supply chain management are generally reflected in each supply chain’s development. Experts in the field agree that there are typically between four and five stages in this development. The various stages can go by many names. We’ll use a five-stage model of supply chain management evolution: Stage 1—multiple dysfunction Stage 2—semifunctional enterprise Stage 3—integrated enterprise Stage 4—extended enterprise Stage 5—orchestrated supply chain Many organizations made these leaps over time as computers and cultures progressed. However, an organization in a particular industry may have been sheltered from some of these changes and may be less advanced than another. Also, some small and midsize organizations may be at a lower level than their larger peers due to a

lack of resources for improvements. Finally, an organization might believe it is in the highest stage but could actually have slipped down a notch through complacency. Therefore, these stages can also be seen as being relative to the capabilities of competing chains. Some enterprises are likely to exhibit behaviors from two or more phases of maturity, as this is an evolution, not a specific end state. Early in the evolution of the supply chain, many organizations operate in a stable chain with predictable supply and demand. In a stable supply chain, costs are low due to predictable demand and minimal need for changes. Production runs can be long, and few line changes will be needed. This is the model that used to hold true for many industries, especially those that were regional and had only regional competitors, but as globalization and technology have connected the world, fewer and fewer industries have this level of stability. Since most industries are no longer predictable, most immature supply chains begin in Stage 1, as described below. Whether the supply chain ownership strategy rests on vertical integration, lateral integration, or a hybrid, the relative sophistication with which the chain is managed develops along a continuum that we have divided into these stages.

Stage 1: Multiple Dysfunction

It’s possible for the nucleus company in a lateral supply chain to lack any disciplined management for both its internal and external chains; it may lack clear internal definitions and goals and have no external links other than transactional ones. Exhibit 1-4 illustrates the lack of coordinated flows of information or solid relationships among potential partners.

Exhibit 1-4: Multiple Dysfunction

This is a reactive supply chain: It fulfills demand but without much concern as to costs. It is perceived as a cost center. It needs minimal competitive or connectivity technologies and capital assets to respond to demand. In the dysfunctional organization, this is what tends to happen: Internal activities tend to be undertaken ad hoc rather than by plan.

Management provides only the most general sense of mission, communicated perhaps by pep talks at best or threats at worst. Forecasting tends to be mostly guesswork, often inflated by unwarranted marketing optimism. Products are designed without advice from other areas that could provide guidance, such as manufacturing or marketing. Warehouses are sited near each market, stocked with an overabundance of inventory in anticipation of a big sale, and staffed with manual laborers who have little training. Trucks or trains are unloaded when they arrive and loaded when an order comes in, without much advance warning in either case. There may be payment flows (but collection may be poorly executed) as well as material flows, but the information exchange tends to be tied mostly to giving orders internally, accepting bids, and sending invoices. Material requirements planning (MRP) takes place at a basic level, involving a bill of material, a master schedule, and current onhand/on-order data. Purchasing is ad hoc and transactional. There may not be preferred suppliers or they may not be consistently used. Purchasing may not consult with logistics at all.

Stage 2: Semifunctional Enterprise

Exhibit 1-5 provides an illustration of the semifunctional enterprise. Information flow has been improved and functional areas have been defined—but they tend to perform their functions one after the other without collaborating on the most effective ways of creating value. At this stage, there are no partnerships with customers and suppliers.

Exhibit 1-5: Semifunctional Enterprise

This is a reactive efficient supply chain: It supports competitive positioning by serving as an efficient, lowcost, and integrated unit. It focuses efficiency and cost management on the total delivered cost of finished goods. It places greater importance on connectivity technology and new equipment to automate functions to reduce labor costs and improve capacity and throughput. In this second stage of supply chain evolution, an individual company undertakes initiatives to improve effectiveness, efficiency,

and quality in specific functional areas. Here are some examples: The largely manual operations in warehouses may be augmented by the addition of basic materials-handling equipment. Inventory management may find ways to reduce levels of inventory within the company’s own facilities. Procurement might take advantage of new purchasing strategies to obtain supplies and services at the lowest possible prices. The traffic department may reduce transportation costs by strategic selection of carriers and routes. Some departments may institute more effective hard skills training and adopt strategies for making jobs more challenging. Marketing may develop more reliable research and forecasting techniques. Manufacturing resource planning (MRP II) software may be in place, and the company may have cross-functional integration of planning processes. While some or all functions engage in initiatives designed to increase efficiency within their departmental walls, there is little or no overlap in decision making from one department to another. When the nucleus company concentrates only on improvements within its separate departments, it may find its efforts wasted through lack of communication. For example, market researchers and well-trained sales representatives may uncover market opportunities among

current and potential customers without being provided an opportunity to share this information in a structured collaboration with product designers. And this lack of collaboration may play out repeatedly among the departments. In this stage some functions may be automated—MRP software, for instance, may include bills of material as part of online workflow. But new software in one department may be incompatible with software in other areas. Mergers and acquisitions can also result in incompatible systems.

Stage 3: Integrated Enterprise In the third stage of supply chain evolution, the individual company begins to focus on companywide business processes rather than individual compartmentalized functions. Historically, this shift in supply chain strategy is associated with the late 1980s and early 1990s—when computers were becoming powerful and affordable. Milestones of this phase include introduction of manufacturing and enterprisewide software, increased cross-functional communication and training, centrally located and easily accessible databases and files, and periodic sales and operations planning meetings attended by representatives for all departments involved. This is a proactive efficient supply chain:

It proposes new raw materials or product designs to lower complexity and costs. It instigates changes to product designs for greater efficiencies. It invests in integrated information systems to facilitate sharing of information across functions. Exhibit 1-6 provides a visual representation of a linked internal supply chain with collaboration between functions and sharing of information through companywide enterprise resources planning software (ERP).

Exhibit 1-6: Integrated Enterprise

This stage is markedly different from the previous one because of the following: The focus on business processes is facilitated with the increased availability of electronic communications, file transfers, powerful databases, and enterprisewide software applications. Cross-

functional cooperation becomes much faster and easier and takes place almost instantaneously across functions, time zones, and international boundaries. A variety of initiatives reduce the time it takes to get an order from a supplier, create the product, and deliver it to the customer, including MRP II and ERP: MRP has been upgraded to MRP II, a breakthrough development that allows cross-functional communication between manufacturing and finance. ERP extends that process by adding modules for each functional area until the most advanced versions tie together entire companies. Further advances have reached through the corporate wall to tie supply chain partners together. Product design in some companies is now a team effort in which production engineers and other stakeholders, such as marketing and purchasing, collaborate with design engineers to “design for manufacturability,” “design for logistics,” or “design for the environment.” This approach results in products that are on target for customer desires and are ready to be manufactured without making costly modifications in processes, equipment, or staffing. There are improvements in customer service due to astute segmentation of markets and more efficient replenishment policies

suited to each segment. Inventory is treated more strategically as Just-in-Time procedures, more accurate demand planning, and improved logistics work together to make fulfillment more efficient and reliable. Warehousing and transportation decisions are carried out in tandem to achieve the optimal balance of cost-effectiveness and customer service. Warehouse management benefits from more advanced equipment and automation. At this point, the nucleus company may begin to take a step toward integration with the external members of the supply chain by contracting with a logistics supplier, such as United Parcel Service (UPS), to “insource” by using its expertise to help optimize logistics decisions.

Stage 4: Extended Enterprise The hallmark of this stage is the decision to extend at least one business process beyond the boundary of the individual corporation. When the nucleus company decides to collaborate on planning, design, replenishment, logistics, or another business process with one of its suppliers or customers, the barrier to developing the

extended enterprise from end to end of the supply chain has been overcome. The company integrates its internal network with the internal networks of selected supply chain partners to improve efficiency, product/service quality, or both. The starting point is generally one inside/outside partnership that points the way toward the completely networked enterprise. Exhibit 1-7 shows how the supply chain has changed.

Exhibit 1-7: Extended Enterprise

This is a strategic driver supply chain: Demand generation and fulfillment are fully integrated. The supply chain contributes to development of the organization’s overall strategy. Forecasting, planning, and replenishment are fully integrated and visible. Technological improvements, knowledge, and real-time information are shared with chain partners.

What is unique to this stage is the following: There is an initial exploratory collaboration between a channel master and one or several partners in the supply chain—often a manufacturer and one component supplier or a retailer and one supplier of finished goods. It may involve only one component or product; the famous collaboration between Procter & Gamble and Walmart began with diapers. If this first collaboration succeeds, it can lead to a more fully networked relationship between the first two partners—more products might be involved, there might be more complete sharing of information across integrated electronic networks and more formal team building and planning across corporate boundaries, and so on. And that relationship can become the model for other partnerships and, eventually, for multicompany collaborations that stretch from retailer through manufacturer into one or more tiers of suppliers. Technology enables the extended enterprise to reach farther, to add new partners, to move faster in response to market changes, and to operate with broader scope than in Stage 3. With MRP II merged with other functional applications and transformed into ERP, enterprisewide planning software is able to link the entire internal supply chain together on one platform.

The networked enterprise is built on a variety of networking platforms. Partners begin to synchronize their ERP systems across corporate boundaries so they can share data as necessary for their efficient collaboration. A retailer may send information from the point of sale to suppliers each time a customer purchases an item to trigger production of a replacement. For example, Dell Computer is able to fill internet orders without keeping its own inventory because customers’ specifications are sent immediately through to component suppliers so the computer can be assembled to order. Cross-functional approaches are implemented with certain processes, such as CPFR (collaborative planning, forecasting, and replenishment). In place of traditional “silo” production planning by sales, marketing, and production, Stage 4 companies institute periodic sales and operations planning meetings in which representatives of sales and marketing, production (or operations), and other functions meet to coordinate demand planning and production scheduling. In Stage 4, there are advances in e-commerce such as interactive sites where customers can order products and services, track their shipment, and communicate with customer service immediately upon their arrival. Behind the scenes of such business-to-

consumer e-commerce, there is also increasing business-tobusiness e-commerce taking place on wired and wireless networks. In the global arena, competition no longer takes place only among individual companies; whole supply chains are now battling one another for customers, for workers, and for capital in multiple countries across the globe. Cooperation among companies is integral to competition among supply chains.

Stage 5: Orchestrated Supply Chain The orchestrated supply chain level of supply chain maturity is often expressed as the supply chain digital transformation; in Europe it is sometimes called Industrie 4.0. This stage is all about realizing the benefits of all of the individual improvements in the different parts of the supply chain. More so than any of the prior stages, this stage is relative to the capabilities of competing supply chains. A supply chain is truly in this stage only when it realizes an actual competitive advantage from becoming better orchestrated than its competitors. Orchestration requires more than just seamless technology; it requires skilled leaders and teams who can leverage these technologies and adapt quickly to change. Therefore, supply chain digital transformation requires maturity in a number of areas for all significant parties in the supply chain.

Exhibit 1-8 shows how the core model of the supply chain is mostly the same as the prior level but with more emphasis on security, resilience (i.e., building in risk management), value realization, and orchestrating people and processes.

Exhibit 1-8: Orchestrated Supply Chain

This is a consistent and systematic supply chain: Improvement and change management teams are cross-functional and are both technically and socially skilled. Change management and readiness is a common skill and value. Data has integrity, is secure, and is actually used in decision making. Technology gaps are being resolved to realize end-to-end visibility. Sourcing is right-sized but resilient (quickly adaptable). Product designs are inclusive, and the number of products is rightsized.

Processes are shared, policies are enforced, and automation is common. It is essential that the teams who will be closing technology or social gaps be cross-functional among key supply chain partners and have multiple layers of expertise. Strong leadership and the right contributors drive the needed changes. A common area for needed relationship improvement is with IT professionals. These relationships sometimes have suffered because prior initiatives have failed to realize the envisioned benefits. Also, IT professionals may have become too reactive (i.e., putting out fires) and need to be given the resources to be more strategic. However, IT relationship building is especially needed because the advances in connectivity with partners creates more avenues for cyber attacks that IT will need to address comprehensively. Also both technical depth and breadth are needed to determine technology gaps or how to make use of the latest technologies such as blockchain. This people- and process-based transformation requires organizations and their partners to embrace change management. Change management is built into the organization’s culture and perhaps its organizational structures. People embrace change because they have become accustomed to it and because they

receive the support they need. Organizations embrace change because they will share in the benefits of the change. The digital transformation goes way beyond simple digitization of trade documents or even digitalization of control systems such as remote sensors triggering an automated response. The digital transformation takes these advances a step further, such as by ensuring that electronic documentation travels seamlessly among supply partners, trade intermediaries, and customs authorities. Demand data from customers may feed directly into not only finished goods planning but also raw materials and suppliers’ planning systems. Digitalized control systems are moved from being locally controlled to being controlled remotely and centralized such as by using a control tower. Data on supply chain inventory and assets is truly real-time, and it feeds directly into decision-making tools and predictive analytics (e.g., predictive maintenance scheduling). Things that require little or no human intervention are fully automated. However, before they are automated, the process itself is reviewed to ensure that it is efficient and is intuitive for end users. Product development is a key beneficiary of data-driven decisions, resulting in products that reflect actual customer requirements while

also being designed for the supply chain, for sustainability, and so on.

Supply Chain Maturity as an Input to Strategy Evolved and sophisticated supply chains in the higher stages have network partners with highly integrated and synchronized connectivity that focus more on creating net value than on pure cost minimization. The goal for a supply chain strategy is to assess if there are gaps that are keeping the supply chain from fully realizing connectivity and visibility goals. After such gaps or misalignments have been resolved, it is important to continually monitor supply chain maturity, since there is no end to this process. Reassessments may be needed after major reorganizations, mergers and acquisitions, or changes in the external environment.

Supply Chain Examples Consider, as a stripped-down supply chain model, a street vendor who sells snacks. This could be fresh crepes in Paris, hot dogs in Washington, D.C., or small tapas plates in South America. These may be small family businesses.

The supplier is probably a small wholesale food distributor that sells basic ingredients to many food kiosks. The worker is the “producer” who turns the raw ingredients into menu items. The stand, operated by one or two owners, is the retailer. Notice that even in this simplest of supply chains, the actual situation is more complex. For instance, there are more suppliers. Tap water to warm the stainless steel food containers comes from a government entity. Nearby is a food preparation area with refrigeration; electricity is provided by another supplier. There is also the supplier of the cart or food truck itself. Somewhere in the supply chain, though they remain invisible in our model, are the suppliers’ suppliers, who bring materials, components, or services to the food wholesaler and the utility companies. Even the flows in a street vendor example aren’t simple. The product flows include ingredients, paper and plastic products, and products used in the manufacturing process such as fuel. Information flows include orders submitted by end users (consumers) of the product, by the distributor (the person on the street with the cart) to the manufacturer (the cook), and by the manufacturer to the suppliers. Planning will include recipes and shopping lists, discussions of potential demand, and reviews of last year’s results. The flows of cash may be based on cash register and credit card receipts.

Cash travels in several separate flows from the manufacturer to suppliers of products and services and, of course, to any lenders or investors for debt or dividend payments. There are also logistics concerns: transportation from one entity to the other—perhaps drawing upon the private fleet of a car or two—as well as warehousing decisions. And, finally, reverse flows are used to return any unacceptable menu items, to compost the food waste, and to recycle. Many global businesses had very humble beginnings. Perhaps the food vendor comes up with a new recipe for crepes; a customer is impressed and asks if the vendor can make 50 crepes for a lunch; someone at the lunch owns a neighborhood restaurant… and before long the vendor has space in a small commercial kitchen facility and a catering business. It’s surprising how many challenges and opportunities can be anticipated in a very simple model. Now let’s get a little more complex. Illustrations of manufacturing versus service supply chain models follow. After that there is a discussion of specialized supply chains.

Manufacturing Supply Chain Model In Exhibit 1-9, two tiers of suppliers and distribution centers and customers are shown.

Exhibit 1-9: Manufacturing Supply Chain Model

Discussions of supply chains typically put manufacturing at the center and suppliers of components to the immediate left. These days, the nucleus firm may actually be a designer of products and a decision maker who outsources all manufacturing. Alternately, it may be that component suppliers are the most crucial consideration when designing and managing a supply chain for manufactured products, but utilities and other services are important contributors to the cost of operations. The exhibit shows that Tier 1 suppliers have their own suppliers in Tier 2. The wholesale food distributor that supplies the daily ingredients and raw materials for the menu items has its material and service suppliers—and they have their suppliers, and so forth.

The flour for the crepes, for instance, is not a raw material but a product with its own supply chain that begins in a farmer’s wheat field and is processed in a plant, shipped to a wholesaler, and distributed. No matter how far you travel toward the left, you will never run out of new tiers of suppliers. Even a raw material extractor, such as a coal mine, has its own suppliers of extraction machinery and services. In fact, the coal mine may ship coal to a generating plant that supplies power to the manufacturer that produces a machine that is shipped to a distributor that sells mining equipment to the same mine that began the process; supply chains can double back on themselves. (A distributor is a business that does not manufacture its own products but purchases and resells these products.)

Service Industry Supply Chains According to the APICS Dictionary, 16th edition, a company in the service industry is 1) In its narrowest sense, an organization that provides an intangible product (e.g., such as medical or legal advice). 2) In its broadest sense, all organizations except farming, mining, and manufacturing. Includes retail trade; wholesale trade; transportation and utilities; finance, insurance, and real estate; construction; professional, personal, and social services; and local, state, and federal governments.

In the case of our food vendor, services most obviously include utilities, transportation, warehousing, carpentry, and cleanup, among others. Utilities, which are suppliers to all manufacturers, are crucial considerations when locating plants and warehouses. If water and electricity (or natural gas, or both) are not available at a proposed site, they cannot be readily made available. Service-oriented supply chains also require sophisticated management. Exhibit 1-10 illustrates, in simple form, the supply chain of an electric utility. It receives products, services, and supplies of its own and dispenses its services into three distribution channels: home customers, commercial customers, and other utilities.

Exhibit 1-10: Electric Utility Supply Chain

Specialized Supply Chains

Service industries are included in the category of specialized supply chains, as are humanitarian and disaster relief, nonprofits, and retailers. Other supply chains that might be considered specialized are industry-specific, virtual or e-business, or small- or medium-size companies’ chains. Maintenance, repair, and operating supplies (MRO) might also be considered an example of a specialized supply chain. If your organization is running one of these types of supply chains, learning how it differs from the large design- and manufacturingoriented supply chains described elsewhere in these materials is critical. However, even if a supply chain manager doesn’t operate a specialized chain, studying these supply chains can help him or her learn from the experiences of the chains. Here are some examples: A humanitarian and disaster relief supply chain has to be developed quickly yet be resilient against theft, misappropriation, and transportation mode disruptions. Since organizations that provide humanitarian aid and disaster relief are continually operating in an environment filled with uncertainty, they learn to maximize responsiveness. They become agile in operating a supply chain where supply and demand are routinely unbalanced, where demand can spike quickly, and where roads, electricity, or the full rule of law may be compromised. One way they stay agile

is by developing ongoing relationships with persons in the community that they can trust. For example, the charity Feed My Starving Children distributes food to children in poor regions as well as to regions recovering from natural disasters. It develops personal relationships with local charities that handle the final distribution of food to those people who need it most. For hospitals (considered a service industry), cost cutting is vital, but the primary goal must always be safe and effective provision of patient care. To this end, visibility and quality are strongly emphasized. Supply chain costs are a significant expense for hospitals. To manage these costs, hospitals are working to ensure that the right level of inventory is kept on hand to avoid shortages while also avoiding carrying too much perishable inventory (e.g., past its expiration date). Automating ordering and validating that actual prices match contract prices also help control costs. Hospitals are investing in keeping databases clean and up to date. They use unique device identifiers (UDIs), required in the U.S. since 2014, to improve tracking and billing accuracy. From a quality perspective, administrators are looking at best outcomes over lowest cost for devices, which often shortens hospital stays and thus reduces total costs.

Shortages caused by the COVID-19 pandemic have been addressed in a number of ways, including by centralizing supplies of critical resources to provide risk pooling and centrally coordinating information on available beds, respirators, and even trained staff resources. This information sharing occurs in some cases not only with government services but also with competitors. Hospitals can work not only to alleviate current bottlenecks but to also forecast potential new bottlenecks in the weeks ahead so they can plan rather than just react. They are also being proactive in carefully scheduling patient services that have room for delays in order to reduce the volatility of demand on the system. Today’s retailers are under tremendous pressure to redesign their supply chains to compete against online retailers like Amazon, who is putting huge cost pressures on retailers with its world-class supply chain. For example, Amazon has so many distribution centers that most orders are shipped within just one shipping zone, while most multichannel retailers have to ship through more zones at a higher cost. From an inbound freight perspective, Amazon picks up most supplier items itself using its own transportation network, while most multichannel retailers pick up less than half of items themselves. From an inventory perspective, Amazon’s distribution centers (DCs) keep the top-selling items in every DC and unevenly distribute the rest to reduce inventory

holding periods; this, plus integrated track and trace, significantly reduces inventory holding costs. Most multichannel retailers have DCs designed for cross-docking. This works well for retail efficiency but not for online order fulfillment, because a key purpose of cross-docking is to create full-truckload assortments for retailers while online orders consist of multiple individual parcels. When redesigning their organization’s supply chain strategy, retailers need to think big and not only close the gaps that keep their supply chains from being less efficient than those of onlineonly retailers but also become an effective multichannel option that is quickly responsive to the changing marketplace. For example, a retailer can use online sales to test new products and move only top sellers to retail spaces. In another example, some retailers are using their stores as distribution centers and are using store inventory to fulfill online orders.

Section B: Demand Analysis and Patterns This section is designed to Describe the importance of understanding the marketplace as it relates to the supply chain Discuss the importance of scanning the external environment for competitor capabilities, market conditions, and global perspectives Explain how to use strengths, weaknesses, opportunities, and threats (SWOT) analysis, market research, and product assessments Explain how to use macro- and microeconomic theories and analyses when evaluating demand at strategic levels Interpret demand patterns of trend, seasonality, cycles, and random variation as well as the impact of sales promotions. Demand analysis such as market research or competitor analysis is needed for strategic, tactical, and operational levels of planning. At strategic levels, this research takes the form of assessing the macroand microeconomic environments as well as using tools such as SWOT analyses to determine how well adapted the organization is to the current environment. At the tactical and operational levels,

analysis includes studying trends, seasonality, and other demand patterns.

Topic 1: Demand Analysis Demand analysis tools include SWOT analysis, market research, and product assessments.

Demand Analysis Road Map Strategic, tactical, and operational plans can run right into the brick wall of a harsh economic climate, changing tastes, a competitor with superior offerings at lower prices, or a new government with new priorities or regulations. Therefore, an environmental scan is needed to validate the current plans. The idea is to develop organizational and related supply chain strategies, tactics, and operations that are flexible enough to adopt changes quickly as demanded by the situation. Demand analysis looks at the organization in relation to its external environment. Demand can be analyzed over the long, medium, or short term. Long-term demand analysis looks at the macro environment, which the 16th edition of the APICS Dictionary defines as “the environment external to a business including technological,

economic, natural, and regulatory forces that marketing efforts cannot control.” While an organization’s macro environment includes external influences on strategy that can only be understood, not controlled, the organization can shape itself or its products and services over time in reaction to or in anticipation of a given environment. The organization can exercise some degree of control over demand at the tactical and operational levels, however. It can influence demand by changing tactics, such as by changing prices, promotions, and customer or employee policies/procedures. At the operational level it can exert control by managing and prioritizing demand. At the long-term strategic level, tools such as a SWOT analysis can be used to look inward at the organization’s strengths and weaknesses and outward at opportunities and threats. A medium- to short-term demand analysis will include market research to identify external influences on demand. Marketing can use this information to determine how to influence that demand, since marketing efforts can have an impact on demand at this level. The process may also include an assessment of the organization’s product and service offerings to see if changes are needed to what is being offered.

Before looking at these demand analysis tools, let’s explore how demand analysis fits into the big picture.

Processes for Procuring and Delivering Goods and Services Demand needs to be planned (analyzed and forecasted), communicated, influenced, and prioritized. Operations planning and control then links supply with demand. Inventory management methodologies need to be selected and supply analyzed using tools such as total cost of ownership or make-versus-buy analysis. Logistics, including warehouse management, capacity forecasting, materials handling, transportation, and delivery patterns are then planned and executed based on the consensus picture of supply and demand. The key processes that supply chain managers need to be able to perform related to procuring and delivering goods and services are Developing supply chain personnel’s knowledge, skills, and abilities Developing supply chain infrastructure Performing supply and demand planning and scheduling Identifying logistical requirements Developing logistical capabilities to support delivery of goods and services

Executing the plans. The following is a general overview of these processes. Developing Supply Chain Personnel’s Knowledge, Skills, and Abilities The process of developing supply chain personnel’s knowledge, skills, and abilities involves the following steps: Setting learning goals with one’s manager Providing opportunities for independent learning, including certification Developing formal or informal coaching or mentoring programs Providing access to training courses as needed for specific skills or industry-specific knowledge Meeting periodically to assess goal progress and set new goals Developing Supply Chain Infrastructure The process of developing the supply chain infrastructure involves the following steps: Completing design of the supply chain infrastructure, including relevant total cost of ownership and make-versus-buy analyses For all “make” decisions:

Completing supply chain infrastructure or process development projects for manufacturing or service delivery, logistics (including warehousing and transportation), and information and funds flows Staffing new roles Providing training on new processes or systems Using change management to ensure that processes and systems are fully adopted in policies and culture For all “buy” decisions and key customer relationships: Working toward desired supplier and customer relationships Developing supplier and customer contracts Implementing, monitoring, and controlling agreed-upon supplier and customer relationships Performing Supply and Demand Planning and Scheduling The process of performing planning and scheduling involves the following steps: Influencing other business functions toward a shared view of demand management Planning, communicating, influencing, and managing and prioritizing demand Analyzing and then forecasting demand Servicing orders

Influencing customers to buy or influencing them to alter purchases if there are supply and demand imbalances Performing master planning, including resource planning (longterm capacity) Performing sales and operations planning to develop a consensus plan as an input to master scheduling Reviewing performance Evaluating demand levels Evaluating supply capability Reconciling demand, supply, and financial plans Planning inventory Performing master scheduling to produce the master schedule and rough-cut capacity plan (medium-term capacity) Performing material requirements planning Performing distribution requirements planning for inventory Performing capacity requirements planning (detailed production capacity) Forecasting and planning warehouse and transportation capacity Identifying Logistical Requirements The process of identifying logistical requirements involves the following steps: Determining logistics objectives and considerations

Determining warehousing objectives and considerations Specifying warehouse capacity requirements Specifying materials-handling requirements Determining transportation objectives and considerations Selecting preferred modes of transport Balancing warehousing, transportation, and other logistics requirements Developing Logistical Capabilities to Support Delivery of Goods and Services The process of developing logistical capabilities to support delivery of goods and services involves the following steps: For internal logistics provision: Completing projects related to logistics, including warehousing and transportation processes, infrastructure, and equipment Staffing new roles Performing training on new processes, infrastructure, and equipment Using change management to ensure that logistical capabilities are incorporated in policy and culture For logistics outsourcing: Selecting logistics service providers

Developing contracts with logistics service providers Executing the Plans The process of executing the plans involves the following steps: Performing production activity control Measuring, managing, and controlling capacity Controlling inventory Monitoring and controlling delivery patterns and transportation modes Monitoring and controlling third-party service providers Expediting supply and transportation processes Complying with all legal and regulatory requirements

SWOT Analysis SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. It is a tool useful for strategic planning as well as long-term demand analysis. As seen in Exhibit 1-11, the SWOT analysis is usually in the form of a quadrant in which distinctions are made between internal versus external focus and positive versus negative points.

Exhibit 1-11: SWOT Analysis

How are each of these determined? Internal strengths and weaknesses are typically derived from comprehensive data collected about the organization. This may include information on skill sets by function, professional development and training activities, facilities, the company’s reputation or standing in the community, etc. Ideally input from external customers and suppliers provides substantiated evidence, as to weaknesses in particular, which can then be appropriately addressed. External opportunities and threats are based on market trends and risk analyses. Environmental scanning may be required to

assemble data on external forces. This involves collecting and analyzing external data on market forces; demographic changes; changing customer needs; competitor pricing and offerings; current and emerging technology; new taxes, laws, and regulations; and social, political, and economic conditions. Opportunities can be acted upon to help move an organization toward achieving its goals. However, if those opportunities are ignored or improperly developed, they can transform into threats (like IBM giving Bill Gates the green light to market his disk operating system [DOS] because they weren’t in the “software business”). Other opportunities may arise from competitors’ activities or products or new markets or from other data seen during environmental scanning. Threats are defined as risks that can impact a company negatively if they are not handled appropriately. External risks include unforeseen events outside the control of an organization that can diminish productivity, profits, or market share, for example, the March 2021 grounding of the ship Ever Given that fully blocked the Suez Canal for six days and held up nearly $10 billion in trade per day. Of course, there can be internal threats that arise due to a company’s actions, such as overzealous geographic expansion or excessive outsourcing.

This valuable information feeds into a written document called the market plan.

Market Research When engineers design a product, they don’t necessarily have anything in mind other than overcoming technical challenges. They assume that others will appreciate the beauty and usefulness of their creations. This, however, is not necessarily the case. Someone must act as a liaison between the manufacturers (product specialists, technicians, engineers) and the potential consumers who either will, or will not, buy their products, and marketing is all about customers. Marketing plays a role in finding, forecasting, influencing, and sustaining demand—from the product concept to the end of the product’s life cycle. Marketing and sales have different but complementary objectives. Marketing translates the external perspective for internal audiences (What does the market need?), while sales translates the internal perspective for external audiences (Why do you need what we have to offer?) Marketing can do these tasks with in-house personnel and/or by contract with an outside company. Market research can begin when the product is merely a sketch or the inkling of an idea. It can also

take place for an existing product or service, especially one that seems not to be living up to its sales potential. In order to design a supply chain that can meet its ultimate goal of delivering the right product at the right place and time and at the right price, it’s important to understand the marketplace.

Market Plan The market plan (shown in Exhibit 1-12) is defined in the APICS Dictionary, 16th edition, as including the current market position, opportunity and issue analysis [SWOT results], marketing objectives and strategies, action plans, programs, projects, budgets, and pro forma profit and loss statement and management controls. The market plan is a subset of the organization’s strategic business plan, which drives several important functions like finance, engineering, marketing, and production. These functions also have input in shaping the overall business strategy. Here we’re going to focus on the marketing function and how it provides foundational information about the marketplace. Knowing your market, customers, competitors, and product can heavily influence how you design your supply chain to meet long-term objectives.

The marketing function develops its own strategically oriented plan based on the strategic business plan. These plans must be in alignment and there should be consistency between them. As seen in Exhibit 1-12, the marketing strategy is based on a number of key elements.

Exhibit 1-12: Marketing Strategy and Plan

Current market position information may include data and findings about demand patterns, products and pricing, customer satisfaction, and service level agreements with partners, distributors, and retailers. (Note that a profit and loss statement is another name for an income statement. Pro forma means that the statement is based on forecasted information rather than historical information.)

When designing a supply chain, one must carefully consider the market plan. For example, if the market plan shows that Europe will be the primary source of demand for product X, it may make sense to assemble that product in the Netherlands instead of China, despite comparatively higher labor costs. By assembling a product in Europe, import duties may be much lower than for importing a finished product. (For example, Tesla assembles battery-powered cars in Tilburg.) The shipping volume of the parts may also be much smaller than the shipping volume of the finished products, so postponed assembly can save money in transportation costs. In addition, one must keep in mind that marketplace factors may evolve over time, and, if they do, that may require modifications to the design of the supply chain and its organization.

Market Research and Its Types Market research is “the systematic gathering, recording, and analysis of data about problems relating to the marketing of goods and services.” Also referred to as marketing research, it may be done by impartial agencies, business firms, market research agents, or an internal marketing staff. Market research can use a variety of information-gathering tools, such as customer surveys, interviews, focus groups, direct mail

questionnaires, websites providing opportunities or incentives for visitor feedback, and market reports sold by research firms. The internal marketing department staff can also do research about potential markets, products, etc. The SWOT analysis is commonly used for this purpose. There are several types of market research: Market analysis: the study of the size, location, nature, and characteristics of markets (for example, product potential), resulting in information useful for market segmentation (i.e., distinct lines of business to offer). Sales analysis (or research): the systematic study and comparison of sales (or consumption) data and market share (“the actual portion of current market demand that a company or product achieves,” APICS Dictionary, 16th edition). Consumer research: the discovery and analysis of consumer attitudes, reactions, and preferences (including motivation research), resulting in information useful for customer segmentation (i.e., categorizing customers in various ways, such as by their requirements or the types of products and services they demand). Sales analysis and consumer research are addressed more elsewhere. More information on market analysis follows.

Market analysis assesses the state of the global, local, and industry economy, the impact of recent events or disasters, and the relative market share that the organization has in a given region at present. Market conditions can be considered challenging when the organization needs to break into a market dominated by other competitors or when the prospective customers are less likely to make a purchase because of the state of the economy. In such situations, the organization’s competitive strategy needs to show how the organization’s offerings will have a clear competitive advantage. During times of recession or when working to make inroads against an established competitor in a region, an organization can look at these challenging situations as an opportunity to capture significant market share. To do so, it will need to satisfy customer requirements more completely or at less cost than its rivals. Another strategy that often works during recessions is to purchase organizations that are showing signs of weakness at a discount. This can help an organization grow into new global markets. Information on market conditions can be found from government or third-party reports, surveys, or white papers on economic conditions. Some of these reports make predictions based on leading market indicators or confirm trends using lagging market indicators.

Purposes of Market Research The purposes of market research include finding potential markets, analyzing markets, and refining product design to fit the markets. Finding potential markets. The most basic question about a product is “Does anyone care?” Is there a significant and unmet need out there for the better product? In an existing company, the sales force may provide the first clue that current customers have unmet needs that seem compatible with the company’s mission. Market research can begin from that point to quantify the need. The process can also begin among the engineers—the folks who look at the current products and see a way to improve them. In that case, marketing and sales can present the idea to current customers to see if there are any signs of interest. They can also begin a wider research campaign to identify the potential for new markets for the suggested product. Analyzing markets. As product design gets underway, marketing can ask more detailed questions about the potential market to divide the market into segments, as is discussed elsewhere in a section on segmentation. As stated there, the basic questions are the best questions: Who? Where? When? Why? What? How many? The answers to such questions constitute market segmentation.

Once you know who and where the likely customers are, you can ask how best to reach them with news about the product. Do they shop at a large retail chain store or at the local hardware store? Do they buy from catalogs or over the internet? Is telemarketing the best way to reach them? Marketing personnel can find out why and how prospects are interested in your product by using phone surveys, online questionnaires, focus groups, analysis of past customer complaints or feedback, or a combination of those approaches. Marketers also want to know when prospects are likely to start buying. Are they ready for the new product, or will market penetration take some time as your prospects get used to the new idea? Will the product have a long or short life cycle? How often will it need to be replaced? How soon will customers demand an upgrade? Demand forecasting is a marketing and sales activity. In collaborative arrangements, such as vendor-managed inventory (VMI) and collaborative planning, forecasting, and replenishment (CPFR), the forecasts need to be shared with cross-functional and intercompany teams to ensure that everyone works from the same forecasting information.

Remember: When it comes to forecasting demand, marketing has a natural bias toward optimism—a bias that may be magnified by top management policies. (Management seldom looks favorably on cautious estimates.) Demand plans based on overly optimistic forecasts can lead to problems. Most obviously, it can cost money if the company increases capacity to meet the demand plan and winds up with unnecessarily large capital expenses and/or inventory hangover. An optimistic bias in marketing can also lead supply areas to distrust the demand plan and compensate by coming up with their own plans, which may well be biased in the other direction. Cross-functional teams and supply chain collaboration can overcome such problems. Refining product design. As market researchers learn more about market and customer segments, the information should contribute to the product’s design. Market research into customer attitudes can help identify features of the product, including a strategic price that will be most attractive to the various customer segments. Some prospects may strongly feel that the new product should contain certain features, while others desire the opposite features. The features that positively contribute to the profit margin should be adopted, and unprofitable variations should be avoided. A proliferation of SKUs (stock keeping units) typically increases inventory overhead and dilutes marketing efforts.

In some cases a product’s features can be varied to match differences in market requirements. For example, computers can be assembled with different components to meet the specialized needs of various segments. A basic version will appeal to customers with limited funds or limited computing needs. Add a powerful processor and sophisticated subsystems, and your basic computer appeals to “power users.” Add a choice of colors and shapes, and you add value for the style-conscious buyer. Other products will not be as profitable with multiple variations, and the marketing input to design will be identification of the most profitable segments. At this point, researchers can also contribute to the reverse supply chain aspect of product design. What sort of support will be necessary to satisfy end users and keep them as loyal customers? Will they need product documentation? How many languages will be necessary in the pamphlets? Will phone, text, or email support options be necessary? What will be the return policy? What is the attitude of potential customers to ease of disposal and impact on the environment?

Competition Organizations need to scan the market for what the competition is offering and at what price. They need to know who has what market

share in each region in which they would like to compete and whether there are any customer requirements that are going unsatisfied. For example, Haier found that since the power went out frequently in many African countries, there was an unsatisfied demand for a freezer that could stay cold for a long time. They developed a frost-free refrigerator that could keep food frozen for 100 hours without electricity. This helped them keep the majority of the market share in Nigeria. Getting a foothold in areas where the competition already has established strong market share requires a well-thought-out strategy. When attempting to get a foothold selling mini-fridges in the U.S., Haier started by negotiating contracts with large retailers, including Walmart, Best Buy, and Home Depot. However, a good strategy that is poorly executed can still result in failure. One way to get an idea of the competition’s strategy is to use benchmarking. SWOT analysis can also be used to get an understanding of the organization’s current state of supply chain maturity. Other environmental scanning could involve determining how mature competitors’ supply chains are relative to one’s own supply chain. What your organization believes is a world-class supply chain may in fact be surpassed by other chains.

Global Perspectives

Global connectedness is causing supply chain management to evolve into a more strategic role. Managers recognize that the actions taken by one organization in the supply chain can influence the success of the rest of the network. While in the past the strategic focus for many organizations was on improving their internal quality and reducing costs, the focus for many now is on implementing total supply chain solutions that require collaboration from partner organizations both upstream and downstream. These new global forces are being met by corresponding technological solutions in supply chains in most nations. Collectively they are revolutionizing supply chain management. Here are some of the powerful forces that impact virtually every supply chain: Global expansion. The globalization of sourcing and manufacturing is making supply chains longer and more complex than ever before, thereby requiring more formal coordination and collaboration. Many manufacturers and retail chains have expanded both nationally and globally, creating the need for more formal mechanisms to coordinate supply chain activities. In addition, companies that have created their own e-commerce sites can now have global exposure.

Increased project complexity and scope. Project size and complexity are increasing. Projects involve, in some cases, large teams operating at different remote sites. Moreover, the information involved is more important than ever, in larger amounts than ever, and more difficult than ever to manage manually with the required speed and accuracy. Greater market volatility. Demand is becoming more volatile and harder to predict due to the increasing power and speed of information available to both consumers and competitors. A successful global organizational strategy will account for these complexities while developing a deep understanding of local customer requirements. This understanding often requires investing in local managers, experts, and salespersons to develop local sales channels that are attuned to the differences in the given region. Haier has done all of these things in each market it enters, but it keeps track of each region using the standardized measurements of the SCOR® model (a framework for supply chain management), looking at the organization’s flexibility, velocity, and predictability, among other things. This way Haier can compare success region to region. A globalized organization will also need the flexibility to withstand global disruptions. The disruption of just one critical link in a globally

interconnected supply chain can impact the whole. When the 8.9 magnitude earthquake and resulting tsunami hit Japan and damaged their Fukushima Daiichi nuclear plant in March 2011, initial concerns and the world’s focus were on the people of Japan. As the weeks progressed, it started to become clear in just how many ways we are all connected. Factory operations were affected, raising fears of shortages or price increases for a number of widely used components. Manufacturers were affected by disruptions of the transportation of finished goods to airports or ports as well as the movement of employees and supplies to production plants. Concerns grew that the earthquake and tsunami could lead to a long-term disruption in the world’s supply of automobiles, consumer electronics, and machine tools. As millions of people around the globe extended their condolences to the people of Japan for the lives lost and suffering, companies around the globe had to quickly assess whether their business would be impacted by this tragedy thousands of miles away. Even after this and other major crises and disasters (the wildfires in California and Colorado in 2020, the record 30 named storms in 2020 with five consecutive years of at least one category 5 hurricane), some companies are hesitant to realize that with the global economy, actions in one part of the world, whether planned,

unplanned, human-induced, or naturally occurring, seem to affect us. We are all connected. Our goal is to prepare you to grasp these concepts, be confident in your actions, and eventually thrive in the world of supply chain management. Remember that “the beginning of knowledge is the discovery of something we do not understand” (Frank Herbert, science fiction author and writer, 1920–1986).

Product Assessments The product portfolio needs be reviewed early in demand management to determine whether the organization’s products and services are still appropriate for the market and the organization. The organization’s products and services form the core of the organization’s brand and value proposition. The organization’s product portfolio is the mix of product classifications, families (groups of products with manufacturing similarities), products, and services that the organization offers. Exhibit 1-13 shows how product and brand management involves a series of verification steps that help ensure that the product portfolio is aligned with the market and the marketing strategy.

Exhibit 1-13: Product Portfolio Management

Source: Ross, Distribution Planning and Control, 3rd edition.

The various steps shown in the above process are discussed more next. Note that once these aspects of the plan are validated, the plan should also be validated against the logistics plan to ensure that customer service goals can be met.

Product Classification Review A review of product classifications starts with the big picture. The broadest categories of product classifications are durable goods, non-durable goods, and services. Durable and non-durable goods have physical substance; services are intangible and noninventoriable. (This classification specifically excludes any products associated with the service.) Durable goods are expected to last for

an extended time period, while non-durable goods deteriorate quickly and may need to be consumed quickly. The next major classifications of physical goods are industrial versus consumer goods, each of which has subcategories, as shown in Exhibit 1-14. The exhibit also lists common rankings of strategic priorities for each type. (Generic strategic priorities include speed, dependability, flexibility, quality, and cost.) Exhibit 1-14: Product Classifications and Typical Strategic Priorities Product Classification

Typical Ranking of Strategic Priorities

Industrial Goods Raw materials and components

Cost and services related to speed, dependability, and/or flexibility

Capital goods (e.g., finished goods, industrial equipment, automobiles)

Quality, cost, flexibility (e.g., product features), and services (speed, dependability, and/or flexibility)

Maintenance, repair, and operating (MRO) materials

Cost, dependability (e.g., availability), and speed

Consumer Goods Convenience goods (e.g., groceries, drug store items, commodity clothing)

Cost and dependability

Shopping goods (e.g., home furnishings, fashion clothing)

Quality (including perceived brand quality), dependability (including service warranty), and cost

Specialty goods (e.g., art, high fashion) Quality (including brand prestige)

A product portfolio review at this level can look at whether the portfolio is adequately diversified. The review can also look at other factors, such as Whether product form (e.g., size, shape, color) fits with the manufacturing and distribution models Whether product durability, reliability, and replacement rates (frequency of repurchase) are appropriate to the production strategy and distribution channel size/costs Whether the costs of quality, the degree of customization allowed, and warranty, repair, or training expenses meet customer expectations and organizational cost goals. A review of the appropriateness of the organization’s product family hierarchy and its various levels is also conducted. For example, it may be necessary to change the number of units offered in a case or pallet if this would help profitability as a product enters a different life cycle stage. Another element of a product portfolio review is a review of product portfolio complexity. Product Portfolio Complexity Management Product portfolio complexity management involves a review of the number of stock keeping units (SKUs) that the organization is maintaining. Product SKUs can differ based on product features,

colors, number of units in a package, and so on. Different SKUs may also have an impact on the number of different manufacturing variations or paths that are required to produce the variety of SKUs, and increasing complexity in this manner lowers manufacturing economies of scale. In addition to impacting manufacturing complexity, other supply chain costs also increase costs at a steadily increasing rate as more SKUs are generated. These costs include higher purchasing costs, inventory carrying costs, and service costs. Marketing messages are also diluted, and the multiple messages confuse customers. However, as shows, too few SKUs can also stifle revenue and profit because customers do not find the varieties that suit their needs, especially if competitors offer more variety.

Exhibit 1-15: Portfolio Complexity Impact

Source: Bowersox, et. al. Supply Chain Logistics Management, 5th ed., which cites David Closs, Mark Jacobs, Morgan Swink, and G. Scott Webb, “Toward a Theory of Competencies for the Management of Product Complexity, Six Case Studies.” Journal of Operations Management,26.

Note, in the chart, how initially increasing the number of SKUs helps provide a rapid increase in sales revenues and profit. However, the steadily increasing rate of cost increases eventually causes profits to fall. Also, adding more and more SKUs results in revenues flattening off after a time due to more marketing confusion as well as some SKUs competing with each other for the same sale. Staying in the sweet spot and avoiding either unprofitable end of this spectrum may require Performing this complexity review separately for each product category or family Developing holistic metrics that highlight total cost of ownership and profit over revenue only (which promotes too many SKUs) or cost only (which promotes too few SKUs) Balancing the demands of marketing (promoting more SKUs) against the demands of operations and supply chain management (promoting fewer SKUs) Differentiating customer wants from needs (In other words, is a feature a true order qualifier or winner, or would most customers be likely to accept a substitute that is stocked?) Evaluating whether a different manufacturing method such as modular design could alter the cost curve and enable the profit curve to likewise shift.

Product Life Cycle Review

While product life cycle durations will vary by product and industry, no product is immune to changes in customer demand over time. Therefore, it is important to conduct a life cycle review to determine whether the product has shifted to a new life cycle stage and, if so, to determine how the manufacturing, supply chain, and marketing strategies will need to change. Exhibit 1-16 shows product life cycle stages of introduction, growth, maturity, and decline, with a comparison of how they relate to market share and market growth.

Exhibit 1-16: Product Life Cycle and Market Growth versus Market Share

Source: Ross, Distribution Planning and Control, 3rd edition.

During introduction, product availability, product volume, and sales volume are low. All three increase during growth, are level in the maturity phase, and are low during decline. Therefore, changes in

sales volume trends (especially in the absence of macro events such as a change in the economy that would explain the trend change) are a potential indicator that the product is entering a new life cycle stage. When it is determined that a product is entering a new life cycle stage, demand plans need to be altered to reflect the new situation so that supply plans (including supply chain plans) can adapt to the new reality. Since demand for products is often directly impacted by the value attached to associated services, the next area to review is services. In other cases, the services are the main offering, and, if so, a services review would be the main task in this process.

Services Review A services review needs to determine whether customer perceptions have been changing relative to the service. A review of services such as warranties, technical support, repairs, trade-in allowances, user training, transportation, or bulk-purchase discounts could reveal whether customers perceive the service to be value-added. When a service enters maturity because all competitors are offering it, this is called saturation. Services in saturation still need to be offered, but they will be order qualifiers rather than order winners. This will impact demand unless new services are developed.

Brand Strategy and New Product Introduction Review The results from the product portfolio, product life cycle, and services reviews are used to determine how to invest the organization’s limited marketing resources. Better information on long-term demand can impact the financial returns expected from marketing campaigns and therefore can affect the decision of whether or how to generate marketing. Perhaps a less expensive form of marketing such as mailings or emails will be all that is warranted. In addition to ensuring that marketing and other expenses will generate more revenue than they cost, there will be more marketing budget left over for new products, which consume marketing funds at a very high rate. Successful new product introduction (NPI) requires market analysis, research and development, marketing, and product phase-in/phaseout plans. NPI attempts to produce entirely new demand in unexpected areas or to build upon previous demand by focusing on the competitive attribute of new product features to enable the product/service package to be differentiated from similar past models or the competition’s offerings. Estimating demand in the introduction or growth phases is especially problematic. An NPI that is entirely new will require significant marketing, but there is no guarantee of how well the sales pitch will

convert into actual sales and there is no data for forecasting. The organization will need to rely on qualitative forecasting methods (forecasts that rely on experience rather than calculation) and determine a level of demand that fits within the organization’s risk tolerance levels. If demand is estimated too high, supply will have huge losses. If too low, supply will have inadequate capacity. For the scenario of upgraded products, the situation is somewhat more straightforward, because the demand plan can base forecasts on the prior model’s sales, which are somewhat more reliable. Other life cycle phases have different brand strategies to create or sustain demand. During growth, the brand strategy competitive attributes are availability and quality so that customers are able to acquire the good or purchase it again and provide testimonials. Mature products typically focus on a competitive price and dependability to minimize defections. Products in decline need to find innovative ways to provide availability at a low cost.

Topic 2: Demand Patterns Demand patterns over the long term can be examined by looking at macro- and microeconomic reports or internal analyses. The demand patterns that require review for short-term demand planning

are historical demand trends, seasonality, cycles, random variation, and the impact of sales promotions.

Demand Patterns Road Map Demand patterns can be studied over the long term as well as over the medium to short terms. Long-term demand patterns can be analyzed using concepts from macro- and microeconomics. Mediumto short-term demand can be analyzed by using historical demand for the organization’s products or by using a proxy such as a benchmark product from another organization. Reviewing macro- and microeconomic reports or internal analyses can help supply chain managers better understand overall market forces and specific demand characteristics for an organization’s products and services. Macroeconomics looks at the behavior of the economy as a whole, while microeconomics looks at the behavior of individuals and firms given changes in prices and resource allocations. Supply chain managers can use this information to shape an opinion of how disruptive forces in the environment might impact the demand curve for the organization’s specific products and services and thus set a strategy that compensates for weaknesses and capitalizes on strengths. If the supply or demand curve for a product shifts,

analysts at the organization can predict the new equilibrium point for the product and then calculate profit margins assuming the market price reaches this point. Knowing the likely selling price of the product can help when setting cost goals for supply chain activities. At that point, they can use marginal analysis to make rational daily decisions for logistics or other areas of the supply chain. Medium- to short-term demand patterns look at a product’s or service’s average demand over a period being studied as well as the volatility of that demand. Demand volatility can come from explainable causes, such as seasonality, or from unexplainable causes, which is called random variation. The impact of sales promotions or other internal drivers of demand can also be accounted for in forecasts of future demand. The demand patterns that are revealed through analysis then become a key input into selection of the best forecasting model(s) and the execution of the forecasts.

Macroeconomic Demand Patterns Macroeconomics is the analysis of the behavior of the overall economy (supply and demand in aggregate) in response to various market forces. Supply chain managers use information on the trend of the economy by country or region or globally to estimate how this

will impact the organization’s industry, the organization, and its supply chain strategies. Exhibit 1-17 shows how the overall economy goes through cycles between periods of expansion and recession (or depression) in terms of gross domestic product (GDP) over time. The size (amplitude) and duration of each wave can differ significantly from cycle to cycle, and, while the overall trend of the economy over many cycles has historically been upward-sloping, this growth trend is not guaranteed. Near the peaks of a cycle, unemployment is low and production is at or near full capacity. Near the troughs, employment and output are low. Innovation can trigger periods of expansion; economic scarcity, political events, or financial instability can trigger recessions.

Exhibit 1-17: Economic Cycles and Long-Term Trend

Since these economic swings have such a large impact on supply and demand, economists study them to determine their causes, what shortens or sustains them, and how to promote stability through public policy. Having a basic understanding of these theories and how current political forces align with them can help supply chain managers modify their strategic plans to reflect the current and predicted future economic conditions.

Real GDP and Weighted Average Price Real gross domestic product is the total value of all final goods and services produced within a given set of economic boundaries such as a country’s national boundaries. Sometimes real GDP is studied against the weighted average price of all products and services sold in the same economy. When overall prices shift higher, people can afford fewer goods and services; when prices are lower, people can afford more. Conversely, and as an opposing force to this effect, when overall prices shift higher, suppliers want to make more; when prices are lower, suppliers will be less motivated to produce and will cut production and idle workers. These two opposing forces work to balance each other out in the long term to a point of equilibrium.

Let’s look at the impact of these macroeconomic forces at a few key points in the economic cycle. At the end of a period of growth, weighted average prices will have gone up to the point where people cannot afford as many goods or services. Supply will lag this trend and will be producing as much as it can to take advantage of the high profits that high prices entail. Note that even if demand is extraordinarily high just before this turning point, supply will not be infinitely high. There is a physical limit on an economy—the total amount the economy can produce based on the scarcity of labor and materials and diminishing returns created by ever-increasing business expenses. The high supply and low demand will generate a surplus of goods, which will further reduce profitability. Plant closings and layoffs will occur, helping to trigger a recession. Weighted average price will fall and the economy will work toward equilibrium, but perhaps the pendulum will swing beyond this point. At the tail end of a recession, weighted average price will be low and so demand will be high. Even though suppliers will be less motivated, they will still want to produce some amount of goods, because labor will be plentiful and cheap and because they have equipment and other overhead that is costing them money regardless of whether or not they produce anything. So supply will start to rise. As long as the weighted average price stays relatively low, there will be high real GDP and a period of recovery will begin.

During this period there may be shortages because aggregate demand outstrips supply, which will tend to increase prices and bring the economy toward equilibrium and perhaps beyond. During the strong part of a growth phase, prices will be relatively low and total real GDP will be high, because there is more real wealth and thus more consumption spending. Real GDP will also be high, in part because as more money is circulating, interest rates fall, which increases capital spending. As the economy prospers but has not yet raised prices beyond the point people can afford, the point of equilibrium will be reached. The point of equilibrium will also be the point of full employment for the economy being studied. Full employment is when the only unemployment is from frictional or structural sources. Frictional refers to normal unemployment, such as new college graduates looking for work and people between jobs; structural refers to changes in the structure of available work (for example, workers who need retraining because their skill sets are obsolete). The potential output of the area’s economy at full employment is also called the long-range aggregate supply.

Interpreting Macroeconomic Information Macroeconomic information cannot be directly applied to one industry’s or one company’s products. It relates to trends of all goods

in the economy in the aggregate. How do economists put this information to practical use? Changes in the macroeconomic environment, such as a market adjustment (e.g., the correction in prices for homes when the housing bubble burst in 2008), have effects that can be predicted using economic models. Other factors, such as population demographics (e.g., a higher proportion of adults at retirement age), can also have a predictable impact. In general, factors that reduce household wealth will reduce demand since consumers will have less to spend. Market interest rates are also a factor. When they are low, businesses have an incentive to borrow to make capital investments and start projects because the return on investment is promising. Similarly, if a country’s net exports increase, aggregate demand increases, and vice versa. Export levels can change due to changes in exchange rates (depreciated currencies increase aggregate exports and demand, while appreciated currencies reduce them) or when other countries increase their GDP. Note that if input prices (e.g., the cost of goods sold) increase, supply will decrease. If raw materials become scarce, supply will decrease, but abundance of materials increases supply. Similarly, an increase in taxes or regulatory costs decreases supply.

An increase in productivity relative to inputs will result in larger real GDP levels at any price. This could be due to a new technology or better-educated workers.

Inflation and Deflation Inflation is a sustained increase in the general level of prices for an area, while deflation is a sustained decrease in prices. One way to detect inflation is with a consumer price index (CPI), which is a sampling of the actual prices of various consumer goods. Inflation occurs when consumers have more money available to spend but the supply is scarce. Creditors are harmed by inflation; debtors are helped. Inflation also harms consumers on fixed incomes. A primary purpose of government central banks is to control inflation. A very small amount of steady inflation is desired (to minimize the risk of deflation), but high inflation or deflation needs to be prevented.

Recessions and Depressions A recession is when real GDP declines for two consecutive quarters. If the long-range aggregate supply decreases during that time or if the contraction is severe or prolonged, it becomes a depression.

Metrics

Supply chain managers need to scan the macroeconomic environment for multiple countries and economic regions. In addition to the consumer price index, the consumer confidence index (CCI) provides leading information on likely future demand because it polls consumers’ feelings about the economy and how likely they are to make purchases. (Modern economics accounts for the strong influence of often irrational human emotions, while in the past it focused on purely rational decision making.) Another index of value is the producer price index (PPI). The PPI measures the prices received by domestic producers for their goods and services, which can help indicate producers’ opinions of the economy. PPI can also help when determining how to set contract terms. Indices such as these may be known under different names in different countries, and some countries may have more historical data available for comparison than others. The methods of collection may also differ, so values for different countries may be more or less comparable. Globalized sources of information are especially important for supply chain managers, since they buy and sell in so many different countries. For example, the World Bank provides “Worldwide Governance Indicators” for 215 global economies. (This resource can be found in our online Resource Center.) These key performance indicators track fairness of elections, rule of law, control

of corruption, and other transparency and effectiveness measures. They also track the growth trends of GDPs. In addition to GDP, the World Bank and other sources such as the International Monetary Fund (IMF) and the World Trade Organization publish economic indicators such as gross national income; government surpluses, deficits, and indebtedness; consumer savings; and foreign investment. (A link to IMF data is in the online Resource Center.) Government agencies publish metrics for their specific countries. Privately funded research organizations publish economic outlooks. Large organizations may have consultants or inhouse economic experts on staff. Risk management business units may also have compiled economic reports and analysis that are available for review.

Microeconomics The 16th edition of the APICS Dictionary defines microeconomics as “the analysis of the behavior of individual economic decision makers (individuals and firms).” Microeconomics focuses on specifics such as the price of a product, how sensitive customers are to changes in that price (how much price changes impact demand), cost trends for a business, or employment levels in a given industry. Supply chain managers can use microeconomic theories and models

to determine when or where to expand output, what product mix to have where, when to raise or lower prices, and so on.

Supply and Demand on Microeconomic Scale Since we are now talking about individual rather than aggregate supply and demand, some economic laws come into play. Law of demand. The law of demand states that as the price of a good or service increases, demand will decrease (all things being equal). When mapping supply and demand on curves, as price goes up, demand goes down. This is called the elasticity of demand. The elasticity of demand relies on economic assumptions about scarcity and the use of pricing in an open market. Scarcity means that goods and services are limited in availability, so businesses and consumers need to make choices about what goods and services they want more than others. Pricing is an efficient mechanism for distributing scarce resources. It creates a system of rationing, or doling out of those resources to entities who want them enough to pay more for them than others. These choices create opportunity costs. Opportunity costs are the other things that the entity is sacrificing to make the chosen good or service a priority.

This is the simplified view of microeconomics. However, the marketplace is diverse, and there are goods and services that might be almost as good as the desired scarce item. These are called substitute goods. The substitution effect states that the prices of substitute goods are interrelated. As the price of one good increases, consumption of the substitute good may increase. The most cost-effective choice is selected when substitutes exist. With this in mind, the law of demand can be viewed in relative terms. If the organization lowers its prices but its competitors lower their prices more, consumer expectations will shift and the organization effectively has had a price increase. Additional forces reinforce the law of demand. The income effect increases demand at low prices. As prices go down, persons or organizations with limited funds will be able to buy more units. A related force is diminishing marginal utility. When consumers purchase units of a good or service, each additional unit purchased will have less utility than the previous one. Law of supply. The law of supply states that as the price of a good or service increases, supply will also increase. More sellers can sell at a profit. Higher prices give producers more incentive to produce and sell goods, so they will make more supply available. For example, the

central United States fracking oil boom created several years of explosive growth in the Midwest. When market oil prices plummeted in 2015, the number of new oil development projects also plummeted, even though the developers had the drilling rights. When oil prices rise again, these developers will have an incentive to resume drilling. Two other microeconomic concepts related to supply are economies of scale and diminishing returns. Economies of scale means that as output is increased, the cost per unit of output decreases because all fixed costs (like overhead) are spread over a larger number of units. At a certain level of output, however, an organization may experience diminishing returns, or diseconomies of scale. This occurs when new costs are incurred to increase output, and these new costs can cause the cost per unit of output to slow its decrease until it is no longer valuable to produce additional units. Equilibrium and the law of supply and demand. Just as supply and demand on an aggregate scale tend toward equilibrium, so do individual prices. The law of supply and demand states that the price of any good will adjust until the quantity supplied and the quantity demanded are in balance. A surplus will result in price cuts to sell off the excess inventory, while a deficit will result in

price increases related to the scarcity of the offering. Some goods adjust to equilibrium faster than others.

Price Elasticity Price Elasticity of Demand As household wealth rises, demand for some products will increase a great deal and others less so. Price elasticity of demand assigns a level of elasticity to various products. The APICS Dictionary, 16th edition, defines price elasticity as The degree of change in buyer demand in response to changes in product price. It is calculated by dividing the percentage of change in quantity bought by the percentage of change of price. Prices are considered elastic if demand varies with changes in price. If demand changes only slightly when the price changes, demand is said to be inelastic. For example, demand for most medical services is relatively inelastic, but demand for automobiles is generally elastic. Innovative products like smartphones are elastic because they rise or fall strongly in demand as price changes. Staple products like eggs are inelastic because they may not have much increase or decrease in demand as price changes. In general:

Low-priced items are generally inelastic and are less impacted by small price changes. Necessities are inelastic and luxuries are elastic. Demand is more inelastic over the short term and more elastic over the long term (e.g., people pay more for gas for a while but may shift to a more efficient vehicle or the bus if prices stay high for too long). Supply chain managers can look up or calculate the price elasticity coefficients for their products and services. There are a number of ways to calculate the price elasticity coefficient, but a simple test is the total revenue test. If you drop the price and demand increases, and if the loss of revenue from the lower price is exceeded by the increase in revenue from more units sold, then demand is elastic. However, if you drop the price and the loss of revenue from the lower price is greater than the gain in revenue from the increase in unit sales, then demand is inelastic. A coefficient greater than 1.0 is elastic; less than 1.0 is inelastic. These coefficients tend to hold true over a particular price range. However, at a higher or lower price point, a good or service may shift from being inelastic to elastic or vice versa. For example, consider the two products in .

Exhibit 1-18: Price Elasticity of Demand Example

Both products have the same characteristics for price per unit and margin per unit. The cost of goods sold is deducted. This shows that as the price goes down, so does profitability. However, the top example is a little elastic (demand goes up steadily as prices fall) while the bottom is highly elastic (demand skyrockets as prices fall). The elasticity coefficients are calculated for all but the first line of each example because the calculation requires a prior price/unit and prior demand amount. In the top example, the US$120 per unit price would provide the highest gross margin, so it would be the best choice of the options shown. (Choosing based on revenue would be an error.) However, in

the bottom example, a price of US$100 per unit would provide the highest gross margin. From a supply chain management perspective, if the logistics costs are subtracted as part of the margin-per-unit calculation (i.e., included in the cost of goods sold), then these are the correct calculations. If, however, logistics costs are omitted from the analysis, the actual highest profit price point could be quite different. When analyzing economic tradeoffs of different prices and demand, all influencing costs need to be included. Price Elasticity of Supply Price elasticity of supply shows how sensitive suppliers are to changes in product price. Over the short term, suppliers will continue to supply products at lower prices, so they are inelastic in the short term. However, over time they will shift away from these products to produce products with higher profit margins, so over the long term, supply is elastic.

Marginal Analysis Another microeconomic concept is marginal analysis. A marginal analysis focuses only on the marginal utility and marginal cost of the choice. Marginal utility is the extra usefulness or satisfaction gained from purchasing one additional unit of the good or service. Marginal

cost is the additional cost incurred for making a given decision or the cost of producing one more unit of a good or service. Costs incurred regardless of what choice is made are ignored. The rule for marginal analysis is that if the marginal utility exceeds the marginal cost, it is a wise economic choice. For example, if it costs €1,000 to move one truckload of freight between two major cities and a truck can haul 10,000 kilograms (kg) of freight, the average cost is €1,000/10,000kg = €0.10/kg. Should an offer to fill in some unused space in the truck for €0.05/kg be rejected? Using marginal analysis, one considers only the marginal costs and benefits. The marginal costs are a small amount of additional fuel to ship the increased weight and a trivial amount of added wear and tear on the vehicle, plus the fuel and driver mileage to another loading and unloading point and time spent in loading and unloading the other cargo. The rest of the driver’s time, all insurance, and so on are already included in the planned trip cost, so these are ignored. They are sunk costs for purposes of this decision because they will be incurred regardless of the choice made here. If the marginal cost for this new freight is €0.02/kg, then the added €0.03/kg is a marginal net benefit. Accepting the offer is the rational economic decision.

This concept of utility can drive supply chain design decisions as well, such as whether a facility or process is adding value in the eyes of the customer.

Short- to Medium-Term Demand Patterns Base demand is the long-term average demand for a product or service. A number of factors can increase or decrease base demand, including trends, cycles, seasonality, random (irregular) variation, and promotions or other internal drivers. Exhibit 1-19 illustrates several of these factors that influence demand. Base demand is the average demand over four years, seasonality is the large wave effect, and the trend is the increase in the size of the waves over time. (A linear trend line is added.) Random variation is the less-than-perfect shape of the waves.

Exhibit 1-19: Base Demand, Seasonality, Trend, and Random Variation

Trends A trend is the “general upward or downward movement of a variable over time (e.g., demand, process attribute)” (APICS Dictionary, 16th edition). A trend is a long-term shift, and two common examples are linear (upward-sloping, neutral, or negative) or exponential (skyrocketing upward or downward). Trends can change direction at any time as a result of internal or external forces.

Cycles and Other External Drivers Cycles are periodic upward, neutral, or downward shifts in demand lasting longer than one year. The economic cycles of recession and growth that form a wave pattern are a primary example. The economic cycle might be one of the causes of a trend.

External demand drivers such as economic cycles, population growth, major events, or disasters are sometimes used to qualitatively adjust a quantitative forecast. A particular driver might also be used if its relationship can be tested and shows strong correlation. These drivers can be leading or lagging indicators. (Leading indicators can give early indication of a trend change; lagging indicators validate a given trend.)

Seasonality Demand may fluctuate depending on the time of year, e.g., holidays, weather, or other seasonal events. Seasonality (also known as seasonal variation) is defined in the Dictionary as a predictable repetitive pattern of demand measured within a year where demand grows and declines. These patterns are calendar related and can appear annually, quarterly, monthly, weekly, daily and/or hourly. Seasonality can refer to the seasons of the year or to changes related to any time-based recurring event—lunchtime, the weekend, Christmas, each February, or the first or last week of the month. Whenever seasonality is present to a significant degree, it needs to be removed before forecasting and then added back in later.

Note the difference between seasonality and cycles. Seasonality is a demand pattern that, based on history, will repeat itself on a calendar basis such as month, week, day of the week, hour of the day, etc., and therefore can be predicted. Cycles are demand patterns that repeat but follow a wavelike pattern that can span multiple years and may change at any time; therefore, they cannot be predicted easily.

Promotions and Other Internal Drivers Promotions, such as discounts or advertising, and other internal drivers of demand, such as deals to gain favorable product placement, will have a measurable impact on demand if they are successful. Promotions that take place in regular patterns will resemble or reinforce seasonality. For many industries, promotions can explain 50 to 80 percent of sales variation. They are worked into forecasts using associative forecasting, for example, by using marketing spend as a driver.

Random (Irregular) Variation Random variation is “a fluctuation in data that is caused by uncertain or random occurrences” (APICS Dictionary, 16th edition). It is the unpredictable part of a data series that cannot be explained by the other factors, basically the remaining variation after the other factors such as seasonality are accounted for. The idea is to

minimize this component by finding more and more explainable factors. Two terms from statistical process control can be used to help understand how random variation differs from the other components of demand. In statistical process control, which is used to track variations in manufacturing or other processes, all variations are categorized as either common cause (general cause) or special cause (assignable cause). Random variation is akin to a common cause. These are the multitude of small factors that affect demand but cannot be added to the model due to the need for simplicity. Demand that is stripped of everything but random variation should conform to a normal distribution (bell curve). Trends, seasonality, cycles, and promotions are akin to special causes, or causes that have an identifiable effect on demand. If the special causes in a data set can be identified prior to their use, a decision can be made about whether or not that data should be included in the forecasting process with or without modifications. In many cases, the impact of these special causes can be removed from the data temporarily prior to forecasting. An example of this is the deseasonalizing process, as is discussed elsewhere.

Section C: Demand Management This section is designed to Define demand and demand management Discuss the linkages among the components of planning, communicating, influencing, and managing/prioritizing demand Describe the inputs and outputs of planning demand, including the demand plan Understand the communication best practices of communicating soon to minimize surprises, structuring communications so they occur, and focusing communications to fit the audience Use the plan-do-check-action (PDCA) model to ensure that demand-influencing activities have a feedback loop Discuss the role of the four Ps of marketing in a customer-focused organization Explain how product life cycle stage affects requirements and supply chain design Describe how product life cycle management (PLM) helps shape early product design phases and end-of-life management as well as help with product traceability over the life cycles of individual products or lots.

This section describes the demand management process and delves into the first three of the four components of demand management. (The final element, managing and prioritizing demand, is reserved for the discussion of sales and operations planning elsewhere in this learning system.) Then it describes ways to manage this demand dynamically by coordinating activities between key internal areas of the organization and with the extended supply chain. The section also shows how a feedback loop such as the plan-docheck-action (PDCA) model can be used to ensure that demandinfluencing activities are properly designed and executed. Then the four Ps—product, price, placement, and promotion—are presented. The section concludes with a discussion of product life cycles and product life cycle management.

Topic 1: Demand Management Demand management includes planning, communicating, influencing, and managing and prioritizing demand. After providing the big picture, the first two of these components are addressed here in more detail.

Demand Management Road Map

Demand is defined in the APICS Dictionary, 16th edition, as a need for a particular product or component. The demand could come from any number of sources (e.g., a customer order or forecast, an interplant requirement, a branch warehouse request for a service part or the manufacturing of another product). Demand management is defined by the Dictionary as (1) The function of recognizing all demands for goods and services to support the marketplace. It involves prioritizing demand when supply is lacking and can facilitate the planning and use of resources for profitable business results. (2) In marketing, the process of planning, executing, controlling, and monitoring the design, pricing, promotion, and distribution of products and services to bring about transactions that meet organizational and individual needs. The supply and demand functions in an organization or an extended supply chain each make plans for identifying/creating and satisfying demand. Demand management is the art of synchronizing supply and demand plans. Demand management is necessary at each of the levels at which supply and demand plans are generated:

Long-term strategic needs, including long-term forecasting, product development, or capacity development Medium-term aggregate demand forecasting and sales and operations planning Short-term demand forecasting and item-level master scheduling Note how the amount or unit of demand becomes more and more specific, from total revenue at the highest levels (not in units at all), to aggregate demand (categories of units such as product families), to specific items. Demand management analyzes the rate of consumption at these various unit levels not only to match the level of needed precision to the time scale of the decision but also to increase forecasting accuracy, as is explained more when discussing forecasting. In organizations with multiple plants and/or supply chain collaboration efforts, demand management can help organize multiple sources of supply and demand. Sources of demand that could require coordination include domestic and foreign demand or wholesale and retail demand; sources of supply that could require coordination include plant capacities or specialization and inventories in plants, warehouses, and retail locations. The APICS Dictionary, 16th edition, defines the demand management process as

a process that weighs both customer demand and a firm’s output capabilities, and tries to balance the two. Demand management is made up of planning demand, communicating demand, influencing demand, and prioritizing demand. These components of demand management, shown in Exhibit 1-20, are used not only to generate and communicate a balanced and realistic demand plan but also to proactively ensure that the demand plan is realized.

Exhibit 1-20: Four Components of Demand Management

Demand management relates to business and customer requirements in that one of its purposes is to influence the organization to produce a product or service that satisfies actual customer requirements and expectations. If marketing professionals succeed in influencing the organization to produce products and

services that meet customer requirements, the product/service package should have certain competitive characteristics that enable demand-influencing activities to have a chance to succeed. The following marketing terms from the Dictionary relate to a product or service’s ability to compete for a customer’s business: Order qualifiers: Those competitive characteristics that a firm must exhibit to be a viable competitor in the marketplace. Order winners: Those competitive characteristics that cause a firm’s customers to choose that firm’s goods and services over those of its competitors. If marketing has successfully influenced the organization to produce a product or service that has the capability of being an order winner, product and brand management, marketing, and sales can work together to convince customers to purchase the organization’s products and services in ways that the organization’s business objectives are met or exceeded. Another purpose of demand management is to convince customers to purchase an organization’s products and services in a manner that supports business requirements, organizational strategy, and objectives (i.e., in a profitable manner). Marketing professionals use the elements of demand management to accomplish these goals.

Planning, communicating, influencing, and managing and prioritizing demand can be linked in several ways, including cycling through each component iteratively. Organizations may also prioritize certain components to match organizational strategy. Exhibit 1-21 shows, on a conceptual level, how the demand management components are cyclical. All of the components are necessary for long- and mediumterm planning (e.g., product development). However, the dotted lines in the exhibit show how the cycle can be shortened at the short-term operational level to reduce the need for management and prioritization and/or planning demand when the principles and technologies of demand management are implemented throughout the supply chain. For example, by transferring customer demand data from the point of sale immediately to all supply chain partners, the short-term forecasting portion of planning demand can be replaced with actual demand data (i.e., moving from a push system to a demand-pull system). Timely communications will also tend to reduce the need for managing and prioritizing demand because supply will more quickly respond to changes in demand.

Exhibit 1-21: Linkages Among the Components of Demand Management

Let’s look at four organizational capacity strategies that focus primarily on one of the four components of demand management. Planning demand (fixed high capacity strategy). This organizational strategy involves meeting demand to the maximum extent possible by providing the necessary capacity to meet peak demand at any time. Ensuring that capacity will be available requires a focus on planning demand, especially in terms of longterm planning. Such a strategy could be pursued if the costs of maintaining excess capacity are considered to be less than those of losing business.

Communicating demand (highly variable capacity strategy). This organizational strategy involves matching supply to demand as closely as possible by being flexible enough to increase or reduce capacity spontaneously as demand changes. Matching strategies such as these require a focus on communications so that the changes in supply can be proactive rather than reactive. Such strategies may employ a great deal of contract work, outsourcing, and flexible work scheduling. Influencing demand (moderately variable capacity strategy). This organizational strategy involves leveling production and carefully managing demand to meet optimal capacity. The focus is on influencing demand so that there is little need to change capacity. Sometimes this process is called demand shaping because it involves convincing customers to buy certain models based on excess inventory. Demand is influenced by carefully scheduling delivery of products and services (e.g., offering discounts for accepting longer lead times) and timing promotions to operational requirements. Demand could also be influenced by convincing customers to buy in a different quantity per order (bulk purchases or more frequent smaller purchases). Managing and prioritizing demand (fixed average capacity strategy). This organizational strategy involves controlling

demand to the maximum extent possible through scheduling, promotions, queues, and rationing. The focus is on managing and prioritizing demand because fixed average capacity will, by definition, result in periods of insufficient supply. This strategy could be beneficial for products or services that require development and retention of expert personnel or other expensive resources. Airlines that promote early ticket purchases with promotional fares and penalize flyers who buy a ticket at the last minute are examples of companies using this strategy.

Planning Demand and Demand Plan Planning demand includes forecasting activities, but that is just its start. Planning demand moves beyond predicting what demand will be because it is a plan for action based partly on those predictions. A key output of the demand planning process should be regular updates to the demand plan. The demand plan is a consensus document requesting products and services from the supply side of the organization to meet the expected future demand for the organization’s products and services in each period. It is an estimate of how many products customers will purchase, in what unit sizes, at what price, and on what timetable so the organization and its suppliers can determine how much to produce, when to produce it,

and when to ship it. The demand plan is based partly on forecasting and partly on commitments by the demand side of the organization to generate the necessary demand to meet the plan and the goals set in the organization’s business plan. Planning demand can be highly collaborative. For example, collaborative planning, forecasting, and replenishment systems help formalize the coordination of forecasting and demand plan creation.

Demand Plan Inputs The demand plan, as shown in Exhibit 1-22, influences and is influenced by forecasting; by commitments by product and brand management, marketing, and sales to create, influence, manage, and prioritize demand; and by the business plan and strategy.

Exhibit 1-22: Demand Plan Inputs

In addition to the plans listed in Exhibit 1-22, other key inputs to the demand plan are the assumptions used and the level of uncertainty encountered by the persons responsible for preparing the forecasts. These assumptions and uncertainties should be documented, reviewed, and challenged in the monthly S&OP review process to validate that the demand plan is realistic and actionable. Knowledge of assumptions and uncertainties will also help the organization determine the best way to arrive at a consensus regarding demand plan numbers.

Uses of Demand Plan The demand plan is used by multiple areas of the organization because it indicates demand both in units and in monetary amounts

such as euros or dollars. In this way, each audience for the demand plan can view the information in the most meaningful terms. Operations, logistics, customer service, and product development can view the plan in units; finance can view the plan in monetary amounts; marketing and sales can view both units and monetary amounts. For example, the plan may provide sales with an indication of the types and numbers of units that will be available to sell per product family and also expected sales goals. Another use of the demand plan is for validation and control of the plans of individual departments within an organization. Operations and logistics can verify that resource plans are sufficient to meet the expected levels of demand. Finance can use the plan to forecast revenues, product costs, profit margins, and cash flows. Executives can review these projections and determine if the demand plan and related plans of product and brand management, marketing, and sales will have the desired financial and market share results. If not, executives and managers can use the replanning process as a business control. However, the demand plan should not be arbitrarily changed to match the business plan: This would send a signal that the demand analysis and consensus activities at an organization are not valued or respected.

A key control to keep demand plans realistic is to treat the plans as a request for product from the supply side of the organization. In making this request, the demand side of the organization is stating that it is committed to creating this amount of demand and selling the products in the requested amounts. Holding the demand side of the organization accountable for the consequences of producing too much inventory can be an effective control over unrealistic demand plans. Close scrutiny of the demand plan can also reveal when inputs may be biased or assumptions unrealistic. For example, if the demand plan input by sales shows a reduction in demand but there is no change in the underlying assumptions from the prior periods, executives could question why the demand was lowered. If the sales force is compensated based on meeting its sales targets, it may have been a case of lowering the target so that success would be easier to achieve.

Planning Horizon and Revision Period A best practice is to produce a demand plan that has at least an 18month planning horizon and to revise it by replanning on a regular basis. Many organizations use the S&OP process to incorporate these regular revisions to the plan and to reconcile and synchronize their internal department plans. Regular revision allows the plan to

quickly reflect changes in external factors, such as the economy or competitor actions, as well as internal factors, such as branding and product life cycle decisions, lower- or higher-than-expected results from marketing activities or sales promotions, and efforts to bring the plan into alignment with the business plan and strategy. An 18-month minimum horizon has other advantages: It ensures that each period’s demand has been planned and reviewed multiple times, with increasing accuracy each time. Planned product and brand management and marketing activities typically span at least an 18-month horizon, and sales activities typically span at least a 12-month horizon, so the most current and reliable information on internal plans and likely actions of customers and competitors falls within this 18-month range. If the demand plan does not seem to be capable of achieving the goals in the business plan and strategy, a longer horizon allows organizations time to plan and execute additional activities to meet the revenue goals. If the demand plan shows a need to increase capacity, it gives the organization sufficient time to approve and execute capital expenditures. By midyear the demand plan will show the next year’s projected demand and can be used as a key input to the annual business plan.

Communicating Demand Communicating demand is the second component of demand management. While clear internal communications are necessary and important, the real power of communicating demand is found when it is extended to supply chain partners. Supply chain managers can counteract supply chain demand variability such as the bullwhip effect by communicating demand effectively to all parties in the supply chain. On a basic level this involves order processing. Order processing is “the activity required to administratively process a customer’s order and make it ready for shipment or production” (APICS Dictionary, 16th edition). From a collaborative demand management standpoint, this may involve producing and forwarding a sales order to the most efficient supply channel, such as An inventory storage location, authorizing the goods to be shipped A production plant, authorizing production and specifying all information required by the master planner (what, how much, and when). The demand manager or another demand-side professional may also send a copy of the sales order to the customer to communicate the terms and conditions of the sale. In this way, demand

management serves as an intermediary between the customer and production planning. Organizations can use information-sharing tools such as collaborative planning, forecasting, and replenishment (CPFR) to find a balance between the desire for centralized supply chain planning to provide network integration and optimization and allowing each region to analyze its own market from a local perspective. Each regional partner can be encouraged to share this local expertise with the larger network. Communicating demand, both internally and externally, rests on the principles of effective communication shown in Exhibit 1-23.

Exhibit 1-23: Principles of Effective Communication

Communicate Soon.

Communicating soon to minimize surprises is the principle that information communicated promptly is of far greater value than communications delayed for any reason. This is true for both good news and bad news as well as for information that is still uncertain. This communications principle is easy to understand but sometimes challenging to put into practice consistently. For example, a marketing person could delay communicating a sales promotion because the effect on demand is proving difficult to quantify. While this is a poor reason not to communicate the promotion, it is also a common example of how people rationalize communications delays. In this case, the promotion might be very successful but the lack of planning for it would contribute to stockouts and the bullwhip effect in later periods. Developing a structure for communicating uncertainty is one mitigating technique for this situation. Communicating bad news is another example of a communication that would be more useful sooner rather than later but is often delayed. For example, a salesperson may hope that poor sales will turn around or that a big customer will finally commit to an order. A forecast analyst may hope that an economic downturn will turn out to be only temporary. The tendency to delay bad news is compounded by a psychological tendency to blame the messenger of bad news, which makes people less likely to want to share it or fully disclose the extent of the issue. The negative effects of delaying bad news

could include products that are built for which there is no demand and use of capacity that could have been devoted elsewhere. Developing a culture that rewards early sharing of good and bad news could improve demand communications significantly.

Structure Communications. Structuring communications to ensure that they occur means that communications cannot be taken for granted. In the prior example of the failure to communicate a sales promotion, a structured process for communicating uncertainty in estimates would have helped the marketing person to communicate sooner. A structured process must be more than just assuming that transactional data will be forwarded along by the organization’s information systems. While data automation has freed an organization’s professionals from spending all of their time on this level of communications, technology is no substitute for interpersonal relationship and consensus building. Person-to-person interaction is needed when setting priorities, explaining nuances, and resolving conflicts. Exhibit 1-24 illustrates some of the types of communications in the demand planning process that should be structured so they can be reliably repeated.

Exhibit 1-24: Communications Structure for Communicating Demand

The exhibit uses arrows to show the required two-way communications and interactions in the process. Starting with demand plan inputs, communications occur in both directions regarding inputs, including assumptions and uncertainties. Note that other inputs include demand-influencing and prioritizing activities planned by the demand side of the organization. During the consensus review, a key communication step is to challenge and validate assumptions and to acknowledge uncertainties. The result of this process is a consensus demand plan that is integrated with finance plans and supply plans during the sales and operations planning process. Communications in the S&OP process

of reconciling and synchronizing plans must be structured so that all parties consistently feel listened to and understand the rationale behind the consensus numbers. Communications can lead to greater buy-in and commitment to action that will be needed to realize the plans. An output of the S&OP process is that the supply side of the organization uses the consensus numbers to perform master scheduling and supply planning. Finally, monitoring performance and providing feedback is a communications process that links to demand-influencing and prioritization activities, to master scheduling and supply planning, and to the S&OP process itself. One way to ensure that these communications occur and feedback is used to keep the plans realistic is to rely on a full-time demand manager. Demand Manager Demand manager is an organizational position that is responsible for Gathering information on demand volume and timing by product, product family, and/or customer segment Performing analytical work on the data and the demand plan Building consensus on a demand plan Communicating demand information to and from the various stakeholders involved in input, planning, execution, monitoring, and revision of the demand plan.

The demand manager may also play a lead role in the S&OP process, for example, by creating various scenarios of demand for supply and finance in an effort to tie the demand plan to the business goals. A best practice is to have this be a full-time position because of the importance and multifaceted nature of the responsibilities. A demand manager needs to have good communication skills and sufficient authority to be successful. This is because the position may be required to respectfully challenge managers on their inputs or gain commitments on demand creation efforts and promises to produce goods according to the consensus demand plan. The position is also required to gather feedback on the results of actions taken to forecast, create, influence, or manage and prioritize demand. The demand manager is responsible for ensuring that the feedback is used to change course, preferably while there is still time to positively influence a developing situation in the organization’s favor. shows how a demand manager can serve as the primary facilitator of communications and feedback.

Exhibit 1-25: Use of Demand Manager as Communications Focal Point

The demand manager is at the center of communications because this position serves as an intermediary between supply and demand organizational areas. Note the three primary feedback and performance monitoring goals that are the responsibility of the demand manager. The demand manager is the recipient of feedback from the demand side of the organization regarding whether their demand-influencing or prioritization efforts occurred as planned or produced less or more demand than was planned for. The demand manager consolidates and communicates this feedback to all relevant stakeholders. When actual demand varies from plan, the demand manager could request additional influencing or

prioritization efforts or start the process of altering supply, demand, or financial plans as needed. When demand is less than was planned for, the demand manager informs the supply organization so that they can alter the supply plan to keep supply and demand as synchronized as is feasible given the costs to change ongoing operations. Note that key customers are listed in the graphic as one of the stakeholder groups with which demand managers may need to communicate. While sales and marketing may maintain all customer interactions at some organizations, demand managers are increasingly communicating the organization’s supply and demand synchronization efforts with key customers and gathering information from them to better understand actual demand requirements.

Focus Communications. Being effective in communicating demand requires ensuring that the right individuals receive timely communications regarding changes in demand or the results of demand-influencing and prioritizing activities. Information must be disseminated to fit the needs of the person receiving the information, such as providing demand data in dollars for finance but in units for operations.

Focusing communications also requires that each person receive just the information he or she needs to make an informed decision. Too little information can lead to an inability to decide on the best course of action. For example, if inputs to the demand plan consist of just a set of demand numbers without the supporting assumptions, risks, opportunities, and uncertainties, the process of synchronizing and reconciling differing estimates will amount to guesswork. Too much information can also hinder decision making. If the demand data used in the demand consensus review meetings consist of multiple pages of detailed graphs and charts, it could result in key problems being hidden from discussion or an inability to get through the entire planning horizon (e.g., all 18 plus months) during the meeting. A key tool to help focus communications to fit the audience is to use dashboards, which are software presentations of key information from the organization’s information systems. Dashboards can be tailored by each user to show just the key performance indicators and information useful to that person. The user can quickly determine when things are running smoothly and when exceptions require attention. For example, there may be two dashboards for a demand consensus review meeting, one in units and one in dollars showing the financial results of the unit plan.

The following elements are important to include in demand dashboards for demand consensus review: Historical demand data for the past three months or more, with relevant key performance indicators and metrics for each month Demand plan for the next 18 months or more (For each month, this shows the demand plan [actual request for product] and, for comparison, the demand that is necessary to achieve the goals in the organization’s business plan.) Prior demand plan (Since plans are revised each month, the prior demand plan can be shown as a point of reference and reasons for significant changes can be discussed.) Assumptions made in demand numbers and pricing assumptions Planned branding, marketing, and sales promotions activities Key risks, opportunities, economic trends, and competitor actions Subtleties and uncertainties Events and issues of note and decisions that were made Exhibit 1-26 shows just the graphic portion of a dashboard for a demand plan in units. The exhibit illustrates how the revisions from the prior demand plan can be made obvious so that significant changes can be discussed. Note that to be complete, the dashboard would also need the other information listed in the prior bullets. This nuanced information is what enables decision making regarding the true state of demand, plan feasibility, actions that need to be planned

and executed to meet the plan and business objectives, and actions to keep supply and demand in synch.

Exhibit 1-26: Example of a Demand Plan Dashboard—Units

Topic 2: Influencing Demand One structured, iterative process that can be used to ensure that demand-influencing activities are being continually adapted to current situations is the plan-do-check-action model. We also review the marketing side’s demand-influencing levers: the 4Ps (product, price, placement, and promotion). After that, since different types of influencing are needed for different life cycle stages, these life cycles are first introduced and then their use in product life cycle

management (PLM) is described. PLM involves additional focus on both the very early stages of a product life cycle as well as the ending of sales and service.

Plan-Do-Check-Action Model Succeeding at influencing demand requires not only generating and executing marketing and sales initiatives but also determining if the plans are working as intended. If they are not, there must be a process in place to make course corrections during execution. One way to do this is by using the plan-do-check-action (PDCA) model, which is defined by the APICS Dictionary, 16th edition, as a four-step process for quality improvement. In the first step (plan), a plan to effect improvement is developed. In the second step (do), the plan is carried out, preferably on a small scale. In the third step (check), the effects of the plan are observed. In the last step (action), the results are studied to determine what was learned and what can be predicted. The PDCA model, shown in Exhibit 1-27, incorporates performance measurement, feedback, and replanning into the processes of planning and executing activities. Note that while PDCA is described here for demand influencing, it can be applied to any process,

including the other components of the demand management process and the sales and operations planning (S&OP) integration process.

Exhibit 1-27: Plan-Do-Check-Action Model

Plan Phase During the “plan” phase, product/brand management, marketing, and sales perform research and develop detailed strategies and tactics for influencing demand. The plans should include a budget, a schedule, and a list of tasks assigned to specific individuals for accountability. The plans should also set measurable targets indicating the increase in demand that the activities should generate. The plans are reviewed and approved prior to the S&OP meetings and are adjusted as needed during those meetings, resulting in commitments to execute a consensus plan.

Do Phase During the “do” phase, product and brand management, marketing, and sales execute the plans. Product and brand management professionals launch, manage, and retire products. Marketing professionals work to create demand and reinforce the brand value. Salespersons work to acquire new customers and retain and develop existing customers. Sales and marketing professionals may be required to provide the demand manager with periodic data on actual results. The marketing and sales managers and the demand manager exercise management and control during this phase by serving as problem solvers and by verifying that the correct activities are occurring.

Check Phase During the “check” phase, the demand manager and/or other demand-side managers review metrics against the plan and document other feedback, such as customer opinions on product pricing, features, and customer service levels. A key aspect of this phase is to determine the root cause of any differences between plan and actual results, that is, whether they arise from identifiable internal or external factors. These activities are performed periodically rather than waiting until the processes are complete.

Dashboards are a common way to track and monitor metrics for demand-influencing activities.

Action Phase During the “action” phase, the demand manager leads replanning efforts to respond to variances from the plan and address root causes of the variances. Replanning may call for increased or decreased investments in various activities depending on what is and is not proving effective. The replanning process could be part of the lead-up to the monthly S&OP process, or it could be performed more frequently if required. However, many marketing efforts take a long time to show measurable results, so a long-term focus is typically necessary.

Demand Influencing: Demand Generation A key aspect of demand influencing is called demand generation. Demand generation involves translating latent demand identified during market research into active demand for a product or service using various forms of communications with potential customers. Demand generation is critical for new product introductions since most new products fail. The market could either stay with the product

it already knows or just not notice the new product. With no historical data to guide forecasts, marketing and sales have to operate on instinct, experience, connections to past products, and market research. A great deal depends upon that research. And the rest depends upon what the marketing experts do with that research, both in the product design phase and during the introduction. Most of all, the product really has to give the market what it wants. If market analysis has correctly identified the needs and desires the new product can satisfy, marketing at least has a good chance to develop a campaign that triggers robust sales. Of course, all those sales have to be matched by production and delivery so your supply chain doesn’t run out of stock and have to turn away eager buyers. Marketing’s major responsibilities when developing a campaign for a new product or rebranding an existing product include educating customers and supply chain partners. Educating customers. The potential buyer has to know that your product is out there. Marketing has to know where buyers are and how to reach them. This means crafting the right message, one that emphasizes the product’s unique benefits and connects them to customer needs and desires that were uncovered during market research. Generating product and brand awareness are activities

that often take longer and require more effort than is planned and budgeted for. Therefore, a longer planning horizon and regular feedback on marketing progress are necessary to increase the chances of a successful product introduction. The message also has to be conveyed through the appropriate media: print ads (Which periodicals?), television, or internet advertisements (Which programs and time slots or websites? Which ad agency? Which style of presentation?), social media presence, email, telemarketing, in-person visits, public seminars, and so on. Finally, marketing has to know who the buyer is. That’s not always as obvious as it sounds. For example, a new type of exterior junction box may have to be marketed to, and accepted by, developers, general contractors, carpenters, and electricians as well as regulators and inspectors. Getting the word out will probably require personal visits and demonstrations. The end user, the homeowner who may eventually plug some outdoor lights into that box, is actually of no importance in the marketing campaign. Educating supply chain partners. Part of getting a product accepted is getting it understood by those who have to design, build, transport, and sell it. Working in conjunction with engineers,

suppliers, logistics managers, retailers—and whoever may be involved along the way (like those homebuilders in the preceding junction box example)—marketing has to be certain that the product is produced, carried, stored, and sold by people who understand it. Training and job aids may have to be designed and delivered at multiple levels. Before using product, price, placement, and promotion to influence demand, a foundational aspect of influencing demand is to influence the organization to support actual customer expectations and needs. However, this influence must be directed toward the organization’s business objectives. Specifically, this means that the organization should support only products and services that have a positive contribution margin. A positive contribution margin means that the increased demand will increase net income (profit) rather than simply increasing sales volume or revenue. Expanding product mixes and varieties to satisfy all customers could otherwise result in unsustainable costs and growth. Demand-influencing activities may also involve convincing customers to accept substitutions or changes in purchase timing. The purpose of demand influencing is to support the organization’s business objectives, and sometimes the best way to support these objectives is to convince customers to purchase an alternative

product or to delay purchases. Substitution may occur because one type of product is in surplus or because there is limited capacity and not all customers can be served without making full use of all products in a product family. Convincing customers to delay purchases or wait in some form of queue can also accommodate capacity limits. In another example, a promotion or discount could be timed to a period in which there is excess production capacity. Similarly, new product introductions or decisions to drop a product line can be timed to lessen the impact on other product lines. Influence over departments such as marketing and operations is not a given, and this is especially the case when dealing with multiple organizations. Developing and maintaining influence requires leadership skills and a certain amount of humility. For example, a supply chain partner may have very good reasons for wanting to have a sale in a particular month. Collaboration on influencing demand may require listening, understanding positions, selling the benefits of changes to partners, and reasonable compromise.

The Four Ps of Marketing and Demand Shaping The APICS Dictionary, 16th edition, defines the four Ps as

a set of marketing tools to direct the business offering to the customer. The four Ps are product, price, place, and promotion. The four Ps are part of what is called demand shaping. The Dictionary defines demand shaping as the practice of using the four Ps … and other market variables to influence the demand of a product or service so that the demand better matches the available supply. Product and brand management, marketing, and sales activities influence demand by developing products that customers are actually demanding, settling on the most profitable product mix, setting strategic pricing, placing products at various physical or online distribution points to establish a presence and level of customer convenience, and promoting products through advertisement and other means. Customer-focused marketing, customer segmentation, and customer relationship management (CRM) philosophies have transformed these components of traditional marketing to respond to the changes in today’s marketplace. In traditional marketing, there was a product aimed at a single targeted audience. There was one price, one channel of distribution, and one marketing message. In customerfocused marketing, a product/service package might be marketed to

a particular niche segment or customized to appeal to the needs and wants of several market segments. A customer-focused strategy may contain all of the traditional components of a marketing program or may, depending on the situation, focus on one or two components. We will therefore continue to use the terms of traditional marketing to describe the components of a customer-focused program.

Product “Product” for our purposes includes both products and services or product/service packages. In traditional marketing, a product or service was designed to appeal to a large group of consumers. The product was essentially static—perceived in much the same way by all customers. Consumer needs were important, but they were not the starting point. For example, electricity was offered to the public before the public expressed any specific needs that it would address. The technology was what was being sold; marketing and time would create the need. Similarly, the first home computers were introduced before there was broad consumer need; it took at least 10 years and the growth of the internet to create the need. In a customer-focused world, the starting point for a product/service package is often customer need. Food products are often designed

by specialized companies to appeal to the needs of certain groups. For example, a highly engineered meat substitute may deliver improved taste to a consumer who doesn’t want to compromise on the desired taste experience but still wants a healthier alternative at times. Increasingly, product/service packages may be designed to be customizable for specific customer segments. This allows the seller (or supply chain) to add desired value and competitive differentiation to the product and ideally sustain or grow profit. For example, a manufactured building like a barn or storage facility may have elements (like windows, doors, partitions, porches, or trim) that can be combined in various ways to create structures that meet very specific needs and tastes. The same credit card may actually be multiple card programs distinguished by features that offer values to specific groups, such as low transfer rates, frequent flier mileage, or co-marketing partners. Value-added products have various implications for a customerfocused program: The product itself must be designed to fulfill customer expectations and pose few challenges for customer use. This necessitates extensive research and/or customer involvement.

The product must be manufactured or created to meet quality levels that satisfy customer expectations and business profit margins. Performance must be continuously and scrupulously measured. Promotion and distribution must be customized as well to address the distinctive needs of a segmented audience. The performance of the program must be tracked so that the program can be retooled for higher performance. Sales methods may need to be customized and measured for effectiveness. The sales force must be thoroughly familiar with each product they sell—with its intended audience and use as well as with the marketing goals for the product. Ideally, they should be aware of what the customer has bought before. Customer care personnel must also be familiar with each product variation, its use, and its potential problems. Ideally, they should be familiar with what the individual customer has bought and the status of the order without having to be told by the customer.

Price Pricing is generally a strategic decision, based on competition, perceived value, and brand identity. While some businesses may still calculate profit by adding an acceptable and competitive price margin to the total costs of creation, sales, and overhead, many take a more nuanced approach to pricing. If the market is highly

competitive and a product has become a commodity, price will be dictated by the competitive situation, but in a more differentiated marketplace, pricing becomes more subjective. In pricing a new drug, for example, a pharmaceutical company may consider not only their research and development, marketing, and manufacturing costs but also the value of the drug to patients. How much would a person pay for a drug that enabled him or her to return to work or that caused fewer side effects? How much would a person pay if there were no other products on the market that could do this? In the customer-focused business model, price and product are tightly connected. Price may be another way to differentiate products for specific customer segments. For example, a credit card company may waive annual fees for highly desirable customers who carry a balance from month to month. A computer company may create product/service packages for different customers. Customers who buy more frequently or who buy more expensive systems may receive free upgrades to higher-performance features or may receive free in-home repair service. Obviously, strategic pricing must be carefully and frequently analyzed to ensure that the pricing structure is attractive to customers but still profitable to the business. Specific sales data for customer segments are invaluable, as they can help automate

delivery of messages intended to move customers into different pricing groups. What pricing is too high to penetrate the market? What pricing is too low to cover salaries and bonuses and still return a profit? Demand is not an absolute; it increases and decreases depending on many factors, and price is often the major variable. Demand may rise as the price falls, but even that correlation has its limits. Some products sell better at a price slightly more than that of the competition, because a higher price adds to their status appeal. A light bulb may be perceived as a better value due to a higher price and a recognized brand name, even if its generic equivalent is produced on the same production line and is identical but for the name. But for some products, and in some markets, the “everyday low price” draws customers in. Synchronizing the selling price with the costs of design, manufacturing, and logistics is an area in which marketing can collaborate across functions and companies.

Placement Placement, or distribution, is another task that falls to the marketing department. Where is the right place—or the right combination of places—to sell the product to the target market in sufficient quantity to meet the demand forecast?

Placement has traditionally referred to the way in which a product is sold—how the product or service gets into the hands of the customer. A company might decide, for example, to distribute its product through warehouses and retail outlets, through a direct sales force calling on customers, or through a website. It’s worth noting that placement was traditionally a one-way form of communication: product being placed by shipping it to outlets or selling it through a sales force, or customers placing orders. In the most traditional location—retail store shelves—placement can include the design of the display. While this might seem to fall naturally within the competence of the retailer, in VMI (vendormanaged inventory) partnerships the supplier may design and construct the display as well as manage the replenishment. In the customer-focused model, placement is often referred to as the contact channel strategy. It is a means to increase profitability, first by ensuring that the most cost-effective and customer-preferred channel is used for distribution and second by securing lifetime customers through effective customer care and research activities. Customer-focused placement may be determined by customer segment. Essentially identical product may be distributed through different channels that have been chosen because they match the communication and contact preferences of different customer

groups. Airline tickets may be sold on the internet, at automated kiosks, at counters, over the phone, via mobile device app, or through intermediaries (agencies). Different means of placement may affect pricing, however. High touch customer service methods may command a premium price. Improved transportation has made placement itself a key element in a product/service package. For example, placement may be customized according to the customer’s need for fast delivery (regular speed, faster, overnight). Other transportation may specialize in consistent delivery that is neither early nor late. Customer-focused placement requires a more interactive form of communication than traditional placement does. Since customers must be satisfied and since information about the customers’ actions and attitudes is critical to the business, information must flow back and forth between the business and the customer. Thus, in the customer-focused model, placement includes the way in which the customer gains information about the product and post-purchase support. Interactive contact channels include call centers, online repositories that allow customers to find desired information, websites that incorporate live dialogue or email communication, and chat rooms for users. Many sites provide incentives for users to

share more information, such as getting a free demo of the product for filling out a survey. One-way channels may also be used in customer-focused placement; these include direct marketing (direct mail, mass mailings by fax or email, telemarketing, and social media presence) and media-based marketing (television, radio, newsprint, periodicals, trade publications, banner ads, billboards, etc.). Throughout the communication process, information is continually being gathered. This information may point out commonalities and trends that suggest future product crafting, promotion, and support. Technology has greatly changed customer care. It’s hard to imagine a new product introduction campaign that doesn’t use e-commerce as part of the mix. A website is necessary even if only for informational purposes. Many products can be both advertised and sold online through one’s own site or through third-party sites. Customers can download software and hardware documentation and manuals, refer problems to automated expert systems, consult information databases, and communicate with technical support or even other customers about problems or questions. Digital products can be advertised, ordered, and shipped via the web; software applications, music, movies, and written materials are examples.

The channel strategy must be continuously evaluated to ensure that it is fulfilling the needs of both the customer and the business. From the customer’s perspective, an effective channel has the following characteristics: Accessible. Are help lines toll-free numbers? Do the hours of operation facilitate different time zones or work schedules? Do websites reflect current or real-time changes? Can the customer contact the organization by chat or text? Reliable. Are materials or services available within the expected time frame without exception? Is the social website always operational? Complete. Can the customer get accurate, current, and complete answers? Secure and error-free. Is e-commerce adequately encrypted? Are orders taken accurately? Direct. Can the customer reach someone who can assume ownership for the issue, has decision-making authority, and can resolve a problem? Are questions easily answered by phone or automation?

Convenient. How many handoffs does the customer have to pass through before reaching someone who can actually solve a problem or answer a question? How much hunting on the website is necessary? How long is a caller on hold? Fast. Does the customer have to repeat account and problem information or can all the customer care personnel access this information automatically? Does the customer receive a quick response to emails or phone messages? Flexible. Can the business be reached easily by those with and without computers? Are there accommodations for non-native speakers? From the business’s perspective, the channel must allow the following: Control and consistency. Does the channel promote the intended values, ideas, or content? Is every customer’s experience the same? Profitability. Does the channel minimize the use of expensive human resources, for example, by using automation whenever possible?

Promotion

The last of the four Ps, promotion, includes such marketing activities as consumer research and market analysis; segmentation of customers or audience; setting of strategy for targeted segments; planning, creation, and placement of advertising; and creation of brand image. It also involves determining and communicating the timing of marketing and promotional activities and collecting feedback on their impact. All of the traditional promotional activities are still valid in a customerfocused business model. What is different is the level of research, segmentation, and customization of the promotional message or offer that is possible. With customer relationship management technology, businesses can capture information about every interaction with customers. This enables unparalleled opportunities to study buyer motivation and behaviors and to segment customers into groups with distinctive CRM programs. Printing technologies allow for cost-effective customization of advertising materials. The explosion of communication channels—including not only the web but also satellite radio, podcasts, and email—allows businesses to select alternative channels that offer clear advantages for specific audiences. Let’s look more closely at two factors related to promotion: branding and packaging.

Branding. Customer-focused promotion helps to create the brand. As defined in the APICS Dictionary, 16th edition, branding is “the use of a name, term, symbol, or design, or a combination of these, to identify a product.” An organization’s or product’s brand can be worth a considerable sum to market analysts. Google’s and Facebook’s brands were worth billions at the time of this printing. The worth of such brands is based partly on current market share and total number of customers and partly on image, which is an intangible quality that sums up a brand’s awareness, popularity, and reputation. As is said about reputation, brand image is something that takes years to build up but that could be destroyed in an instant. Therefore organizations take great pains to protect their brand image. Part of educating customers about a new product is choosing a name and logo that emphasizes product characteristics that will attract targeted segments. If the initial research accurately measures customer needs and attitudes, and if the product’s design successfully incorporates those selling points, then the name should follow suit. Automobile names often highlight concepts that appeal to a target market. Dodge Ram emphasizes toughness and power; Jaguar suggests grace, speed, and elegance; Honda Civic implies a sensible, economical city car.

A new product’s name and the logo that represents it visually can either link the product to an existing product family or set it apart. The name Macintosh kept the familiar association with Apple but also signaled the advent of a new line of products. Sometimes a new model can be created from an existing model simply by acquiring a different name. Perhaps because of the rate of change in product availability, customers are increasingly transferring their loyalty from specific products (e.g., a line of jeans) to the provider of those products (i.e., the retailer who keeps those jeans available in the right size). They grant their business to these organizations because they trust that they will find the products they are looking for and that they will be taken care of if any problems occur. This means that businesses must keep in close touch with what customers want and are buying so that they can continually upgrade, alter, or customize product and supply chain options to meet customer expectations. They must also ensure customer satisfaction. Because customers are more aware of service, products, and the personal experience they should receive, a single failure may undo the brand image and drive customers to a competitor. Dissatisfied customers have the means to make their disloyalty well known. Complaints posted on popular apps, websites, blogs, tweets, chat rooms, or other social media can have a significant

impact on today’s internet-savvy customer and can destroy a once-strong business relationship. Packaging. The package that contains a product also serves a marketing purpose. The more obvious marketing elements of packaging—colors, images, words, even the textures of the wrapping—are marketing devices. The package should command attention and reinforce the features and benefits that sell the product. (Market research such as focus groups provide this insight.) Some packages are educational or functional—like food boxes containing cooking instructions on the outside or packaging that facilitates proper cooking of the item. Packages can promote other organizational goals such as sustainability. Hewlett Packard’s laser cartridges are packaged in a box that can be used to return the spent cartridge, thus solving the end user’s reverse logistics problem and protecting the environment. Market research likely determined that such a box would increase the number of cartridges that were returned, which would reduce net costs even after the free shipping expenses were included. Services, too, are “packaged” for sale. Presentation of meals, design of hospital waiting rooms, and the uniforms worn by many

service personnel—all these matters of style and appearance serve a marketing purpose.

Product Life Cycle Stages Product design is only the first step in a product’s life cycle. In supply chains, it is important to remember that after a product has been designed, produced, and sent off into the market, the product life cycle undergoes different stages that impact how the supply chain for the product might be handled. The product life cycle can be defined as “the stages a new product goes through from beginning to end.” (Refer to the APICS Dictionary, 16th edition, for more information.) As illustrated in Exhibit 1-28, an extended product life cycle includes development, introduction, growth, maturity, and decline.

Exhibit 1-28: Product Life Cycle

Development. Product (or service) development is the incubation state of the product life cycle. There are no sales at this point as the organization prepares to introduce the product. Traditionally, this is the period when market research, product design or service definition, testing, and finalization are accomplished. Introduction. During the introduction stage, sales of the product or service will be low until customers become increasingly aware of it and its benefits. The organization is likely to have additional costs associated with establishing distribution of the product or service. The higher costs added to the low sales volume typically make this stage a time of negative profits. Growth. The growth stage is a time of rapid revenue growth. Sales increase as more customers become aware of the product and its benefits. Once the product has proven success and customers begin seeking it, sales will continue to increase as retailers become interested in offering the product. Distribution may be expanded at this point. During this stage, competitors may enter the market. The organization’s promotional costs may increase in order to sustain market share. As the base of customers and distributors grows, businesses must commit increased resources to both satisfying the market’s needs and gathering and analyzing data in an ongoing manner.

Production and inventory levels must be managed to avoid stockouts or delays that could lead to customers switching brands. A make-to-stock strategy may work well for many products in the growth stage. Maturity. The maturity stage is the most profitable. While sales continue to increase, they do so at a slower rate. Competition will result in decreased market share and/or prices. The competing products may be very similar at this point, making it difficult to differentiate them from that of the organization. Decline. Eventually sales begin to decline as the market becomes saturated, the product becomes technologically outdated, or customers’ tastes change. If the product has developed brand loyalty, profitability may be maintained longer, but with the declining production volumes and increased unit costs, eventually no more profit will be made. Organizations that used a make-tostock strategy may need to transition to a make-to-order strategy to prolong profitability as long as possible. Ideally, new products have been developed and the cycle will continue. One purpose of learning the differences between these phases is to enable product life cycle analysis. The Dictionary defines life cycle analysis as

a quantitative forecasting technique based on applying past patterns of demand data covering introduction, growth, maturity, saturation, and decline of similar products to a new product family.

Product Life Cycle Management TheAPICS Dictionary, 16th edition, defines product life cycle management as the process of facilitating the development, use, and support of products that customers want and need. PLM helps professionals envision the creation and preservation of product information, both to the customer and along the reverse-logistics portion of the supply chain. Product life cycle management (PLM) is a process of managing new product introductions, managing the life cycles of products throughout their phases, and creating and executing end-of-life plans. PLM may feature a sustainability component, especially if products at the end of their lives must or should be reclaimed or recycled. PLM can be managed using software of the same name or can be performed using a mix of manual tools and existing systems. In addition to helping manage the product life cycle for a type of product, PLM software also has tools to help manage the individual life cycle of a unit or a batch. It often includes tools to help planners

with product, component, and bill-of-material versioning, effectivity plans (plans for when to make a particular set of engineering drawings and documents be the official version as of a particular effectivity date), and traceability. PLM software can help track products by production lot numbers or serial numbers all the way to the customer for individual units or batches. This helps enable upgrades, recalls, and reverse logistics for units or batches at any stage of production. PLM from a product and brand management perspective builds off of the product life cycle stages of introduction, growth, maturity, and decline but adds substeps. Some models also highlight three distinct phases: beginning of life, middle of life, and end of life. Beginning of life includes a new component of research and development plus the introduction stage. The middle-of-life phase encompasses growth, maturity, and decline. The end-of-life phase is new to the product life cycle (but implied by it). Exhibit 1-29 shows these phases and lists potential substeps in PLM. (Specific substeps may vary.)

Exhibit 1-29: Product Life Cycle Management

The substeps shown above contain many steps for the beginning-oflife phase. The middle-of-life phase shows how the focus area during growth starts by ensuring that manufacturing and distribution are capable and have the capacity for the demand. As the product moves into maturity, this shifts to a focus on how the product is used. The focus then shifts to service as the product enters decline. Decline also features phase-out or end-of-life planning. Actual phase-out ends the decline phase. There may be a mandatory support and service provision period for the expected life of the last products sold or, at a minimum, for the warranty period. The organization may be involved in helping recycle the products at the end of their lives, and this could also include recovering rare or

hazardous materials, remanufacturing, repurposing or selling manufacturing equipment, reassessing suppliers, and so on.

New Product Introduction Schedules Developing a new product introduction (NPI) schedule involves mapping out and managing the process. This may include using project management. NPI is a component of the development chain, which parallels the supply chain and interacts with it at many points. In addition to NPI, the development chain may include product engineering, make-or-buy decisions, early supplier involvement, concurrent engineering, strategic sourcing, supplier footprint, and contracting with capable suppliers. Here are some potential phases in NPI or the development chain: Innovation. During this phase, research is conducted. This can include market research (e.g., collecting and disseminating customer feedback), competitor scanning, experimentation, and invention. Concept. Research coalesces into a vision of the product/service that is vetted for customer demand and financial promise. Development. Engineering, manufacturing, and other functions may work together to add detail to the concept through a number of iterations. Concurrent engineering or design for

manufacturability, logistics, or the environment may be applied to ensure that the product will be cost-effective to source, make, and deliver. Prototyping. A working model of the product and related services is developed. A prototype’s purposes include proving feasibility and eliciting feedback. A prototype schedule helps manage iterations of the prototype that capture feedback both from the demand side and the supply side. Demand-side inputs include focus groups and market-based release deadlines; supply-side inputs include make-or-buy analysis, supply availability, production feasibility and cost, product architecture (e.g., integrated versus modular), scalability and economies-of-scale plans, and capacity requirements versus current load. Engineering. Engineers develop the product structure and bills of material, including detailed drawings, tolerances, level of modularity, and manufacturing requirements. A document management system can be used to help manage configuration (versions) and collaboration efforts. Supply. Supply requirements are developed, capable suppliers are identified, and the supply footprint is mapped out. It is important at this point to review supply constraints that may impact the NPI schedule. In addition to finding capable suppliers fast

enough, another supply constraint is lead time versus cost, which can be significant due to global sourcing. This differs by product type: Innovative products typically require compressed timelines to shorten time to market. Functional products tend to have low margins, making cost the primary factor. Manufacturing. While manufacturing is listed in Exhibit 1-29 as a middle-of-life activity, clearly manufacturing capability and capacity need to be developed earlier, at least to the degree needed for the first planned phase of demand. The manufacturing choices are also determined. Future demand growth may later require more investments in capacity and throughput. Launch. Marketing and sales launch the product and foster awareness of it. Note the mention above of innovative versus functional products. Different sorts of products will require different NPI frequencies and different supply chain strategies to make them work, as discussed more next.

NPI Frequency versus Demand Uncertainty

New products occupy a spectrum from innovative products at one end to functional products at the other end. Designing and Managing the Supply Chain cites an article by Marshall Fisher, who coined the term technology clockspeed. Clockspeed is the rate of technology change for the given industry, market, or product. Clockspeed strongly influences the duration of the product life cycle. Innovative products have fast technology clockspeeds and life cycles, while functional products have slow technology clockspeeds and life cycles. Fast clockspeeds require compressed NPI schedules. The product design strategy and the supply chain strategy need to align with the type of product being developed. For example, organizations that have a strategic focus on innovation as their basis of competition may have one supply chain specifically dedicated to new product introductions and a different supply chain for established products. They will also need to ensure that new products are designed for the supply chain (in part by collaborating with suppliers) so speed, dependability, or cost objectives can be met. An important supply chain factor to consider is demand uncertainty. Items with low demand uncertainty can be pushed out to the market because there is steady demand. Items with high demand uncertainty should move more toward a pull model so that only what

is demanded is produced. Exhibit 1-30 compares NPI frequency to demand uncertainty, which results in four quadrants of product types.

Exhibit 1-30: NPI Frequency Versus Demand Uncertainty

As shown in the graphic, the four categories of products are as follows: Unstable demand, low clockspeed. The life cycle for the products is long, and the products can have an integral design (not

modular). The products can be pushed to a certain point (e.g., components produced based on a demand forecast), and then demand-pull can take over (e.g., final assembly in response to actual customer orders). This could occur by centralizing inventory and drop-shipping, for example. Unstable demand, high clockspeed. Due to the high rate of change and short life cycles, manufacturing uses pull manufacturing (e.g., make-to-order) and highlights responsiveness over cost. Modular designs, short lead times, maintaining excess capacity, and dynamic market pricing can help ensure that supply can quickly respond to changing demands. Stable demand, low clockspeed. These are staple items that have low margins and need to be produced economically and create high turnover to ensure profitability. Since these are maketo-stock items, they can have an integral design. Stable demand, high clockspeed. There are few finished goods in this category, but many types of components fit in this area if enough buyers exist to keep demand stable. Due to the short product life cycles, modular designs enable variations on products, and, as NPI occurs, portions of the product or component that don’t need to change might be able to be used in the new version.

Push manufacturing and supply chain efficiency help ensure profitability.

Section D: Forecasting This section is designed to Describe the principles of demand forecasting Describe qualitative forecasting methods, including judgmental/expert judgment forecasting and the Delphi method Describe quantitative forecasting methods, including time-series and associative forecasting Use a forecasting process to select the right forecasting model, including by visualizing forecast data in charts to see trends Differentiate time-series methods, including naive forecasting, the simple moving average, the weighted moving average, and exponential smoothing Understand that forecasts with seasonality need to be deseasonalized prior to forecasting, after which the seasonality is added back in Describe how simple regression (an associative forecasting method) uses an independent variable such as a leading indicator to predict a dependent variable such as future sales Describe how service industries may forecast demand by the hour Discuss the basic concepts in measuring forecast error

Understand the features of mean absolute deviation, the tracking signal, standard deviation, mean squared error, and mean absolute percentage error. Marketing or sales typically conducts forecasting, but supply chain managers rely on these predictions for multiple decisions related to synchronizing supply and demand, ensuring that the right amount of warehouse space or transportation services are available, and so on. Supply chain managers need to know how forecasts are created and what can go wrong with them, because a forecast that is biased or has too much error can directly result in numerous incorrect decisions being made in the supply chain, all with a significant cost.

Topic 1: Forecasting Principles and Process There are numerous techniques available to use when developing a forecasting process. Whatever the process, however, it needs to be formulated with the following basic forecasting principles in mind. After that, a generic forecasting process is provided to show the big picture.

Principles of Forecasting

According to the APICS Dictionary, 16th edition, forecasting is the business function that attempts to predict sales and use of products so they can be purchased or manufactured in appropriate quantities in advance. The purpose of forecasting is to engage in demand planning. The Dictionary defines demand planning as the process of combining statistical forecasting techniques and judgment to construct demand estimates for products or services (both high and low volume; lumpy and continuous) across the supply chain from the suppliers’ raw materials to the consumer’s needs. Items can be aggregated by product family, geographical location, product life cycle, and so forth, to determine an estimate of consumer demand for finished products, service parts, and services. Numerous forecasting models are tested and combined with judgment from marketing, sales, distributors, warehousing, service parts, and other functions. Actual sales are compared with forecasts provided by various models and judgments to determine the best integration of techniques and judgment to minimize forecast error. Everything in the supply network depends upon the number of customers that make purchases from the wholesaler, retailer, or direct sales/website offering your product: manufacturing, capacity,

warehousing, transportation, location and type of retail outlets, amounts of raw material to extract—everything. If production outstrips demand, you suffer financial losses or worse. If orders exceed supply, your frustrated customers may go instead to your competitor. Forecasting demand is a necessary part of business planning. You have to have some guidelines when deciding how much product you’re likely to sell and how much, therefore, you need to produce. Demand forecasting is “forecasting the demand for a particular good, component, or service” (Dictionary). Even make-to-order business models need to have sufficient capacity and components prepared prior to receiving customer orders. A number of principles of forecasting follow that, if understood, help people know how to best conduct forecasting and how much to rely on the results.

Forecasts Should Be Based on Demand Rather than Orders. Forecasting needs to be based on an estimate of actual demand rather than on customer orders, which can differ from actual demand in important ways. Customer orders are often the starting point for estimating demand, but they should not be the ending point. Orders from intermediate customers such as distribution centers,

distributors, and retailers can include quantities ordered not due to actual demand but instead due to other decisions, such as in anticipation of a shortage. Given stockouts, an estimation should be made of the sales that would have occurred if there had not been a stockout. Similarly, customer orders need to be modified to account for returns.

Forecasts Are (Almost) Always Wrong. No matter how sophisticated the statistical technique, no matter how wise and experienced the experts, a forecast is at best an estimate of what may happen in the future—if there are no surprises. Even if the sales force were able to poll every potential customer for a new product or service, there would be some degree of error in the forecast for individual selling or shipping locations. Circumstances and minds can change. For this reason, forecasts require regular review. Forecasting techniques should be reviewed if forecast errors grow too large. Forecast uncertainty is one potential contributor to the bullwhip effect, the observation that demand fluctuations at the retail level tend to be magnified in orders placed further up the supply chain. The more forecasts miss their target, the more orders vary, with that variation expanding up the supply chain.

Conventional “forecasting” all too often assumes that each sales period should yield an increase of some arbitrary percentage of the volume from the prior year, but this is a business goal, not a forecast. The forecast needs to avoid bias by being data-driven rather than goal-driven.

Forecasts Should Include an Estimate of Error. Just as opinion polls often specify a margin of error (e.g., 40 percent favorable rating plus or minus three percent), demand forecasts should include an estimate of how large the forecast error is likely to be. Statistical analysis of the variability of demand around the average demand provides the basis for this error estimate. If your forecast error grows unacceptably large over time, you know that you need to either improve the forecasting process or arrange your supply chain to accommodate a large amount of uncertainty. Error estimates should also be given in terms of the monetary value of the error so that the errors with the most dollars at risk can be addressed first.

Forecasts Are More Accurate for Groups than for Single Items. Accuracy generally increases with the size of a product group, assuming that forecasts for each item in the group are as likely to be

too high as too low. The low forecasts tend to balance out the high forecasts, at least in sizable groups. The general principle at work in these cases is risk pooling—taking individual risks and aggregating them into a pool. The overall risk for the pool tends to be less than the average of all the risks that flow into the pool. Risk pooling can also refer to centralization of inventory. For instance, a retailer will have better luck forecasting demand for all blue jeans than for loose-fit Levi brand jeans. A hospital will be better able to forecast numbers of surgeries than numbers of quadruple heart bypass procedures. In a similar fashion, a manufacturer can improve production forecasting accuracy by pooling the demand forecasts for all customers who order the same product—all wholesalers who order the same brand or style of blue jeans, for example. The manufacturer uses the improved forecast to its advantage if it can send large orders of the trousers to a distributor who serves multiple customers. Any errors on the low side for individual customers may balance errors on the high side for others, and they will all be drawing from the same supply. (This is the other meaning of risk pooling.)

Forecasting at more detailed levels is still needed, but the detailed levels are reserved for the shorter-term forecasts. For example, an overall product family forecast may still require a mix forecast later in the process. Mix forecast , as defined by the APICS Dictionary, 16th edition, is a forecast of the proportion of products that will be sold within a given product family, or the proportion of options offered within a product line…Even though the appropriate level of units is forecasted for a given product line, an inaccurate mix forecast can create material shortages and inventory problems. Forecasting at more detailed levels for shorter-term forecasts is acceptable due to the principle to be discussed next.

Forecasts for the Near Term are More Accurate than for the Long Term. The further you extend a forecast into the future, the more likely that chance and change will derail your estimates. (For similar reasons, lenders generally charge more interest for long-term loans than for short-term loans.) While an item-level forecast would be very likely to have significant error if conducted for a long horizon, when a very short horizon is used, the potential for significant error is much lower.

Forecast accuracy review against actual results also can be tied to an appropriate time horizon. Long-term forecasts are generally reviewed on an annual or quarterly basis, medium-term forecasts on a monthly basis, and short-term forecasts on a weekly basis. In addition to regular reviews, taking steps to shorten the required lead time for items can shorten the forecasting horizon and thus improve the accuracy of forecasts.

Forecasting Process Here are the steps in the forecasting process: 1. Determine the purpose of the forecast. For example, to determine manufacturing or purchasing targets, capacity, or service staffing. 2. Determine the level of aggregation and what will be forecasted. Specify units of measure and total sales, product family, product, or stock keeping unit (SKU). 3. Determine the time horizon. Specify a short-, medium-, or longterm forecast and the planning bucket (e.g., by week, month). 4. Visualize the data. Map any available historical data on a graph to see if they have obvious trends or seasonality. This will help when selecting the forecasting method. 5. Choose the forecasting method or model. You can choose qualitative or quantitative methods or both. For quantitative

methods, decide if a time-series forecast or an associative forecast would work better, and choose a subtype. If historical data are available and the trend appears to be relatively steady, a timeseries forecast is a good choice. If no data are available or the trend changes frequently, it may be best to develop an associative forecast based on elements that appear to be driving the changes in the trend. 6. Prepare the data. Gather data to be used as forecast inputs. If the visualization showed strong seasonality, remove this temporarily using deseasonalization. 7. Test the forecast using historical data. If historical data are available, prepare a forecast for a few periods back from the present and compare the forecast results to the actual historical results. Forecast using multiple methods to find the most accurate one. 8. Forecast. After making any necessary adjustments, use the model. If seasonality was removed from the data, add it back in. Any qualitative adjustments would be made at this point. 9. Perform sales and operations planning. The result is that demand-side, supply-side, and financial professionals arrive at a single demand forecast that everyone agrees to use. This is called a one-number system (one forecast). 10. Periodically review and improve models for accuracy. Monitor and control error levels and continually improve models.

Topic 2: Forecasting Methods Forecasting methods can be qualitative (based on experience and judgment), or they can be quantitative (based on historical or publicly available data and calculated). Quantitative methods can be a projection of historical data over time, which is called time-series forecasting, or be based on trend indicators such as government data on leading indicators, which is called associative forecasting. Various methods can also be combined.

Qualitative and Combination Methods Qualitative forecasts rely on judgment rather than math. These methods lack scientific precision but can be used on their own in volatile situations or when there are no historical data available, such as for a new product. Sometimes a similar product might be used as a proxy, and this possibility should be explored prior to resorting to a pure qualitative forecast. Qualitative forecasts depend on the experience level of the forecasters, so results can vary widely. This can be true even when a qualitative method is used to adjust a quantitative method. Bias is a real risk when using qualitative forecasting on its own or after quantitative forecasting. Estimators may be motivated to estimate too high or too low depending on their incentives. For

example, a salesperson could estimate too low to make a sales target easy to reach, while a culture of optimism might lead to aggressive sales goals. One way to mitigate bias is to ask estimators to provide a pessimistic estimate, a most likely estimate, and an optimistic estimate. The three estimates can be combined and divided by three (the simple average), or the most likely estimate can be given more weight. A common way is to multiply the most likely result by four (putting four times more weight on this estimate) and then divide the total result by six:

Two common types of qualitative forecasting are judgmental/expert judgment forecasting and the Delphi method.

Judgmental/Expert Judgment Forecasting Executives, salespersons, market analysts, and others can use their detailed knowledge of their products and their customers, along with their memory of the differences between prior forecasts and actual results, to generate a forecast or, more often, to adjust a quantitative forecast. Tracking these adjustments separately from any quantitative component will help in determining whether these modifications are increasing or decreasing accuracy and in showing whether they are introducing bias by being consistently high or low.

Delphi Method A more involved and sophisticated qualitative forecast can be created by surveying experts and collating their responses into a document that keeps the responses anonymous. The compiler continues to work toward consensus in successive rounds by highlighting areas where there is disagreement and allowing responders to change their responses after reading the current group opinion. Anonymity is used for two reasons. First, it helps prevent dominant personalities or emotions from influencing the group opinion, called the “groupthink” effect. When the groupthink effect is in play, otherwise independent thinkers might become emotionally committed to an unrealistic forecast. The other problem anonymity prevents is a “stake in the ground” mentality. This is when a person has already publicly committed to a forecast result and doesn’t want to lose face by changing his or her declared position. Since the position is anonymous, it is easier to change given more information. This method has had good success at arriving at reliable forecasts, but it is time-consuming and labor-intensive. It is often used only for strategic-level estimation.

Combination Methods Good forecasting is best done with a combination of quantitative and qualitative considerations. For example, a forecaster for an

electronics company might use a mathematical model to estimate demand for future periods. The forecaster should then modify the projection with all pertinent and available intelligence. This could include knowledge of competitor sales promotions or product launches, the state of the economy, trends in discretionary spending, and so on. The assumptions used need to be openly discussed so that everyone can arrive at a shared set of assumptions. Documenting the assumptions is important for post mortems. When using combination methods, both the quantitative forecast and the qualitatively adjusted forecast can be measured separately for error to determine the degree to which qualitative methods are helping or hindering forecasting.

Quantitative Methods: Time-Series Forecasting Quantitative forecasting uses mathematical formulas to predict future results based on past trends. Two basic categories are time-series and associative. Time-series forecasting is more commonly used because the methods are less complex mathematically and thus easier to explain to decision makers. Time-series methods assume that the factors that influenced the past will continue on into the

future. When that trend is unlikely to be stable, associative forecasting may be needed. There are a number of types of time-series forecasting, ranging from the very simple to the relatively complex. Naive forecasting is the simplest; it assumes that the last period’s demand will be this period’s forecast. It can be cost-effective but does not account for trends, and any random spike or trough in demand would be carried forward. The naive method is not discussed further in this text. Other time-series methods include the simple moving average, the weighted moving average, and exponential smoothing. We’ll examine these in a moment, but first we’ll look at some of the steps in time-series forecasting.

Visualizing Visualizing the data is an important part of forecasting because you can often spot seasonality or other trend or cycle information very quickly and decide how best to forecast. Exhibit 1-31 shows some visualized raw data for a product with strong demand in the winter months and very low demand in the summer months.

Exhibit 1-31: Visualize the Raw Data

In this case, the data for three years were placed in Microsoft ExcelTM and one of the features was used to generate a chart automatically. An additional option was selected to automatically calculate the linear trend, shown as the dotted line. It is slightly upward-sloping. However, the waves are very strong, showing strong seasonality. A time-series forecast done during a seasonal upswing would predict this upswing to keep on going upward, while your visual review clearly shows that the upswing will very likely go to a downswing in a predictable manner. The seasonality needs to be removed (deseasonalizing) or the results will be of little use.

Deseasonalizing The process of deseasonalizing data involves generating a seasonal index. Calculating a seasonal index requires several years’ worth of

data (for seasonality that occurs over an annual period). The data used to create the chart in Exhibit 1-31 are shown in Exhibit 1-32 below along with the calculations required to find the seasonal index.

Exhibit 1-32: Creating a Seasonal Index

If you would like to experiment with an interactive version of the worksheet used as a running example for both time-series forecasting and error calculations, download the “Forecasting Model” spreadsheet from the Resource Center. The index is calculated as follows, using monthly time buckets with three years of data. (Other time periods and buckets could be used instead.)

1. Calculate the month average for each month. The month average is the sum of each year’s results for a given month divided by the number of years. For example, January results for year 1, year 2, and year 3 are summed and divided by 3 to find the month average of 31 units. This is then done for each of the other months. 2. Calculate the year average. Sum the 12 month averages and divide by 12. In the example, this is 168/12 = 14 units. This year average is deseasonalized because it averages out the rise and fall in sales. 3. Calculate the seasonal index. Divide each month average by the year average. In Exhibit 1-32, the seasonal index for January is 31/14 = 2.214. This is repeated for each other month. Note how the months with higher-than-average demand have an index over 1.0 while months with lower-than-average demand have an index of less than 1.0. The general formula for calculating the seasonal index is

The next step in the deseasonalization process is to apply the seasonal index to the raw data, which will result in deseasonalized data.

Deseasonalizing data involves dividing the raw data by the seasonal index for the given month. Exhibit 1-33 shows this for the year 1, year 2, and year 3 data. For example, the January year 1 data of 34 units was divided by 2.214, resulting in 15.35 units. The process is repeated for each of the 36 data points.

Exhibit 1-33: Generating Deseasonalized Data

Simple and Weighted Moving Averages, Exponential Smoothing Once the data are deseasonalized, they are ready for use in forecasting with the simple and weighted moving averages and exponential smoothing.

The simple moving average is the average of demand from several preceding periods. Three- and six-month periods are commonly used. For example, a three-month moving average would be calculated as follows, where M1, M2, and M3 are the three most recent months:

This is a moving average because it is recalculated using the most recent set of months (or other periods), dropping the oldest month and adding the just-ended month to the list. The simple moving average can be useful when demand is relatively constant from period to period. The method can be used to prevent an overreaction to a random or irregular spike or dip in a given month because it smooths out these variations. However, if there is a change in a trend, this method would be slow to respond to it. It would lag the trend, in other words, so is best used when a trend is relatively flat. Using more periods. such as a sixmonth moving average, will make the method even less sensitive to random variation by smoothing more, but it would also make it lag a trend more. One disadvantage of averaging multiple periods is that data collection and organization can be complex when multiple products in a product family need to be forecasted.

The weighted moving average (or weighted average) forecasting method places weights on the periods being averaged, usually to put greater emphasis on the more recent periods and relatively less emphasis on the more distant periods. Thus it allows trends to have more of an impact on the forecast. The weights are usually selected using expert judgment and trial and error. While any weighting system can be used, only testing against historical data can prove whether a given set of weights is a better predictor than another set. When calculating the average, you divide by the sum of the weights rather than the number of periods. For example, if the third month out is given a weight of 1, the second month out a weight of 2, and the most recent month a weight of 3, you would divide this three-month weighted moving average by (1 + 2 + 3) = 6, for example:

Exponential smoothing uses three inputs in its equation: the last period’s forecast, the last period’s demand, and a smoothing constant, a number greater than 0 and less than 1 represented by the Greek letter alpha (α), which is basically a percentage

weighting where 1 = 100 percent. One way to calculate exponential smoothing is

Using this equation produces a weighted average of previous results. As you increase α closer to 1.0 or 100 percent, you get closer and closer to a naive forecast, with 1.0 being a naive forecast since it is 100 percent weighted on last period’s demand and 0 percent weighted on the prior period’s forecast. A constant of 0.3, on the other hand, would put 30 percent of the weight on the last period’s demand and 70 percent on the last period’s forecast. This constant smooths out random or irregular spikes or dips in actual demand by placing more weight on the prior forecast. Most organizations select a smoothing constant between 0.05 and 0.5. A constant of 0.05 would give minimal weight to the preceding period’s actual demand, while 0.5 would equally weight the actual and forecast results. The constant value is selected by experience, trial and error, and testing against historical data. This method is often used when you want to minimize the lag that exists when trends shift, but, like all time-series models, it cannot eliminate this lag. Exhibit 1-34 shows how the simple and weighted moving averages and exponential smoothing would be calculated in a worksheet. All of

the data shown in the exhibit are still deseasonalized. The data would be entered in columns, and formulas would be entered (or dragged down) wherever the numbers are bold. The last column in the left-side version shows deseasonalized actual results. Also in this version, each month’s forecast would be created as soon as the actuals for the necessary number of periods become available. Exhibit 1-34: Comparison of Forecasts (Deseasonalized Data)

The smoothing constant selected for exponential smoothing in this example is 0.3. Exponential smoothing cannot be calculated unless the prior period’s actuals are known, but you can use the other forecasting methods to project further into the future. To do this, you would substitute forecast data for demand data for those future periods, as is shown in the right-hand version. Note, however, how the forecast quickly becomes repetitive when forecast data are used in place of actual results; after a few periods, everything is based on forecast data and an average or weighted average of the same three numbers results in the same number. It shows how these methods are less useful the further you go into the future. Note that the three methods produce fairly accurate results, but there is some variance from the actual results for all three methods. The exponential method seems to do better in most periods, but the actual results of 14.64 units (cell I58) is lower than the predicted 15.64 units (cell E58), which will have an impact on the error for that period. However, it bounces back to being more accurate in March because of the 70 percent weight placed on the last period’s forecast.

Reseasonalizing Reseasonalizing involves multiplying the deseasonalized data by the given period’s seasonal index to find the seasonalized forecast values. In Exhibit 1-35, the deseasonalized data for the moving average (the “Moving Year 4” column) is multiplied by the seasonal index and the resulting forecast in units is shown in the “Moving Average” column (column R). For example, the seasonal index of 2.214 for January is multiplied by the moving average January forecast of 13.99, resulting in 30.97 units (which would be rounded up to a forecast of 31 units). The weighted average and exponential columns are similarly calculated.

Exhibit 1-35: Comparison of Forecasts (Reseasonalized Data)

Note the February year 4 actual results—only 29 units were sold. While all of the forecasts were high, the exponential forecast was off by the most. On the other hand, it returns to low amounts of variance right after that month of irregular demand and otherwise has lower error rates. When you are done creating a forecast, it is generally useful to finish by visualizing the data again in chart form. You can also use charts to present the forecast to decision makers since they can make your forecast easier to digest. Exhibit 1-36 shows a chart with both the raw data and the deseasonalized data and uses dark shading to show a one-year forecast of demand using the three-month moving average method applied to the deseasonalized actual demand (which would become available month by month). The resulting forecast is then reseasonalized. Note that the deseasonalized data would normally not be shown in a chart at all since it is not useful for making decisions in and of itself. It is simply used to produce the reseasonalized forecast for demand planning.

Exhibit 1-36: Deseasonalized and Reseasonalized Data with Forecast

When trends vary too much for these time-series methods to be useful in predicting demand (or anything else being forecasted), associative forecasting can be used.

Service-Sector Forecasting Some service businesses present special forecasting challenges, since their demand may fluctuate hour by hour rather than on a monthly basis. These rapid changes in demand have significant implications for scheduling and ordering.

Restaurants, for instance, must take into account variations in amount and type of demand by hour of the day, day of the week, and season of the year. They require sophisticated demand planning in more ways than one, since they have to guess right about not only the level of aggregate demand but also the amount of demand for each of the menu items. Running out of an item means disappointing some customers; stocking too much of a perishable item means financial losses and waste. Computers can be invaluable in tracking point-of-sale data as they occur. Before automation, detailed tracking meant keeping a manual log during the day or sorting through receipts. Exhibit 1-37 illustrates the forecast for a fast-food restaurant’s demand requirements from lunchtime through dinner.

Exhibit 1-37: Restaurant Demand by Hour of Day

These projections are useful in determining all the capacity requirements of a restaurant—numbers of workers to put on each shift, number of registers to maintain, number of tables, space requirements, and so on—as well as in making decisions about food items to stock.

Quantitative Methods: Associative Forecasting Associative forecasting (also called causal, correlation, explanatory, or extrinsic forecasting) uses data gathered from one or more internal or external sources as a predictor of something that is presumed to be correlated. The predictor is called the independent variable. The element being predicted is called the dependent variable, and it could be demand for a product family or for total organizational sales. While the time-series method is best for short- or medium-term forecasting, the associative method is best for long-term forecasting, especially at the aggregate level. Part of the reason for this is that these models require larger data sets and generally have higher costs; they use information with predictive value to form a forecast rather than just looking at past results.

Prior to discussing specific associative methods, let’s look at the distinction between correlation and causation. We’ll also examine leading versus lagging indicators, since they are often the predictors used in an associative forecast. After that, simple and multiple regression are covered.

Correlation Versus Causation Correlation is an observation that the change in an independent variable has a measurable effect on a dependent variable. However, just because the effect can be reliably observed over time does not mean that it can be called causation, which occurs when a change in an independent variable directly causes the measurable effect on a dependent variable. It could be that some third force is affecting both of them, or the correlation could be a coincidence that would be proven incorrect after a longer period of study.

Leading and Lagging Indicators According to the APICS Dictionary, 16th edition, a leading indicator is “a specific business activity index that indicates future trends.” Leading indicators provide information that enables organizations to anticipate or predict micro- or macroeconomic changes. Acknowledging trends allows a company to prepare to take action to achieve a certain outcome and avoid undesirable circumstances. For instance, if a residential hardware manufacturer researches the

residential home market and sees that building permits are down and a recession is near, it may decide that it should order more inexpensive components from its suppliers for its faucet products, since consumers will probably be more interested in making repairs to existing hardware rather than buying brand-new faucets. The following are some leading economic indicators: Building permits issued for new production facilities, housing, warehouses, utilities (Building permits imply future construction, and construction leads to other types of production.) Initial unemployment insurance claims (Initial claims for unemployment are more dependent upon business conditions than other unemployment metrics.) Orders for plant equipment or manufacturers’ orders for durable goods and materials (New orders indicate increased production, which decreases inventory and increases unfilled orders.) Changes to the total amount of money in an economy that is available at a specific point in time—the money supply adjusted for inflation (Bank lending typically declines when inflation rises faster than the money supply, and this harms economic expansion.) Standard & Poor’s 500 stock index (Investors’ expectations about the economy and interest rates are reflected by changes in the stock prices of the 500 largest U.S. companies.)

The difference between long- and short-term interest rates (The line that results from plotting, at a certain time, the market interest rates of a financial instrument— for instance, a bond—over a range of maturity dates is called a yield curve. An inverted yield curve indicates that shorter-term yields are higher than longerterm yields, a possible sign of an upcoming recession. Changes to the yield curve usually accurately predict economic swings.) The level of consumer optimism about the economy (Consumer expectations often indicate future changes in spending.) Lagging indicators are the economic and financial factors that reflect the changes that have already occurred in the economy. They usually confirm a pattern and often provide data or actionable information about six months after the fact and therefore are more reactionary. For example, the unemployment rate is one of the most widely used lagging indicators. Generally, the unemployment rate will fall after a few months of economic growth. If a leading indicator of hours worked is increasing, after a few months the lagging indicator of unemployment should fall. Some other lagging economic indicators include the following: Outstanding business and commercial loans (Demand for loans generally peaks about a year after a peak in the overall economy.)

Comparison of inventory to sales (Increases in inventory usually mean that sales goals were missed, indicating a slowing economy.) Changes in company profits (Decreases in profitability have a domino effect often felt by many members of a supply chain.) Spending by businesses (Decreases in customer spending, particularly manufacturers’ customers, ultimately result in a downturn in the manufacturers’ business, too.) Consumer price index (CPI) (Increases in the prices of consumerrelated service products usually occur within the first few months of a recession and taper off at the start of a recovery.) Average duration of unemployment (This is the average number of weeks an unemployed person has been out of work.) By paying attention to both leading and lagging indicators, a company can reinforce that it is on the right track. It is important to apply common sense when selecting indicators to use as independent variables (predictors). The indicators selected should be easy to measure, objective, pertinent to the strategy, costefficient, and embraced by the group whose processes are being analyzed. For example, a roofing shingle company might predict sales of its roofing materials using data on the prior month’s housing starts, total marketing spend, or extreme weather events like

hurricanes. These make sense. However, even if data on recent college graduation rates correlate with roofing material sales, they are less likely to be a good predictor. Remember that chosen predictors need to make sense to decision makers, too.

Simple Regression Simple regression (also called linear regression) uses a formula to make an association between the dependent variable y (the element being predicted) and the independent variable x (the predictor), with two other elements, alpha and beta. Beta (β) is the slope, which is a value used as a multiplier to find the correct placement of the forecast result. Alpha (α) is the intercept, which is where the slope intercepts 0 on a chart. In the case of the housing starts to roofing sales example, if there were 0 housing starts the prior month, what would roofing sales be? That is the intercept. These two values can be calculated manually for a data set, but often forecasters calculate them quickly using the free add-on data analysis toolset for Microsoft Excel. Once you know these values, it is a simple matter of plugging the value for x (e.g., housing starts) into the formula below to find the forecast, y. Exhibit 1-38 shows the prior month’s housing starts against the organization’s total roofing sales and helps to explain how those two variables work.

Exhibit 1-38: Simple Regression Slope and Intercept Defined for Roofing Sales Example

Exhibit 1-39 shows the same data, but now both housing starts and roofing sales are shown over time. This visualization shows that there is some correlation, so further analysis is worthwhile.

Exhibit 1-39: Simple Regression Slope and Intercept Defined for Roofing Sales Example

So, how do we tell whether there is enough correlation to use this predictor in our sales forecast? The statistical term that defines the strength of correlation is called the coefficient of correlation (r). Basically, it is a number between –1.0 and +1.0 where –1.0 is perfect negative correlation: An increase in the predictor causes an equal decrease in the predicted element. +1.0 is perfect positive correlation: An increase in the predictor causes an equal increase in the predicted element, and a decrease in the predictor causes an equal decrease in the predicted element. (They rise and fall together.) 0.0 is not correlated at all.

In this example, the value is +0.79, which means that the element is positively correlated at about 79 percent, which is a strong positive correlation worth pursuing. Another way of stating this is that this predictor explains about 79 percent of the change in roofing sales, with the remaining factors being other causes. Weaker values would indicate that you should find some other predictor.

Multiple Regression Multiple regression is an extension of simple regression; there are multiple predictive variables rather than just one. For example, one could add marketing spend as another predictor to the roofing sales analysis to see if this increases or decreases the predictive value of the model.

Topic 3: Measures of Forecast Error Here we look at forecast error and accuracy and the effect of bias and random variation along with several error-tracking methods: mean absolute deviation, the tracking signal, standard deviation, mean squared error, and mean absolute percentage error.

Forecast Error and Accuracy

Since the first principle of forecasting is that forecasts are (almost) always wrong, organizations need to track forecasts against actual demand results and find ways to measure the size and type of error. Note that the size of an error can be measured in units or percentages, but often finding a way to put a monetary value on the error can help in focusing on the most expensive errors. (Being off by 1,000 on an item that costs US$1 will differ significantly from the same amount of error for an item that costs US$100.) Forecasters can use error measurements to modify forecasts to reduce the amount (and costliness) of error. If software does your calculations, the program can select the smoothing constant that will reduce your historical forecast errors to a minimum. Forecast error is “the difference between actual and forecast demand” (APICS Dictionary, 16th edition). The formula for forecast error as an absolute value follows. (Assume a time-series forecasting result with actual demand of 29 units and forecast demand of 33.51 units.)

An absolute value is a number that is stated without regard to positive or negative signs, so the absolutes of +4.51 and –4.51 are both 4.51. The equation above expresses the absolute value mathematically using vertical bars, e.g.,│–4.51│ = 4.51. Absolute values of forecast error are used in some of the error tracking methods discussed elsewhere, such as mean absolute deviation. When expressing forecast error as a percentage (also known as absolute percentage error [APE]), the equation is as follows (with a continuation of the prior example):

Forecast accuracy is simply the complement of the forecast error as a percentage, expressed as follows (with a continuation of the prior example):

Bias and Random Variation Forecast error can be the result of bias or random variation.

Bias . Bias is defined in the APICS Dictionary, 16th edition, as a consistent deviation from the mean in one direction (high or low). A normal property of a good forecast is that it is not biased. Bias exists when the cumulative actual demand differs from the cumulative actual forecast. For example, if actual demand is 34, 29, and 13, cumulative actual demand adds these amounts to arrive at 76. If the forecast demand is 34.4, 33.51, and 12.05, the cumulative forecast demand is 79.96. Calculating bias can use a variation on the forecast error calculation, but it doesn’t use absolute amounts because the plus or minus sign can show the direction of the bias:

Any answer that does not result in zero reflects a bias. The size of the number reflects the relative amount of bias that is present. A negative result shows that actual demand was consistently less than the forecast, while a positive result shows that actual demand was greater than forecast demand. Bias could be the result of a temporary situation or an unaccounted-for change in a trend or seasonal effect. Tracking the

circumstances surrounding each significant bias can help distinguish between the two. For example, bias caused by a onetime bulk sales order would not require modifying the forecasting model, but a significant shift in a trend or seasonal effect (or shifts in the timing of these effects to earlier or later periods) requires changes to the forecasting model (e.g., seasonal index or smoothing constant) or process (e.g., could be a result of overly optimistic qualitative adjustments). Random variation. In terms of measuring errors, random variation is any amount of variation in which the cumulative actual demand equals the cumulative forecast demand. For example, if actual demand is 100 for three periods, cumulative actual demand is 300, and if forecast demand is 90, 110, and 100, the cumulative forecast demand is 300. Because of the zero net difference, the error over this period can be said to be the result of random variation. Note that wide swings in either direction that just happen to balance out would still be difficult to plan around.

Mean Absolute Deviation (MAD) A common way of tracking the extent of forecast error is to add the absolute period errors for a series of periods and divide by the number of periods. This gives you the mean absolute deviation

(MAD). Note: In the formula below, the Greek uppercase letter ∑ stands for “the sum of.”

The APICS Dictionary, 16th edition, defines MAD as the average of the absolute values of the deviations of observed values from some expected value. It can be calculated based on observations and the arithmetic mean of those observations. An alternative is to calculate absolute deviations of actual sales data minus forecast data. These data can be averaged in the usual arithmetic way or with exponential smoothing. With absolute values, whether the forecast falls short of demand or exceeds demand doesn’t matter; only the magnitude of the deviation counts in MAD. We can see how this works using the time-series demand and smoothing forecast example shown in Exhibit 1-40. Note that error rates for all three methods are shown, but we will focus on the exponential smoothing method primarily.

Exhibit 1-40: Mean Absolute Deviation with Smoothing

A MAD of 1.68 units implies that forecasts are off on average for the review period by about plus or minus 1.68 units. Exhibit 1-41 shows MAD from Exhibit 1-40.

Exhibit 1-41: Normal Distribution Curve for MAD of 1.68 Units

MAD may be used as the basis for safety stock calculations. This is because when a forecast is in error and lower demand is planned for than the actual demand that occurs, stockouts could result. Higher levels of safety stock will be needed to safeguard against those less probable events at the stockout end of the normal distribution curve. In Exhibit 1-41, the center is the average or central tendency, which would be a forecast matching actual demand in this example. The left-hand side of the curve is the likelihood that demand will be less than the forecast, which means that 50 percent of the time there will

be sufficient inventory or possibly an overstock situation. The righthand side of the curve is the likelihood that demand will be greater than the forecast, or a potential stockout situation if not enough safety stock is held. Note that this is a normal MAD distribution curve. In the exhibit, ±1 MAD, or up to ±1.68 units in error, should be experienced 60 percent of the time (plus or minus 30 percent from the mean). For a stockout probability, 1 MAD adds the 50 percent overstock probability to the 30 percent zone for 1 MAD for an 80 percent probability that there will still be sufficient stock if 1.68 units are held as safety stock (two units if rounded up). Moving further out in the curve, ±2 MAD means that in some instances the error will be up to two mean absolute deviations, and adding the two 15 percent zones means that 90 percent of results should be within ±2 MAD, or ±3.36 units (1.68 × 2). Again, for a stockout probability, 2 MAD adds the 50 percent overstock probability to the 30 percent zone for 1 MAD and the 15 percent zone for 2 MAD, to equal a 95 percent probability that sufficient inventory will be in stock if at least 3.36 units are held as safety stock (four units rounded up). Similarly, 98 percent of all results should fall within ±3 MAD, or ±5.04 units (1.68 × 3), which equates to about a 99 percent probability that there will be no stockouts if at least 5.04 units (six units rounded up) of safety stock are held. The chance of a stockout is calculated as one minus the

percent chance of sufficient inventory. For 2 MAD, this is 1 − 0.95 = 0.05 = 5 percent chance of stockout. Note that an analyst would provide actual MADs for a given service level. If a specific service level is desired, such as 98 percent of orders with no stockouts, analysts can calculate the exact MAD to use as the multiplier in the calculation of units of safety stock. This multiplier is called a safety factor. The APICS Dictionary, 16th edition, defines safety factor in part as follows. The numerical value used in the service function (based on the standard deviation or mean absolute deviation of the forecast) to provide a given level of customer service. For example, if the item’s mean absolute deviation is 100 and a .95 customer service level (safety factor of 2.06) is desired, then a safety stock of 206 units should be carried. This safety stock must be adjusted if the forecast interval and item lead times differ. Exhibit 1-42 shows a safety factor table. For the purposes of the following example, note how a 98 percent service level has a safety factor of 2.56 MAD (or 2.05 if standard deviation in units is known).

Exhibit 1-42: Safety Factor Table Percentile Customer Service Level

Standard Deviation Units x Factor Below

MAD Units x Factor Below

50.00

0.00

0.00

75.00

0.67

0.84

80.00

0.84

1.05

84.13

1.00

1.25

85.00

1.04

1.30

89.44

1.25

1.56

90.00

1.28

1.60

93.32

1.50

1.88

94.00

1.56

1.95

94.52

1.60

2.00

95.00

1.65

2.06

96.00

1.75

2.19

97.00

1.88

2.35

97.72

2.00

2.50

98.00

2.05

2.56

98.61

2.20

2.75

99.00

2.33

2.91

99.18

2.40

3.00

99.38

2.50

3.13

99.50

2.57

3.20

99.60

2.65

3.31

99.70

2.75

3.44

99.80

2.88

3.60

99.86

3.00

3.75

Percentile Customer Service Level

Standard Deviation Units x Factor Below

MAD Units x Factor Below

99.90

3.09

3.85

99.93

3.20

4.00

99.99

4.00

5.00

Source: www.supplychainchannel.org

Note also the relationship between standard deviation and MAD. Look at the 84.13 percentile customer service level row. When standard deviation is 1.0, MAD is 1.25. In fact this relationship continues throughout. A rule of thumb is that multiplying MAD times 1.25 results in an approximation of standard deviation.

Tracking Signal According to the APICS Dictionary, 16th edition, the tracking signal is “the ratio of the cumulative algebraic sum of the deviations between the forecasts and the actual values to the mean absolute deviation.” The tracking signal can be calculated as shown in Exhibit 1-43 (Note that the example uses data from column AF.)

Exhibit 1-43: Tracking Signal

The algebraic sum of forecast errors is a cumulative sum that does not use absolute values for the errors. Therefore the tracking signal could be either positive or negative to show the direction of the bias. Organizations use a tracking signal by setting a target value for each period, such as ±4. If the tracking signal exceeds this target value, a forecast review would be triggered.

Many organizations calculate and track each stock keeping unit (SKU) on a monthly basis. This helps measure two aspects of the forecast: Forecast bias. If the tracking signal is continually negative, we are consistently over-forecasting. If it is consistently positive, we are under-forecasting. Ideally, the tracking signal should oscillate between positive and negative values. If not, it should be the first thing to work to eliminate. Suitability of the forecasting method. If the tracking signal remains in a range of +4 to −4, then, as a rule of thumb, the method being used to forecast the SKU should be considered to be working correctly. If it is outside this range, review the forecasting methodology to find something more suitable.

Standard Deviation Another way to estimate forecast error would be to use standard deviation. The APICS Dictionary, 16th edition, defines standard deviation as follows: A measurement of dispersion of data or of a variable. The standard deviation is computed by finding the differences between the average and actual observations, squaring

each difference, adding the squared differences, [and] dividing by n. A formula for standard deviation is commonly available in most forecasting or spreadsheet software programs. Note that standard deviation measures the amount of variation in actual results from the central tendency (the peak of the bell curve) and does not use forecast error as an input but rather assesses the relative level of variability of actual results as a proxy for how much error in a forecast is likely. It can also be used to determine how much safety stock to use using a safety factor table. (There is a variant called root mean squared error that does use forecast error as an input.) The final part of the standard deviation formula is to take the mean of the squared differences (that is, after dividing by n [n = number of data points]) and apply a square root to it. Note also that a variation on standard deviation instead divides by n – 1. This formula is used in the more common situation when this is a sample of data that you want to extrapolate to the whole population; n is used when you are using the entire set of data and don’t need to extrapolate. Alternatively, some practitioners use n– 1 when there are 30 or fewer samples from the population and n when there are more samples than these, since the effect being corrected for is not as important when more samples than these are used.

The more common formula for standard deviation follows. (Note: In the formula below, the Greek uppercase letter ∑ stands for “the sum of.”)

Exhibit 1-44 shows a bell curve for standard deviation along with the percentage probabilities of a result being in a particular number of standard deviations from the mean (center dotted line). For example, 1 SD is 34.13 percent and 2 SD adds 13.59 percent more probability, so the chance of a stockout at 2 SD is the sum of these amounts, or 47.72 percent. However, since there is also a 50 percent chance of an overstock (left side of the bell curve), this is also added, which results in a 97.72 percent chance of an item being in stock at 2 SD.

Exhibit 1-44: Normal Distribution Curve for Standard Deviation

If standard deviation is the information you have at your disposal, you can use a safety factor table to calculate the safety stock at a given service level. Let’s assume SD of 2.1 units. Also assume a desired 98 percent service level, which is a safety factor of 2.05. This results in a need to hold about five units of safety stock:

Mean Squared Error (MSE)

Another method of calculating error rates, the mean squared error (MSE), magnifies the errors by squaring each one before adding them up and dividing by the number of forecast periods. Squaring errors effectively makes them absolute, since multiplying two negative numbers always results in a positive number. Note that the errors are squared before being summed, which requires new columns in the worksheet, as shown in Exhibit 1-45. The formula for mean squared error follows (with an example from the exhibit below):

MSE and MAD Comparison Note in Exhibit 1-45 how the process of squaring each error using the MSE method gives you a much wider range of numbers than when the mean absolute deviation (MAD) is used. For example, in row 4 of the spreadsheet, the MAD for the exponential smoothing method is –4.51 while with MSE it is the 20.31. In addition to the large results being much larger, fractional results become smaller. This is seen in row 3 of the spreadsheet, where the MAD is –0.40 but squaring this for MSE results in 0.16.

The greater range gives you a more sensitive measure of the error rate, which is especially useful if the absolute error numbers are relatively close together and reduction of errors is important.

Exhibit 1-45: Mean Squared Error and MAD Compared

Measuring the extent of deviation helps determine the need to improve forecasting or rely on safety stock to meet customer service objectives.

Mean Absolute Percentage Error (MAPE)

There is a drawback to the MAD calculation in that it is an absolute number that is not meaningful unless compared to the forecast. Mean absolute percentage error (MAPE) is a useful variant of the MAD calculation because it shows the ratio, or percentage, of the absolute errors to the actual demand for a given number of periods. The example continues the study of the exponential forecast error in Exhibit 1-46.

Exhibit 1-46: Mean Absolute Percentage Error (MAPE)

Exhibit 1-46 shows how the absolute percentage error (APE) is first determined for each period by taking the absolute error divided by the actual demand. This is done for each month in a new set of columns. Then, the sum of the APE (percentage) for periods 1 through 12, which is 206.9 percent for the exponential method (see column AA), is divided by the number of periods, 12 in the example, to calculate the MAPE. On average, MAPE is 17.2 percent. Note that the result is expressed as a percentage. Exception rules for review can be applied to any stock keeping unit or product family that has a MAPE above a certain percentage value. Percentage-based error measurements such as MAPE allow the magnitude of error to be clearly seen without needing detailed knowledge of the product or family, whereas an absolute error in units (or an error in dollar amounts) requires knowing what is considered normal for the product or product family.

Section E: Supply and Demand Alignment This section is designed to Describe operations planning and control, master planning, sales and operations planning (S&OP), the demand plan, and the production plan Review the role of strategy in operations planning and control and its overall process Identify the purpose and elements of S&OP Describe what occurs in the meetings and steps of the S&OP process Explain how to use a demand plan dashboard Explain that S&OP reconciles the requirements of multiple areas: demand, supply, and financial plans Describe ways to promote and implement S&OP at an organization Describe how demand management and prioritization are achieved using a process of reconciliation and analysis Describe the demand management functional responsibilities and interfaces with product development, marketing, sales, and operations.

This section covers the operations planning and control concepts that help supply chain managers enable long- and short-term demand, supply, and financial planning so that sourcing, acquisition, manufacturing control, delivery, invoicing, and payment form a smooth and fast cycle.

Topic 1: Supply and Demand Alignment Here we set the stage for the sales and operations planning process by providing an overview of the supply and demand alignment process called operations planning and control. After that, strategic planning, master planning, and resource planning are addressed more.

Supply and Demand Alignment Road Map Exhibit 1-47 provides an overview of how supply and demand are aligned using a process called operations planning and control.

Exhibit 1-47: Operations Planning and Control

The core functions in this process are called master planning. The APICS Dictionary, 16th edition, defines master planning as a group of business processes that includes the following activities: demand management (which includes forecasting and order servicing); production and resource planning; and master scheduling (which includes the master schedule and the rough-cut capacity plan).

Note how master planning uses strategic planning (and business planning) as a key input, plus information from the demand and supply sides of the organization that is brought together using sales and operations planning to produce a consensus demand plan and production plan. The center column shows the supply-side outputs. The production plan, based on a consensus demand plan from sales and operations planning, is developed to guide master scheduling, which produces a master production schedule and plans for the necessary raw materials in material requirements planning. This in turn is used for controlling production and scheduling assembly (production activity control and final assembly scheduling). The exhibit shows how both the demand and supply organizations have continuing input as plans grow more and more detailed and time horizons grow shorter and shorter. The high-level demand-side activities of forecasting and demand management involve demand sensing and creation activities and result in a demand plan. The distribution requirements planning process involves determining the inventory replenishment needs at distribution centers. The supply-side activities start with resource planning, which determines the need for capital investments or capacity

modifications. The remaining activities in the right-hand column of the exhibit address whether evolving plans are feasible from an operations capacity standpoint. To expand upon Exhibit 1-47, the basic steps in operations planning and control can be summarized as follows. Demand history data are gathered and cleansed. A statistical forecast is run and analyzed for events or outliers that are not expected to repeat in the future. The statistical forecast with associated errors is reviewed with the product and brand management, marketing, and sales teams. The teams add information to the demand plan that will improve forecast accuracy. The demand plan is finalized with the demand-side teams and passed on to supply. The supply team reviews the demand plan and constrains it based on capacity and material availability. Both supply and demand review the constrained plan with the finance team and executive management. When the executive S&OP meeting is held, the result is the communication of a single plan: Sales sells to the plan and supply produces to the plan. One of the outputs of S&OP is the production plan, which provides the rate of production at the product family level. Resource

requirements are evaluated with the resource plan. The production plan is the input to master scheduling, and its output is the master production schedule (MPS). The MPS is typically a weekly plan at the item level with an evaluation of capacity using rough-cut capacity planning. Then material requirements planning uses bill-of-material data, inventory data, and the MPS to calculate requirements for materials, resulting in planned production and purchase orders. Production activity control receives the output of material requirements planning and detail planning, and shop floor scheduling is done.

Strategic, Master, and Resource Planning Strategic and business planning, master planning, and resource planning are addressed next.

Strategic and Business Planning The organization’s strategic and business plans are the foundation for the organization’s master planning, sales and operations planning, and resulting production plan.

The strategic plan is a long-term plan, extending over five to ten years or more, that focuses on how to marshal resources and determine actions to support the mission and goals of the organization. It clearly identifies the mission, goals, and objectives and sets the high-level direction of the organization, including broad goals for market share, revenue, profits, and growth. The objectives of organizational strategy indicate what value the organization will provide to customers or constituents in terms of products/services and what value operations should generate for the owners. While organizational strategy is set for the long term, it is updated periodically in response to the organization’s strengths and weaknesses and the opportunities and threats in the current operating environment. An organization’s business plan states organizational strategy in more specific terms and sets goals for achieving the strategy over the next one to three years or more. The business plan specifies how value will be created for both customers and owners and what the results should be in terms of market share, revenue, cash flow, profits, and measurements such as customer satisfaction. The business plan is typically stated in dollars and grouped by product family. There may be overly optimistic projections from marketing at some points, but the numbers are there for later review

as well as to specify projected revenues, costs, profits, and objectives for the product families—all to support the long-range strategy proposed for entering the marketplace. Key inputs to the business plan include the demand plan and its long-term forecasts. Budgets and projected financial statements are key outputs. A business plan should Clarify strategy by stating an explicit vision for the business—a reason for being Provide a point of reference for the sales and operations plan Describe long-term strategies that will be used to guide shorterterm tactical plans for producing and selling the product. As the organization begins spending the lender’s or stockholders’ money and the market heats up (or doesn’t heat up), the plan sometimes disappears into a file and becomes part of history. It shouldn’t. An objective for business planning is to update the business plan annually to reflect changes in strategy and to use the disciplined sales and operations planning process on a monthly basis to evaluate progress against the plan and make adjustments as needed. Thus the business plan is the parent of every operations planning and control activity described here.

Master Planning

The next step after the business plan is development of a master plan. This is a long-term resource plan and a near-medium-term sales and operations plan based on the longer-term views of the business plan. Master planning starts by taking the forecast and determining what production can accomplish using available capacity (S&OP) and by directing investments in capacity (resource planning). The overarching goal is always to satisfy the organization’s stakeholders. In a for-profit organization, this means providing the lenders and investors with the return on investment they anticipated when they signed on as financial partners in the enterprise.

Resource Planning Resource planning (RP), or resource requirements planning (RRP), takes the longest view of the system’s capacity, typically going out 15 to 18 months but sometimes requiring much longer planning horizons for capital investments. Resource planning is defined as follows according to the APICS Dictionary, 16th edition: Capacity planning conducted at the business plan level. The process of establishing, measuring, and adjusting limits or levels of long-range capacity. Resource planning is normally based on the production plan but may be driven

by higher level plans beyond the time horizon for the production plan (e.g., the business plan). It addresses those resources that take long periods of time to acquire. Resource planning decisions always require top management approval. The duration of the planning horizon depends on the lead time of the needed resources, which may be a machine to produce the planned product. The total lead time needed would include not only order lead time and installation time but also the lead time needed to conduct operations. Equipment or facility construction with long development lead times may be driven primarily by the business plan, while realigning existing facilities and the workforce to change capacity is more likely to be based on the production plan generated during the S&OP process. Note that capital expenditures in facilities or expensive equipment is an executive-level decision, while the resource planning that is based on the production plan is more likely to be a supply chain management decision. In this latter case, resource planning may be used to plan for materials with very long lead times.

Topic 2: Sales and Operations Planning

Sales and operations planning (S&OP) is an important process for supply chain managers because it is how the organization comes to consensus on what is needed and what is capable of being purchased or produced. Here we present the big-picture overview of S&OP, followed by a discussion of the important inputs to and outputs of the process. Reconciliation is the final step in the S&OP process, where supply, demand, and financial plans are reconciled with each other. A discussion of how to implement S&OP is also provided. Finally, we address demand management and prioritization, which is the final component of the demand management process.

S&OP Process The APICS Dictionary, 16th edition, defines sales and operations planning (S&OP) as follows: A process to develop tactical plans that provide management the ability to strategically direct its businesses to achieve competitive advantage on a continuous basis by integrating customer-focused marketing plans for new and existing products with the management of the supply chain. The process brings together all the plans for the business (sales, marketing, development, manufacturing, sourcing, and financial) into one integrated set of plans. It is performed at least once a

month and is reviewed by management at an aggregate (product family) level. The process must reconcile all supply, demand, and new-product plans at both the detail and aggregate levels and tie to the business plan. It is the definitive statement of the company’s plans for the near to intermediate term, covering a horizon sufficient to plan for resources and to support the annual business planning process. Executed properly, the sales and operation planning process links the strategic plans for the business with its execution and reviews performance measurements for continuous improvement. S&OP stands both for the sales and operations plan and sales and operations planning. It is both a plan and the process that creates, implements, monitors, and continuously improves the plan. The S&OP process involves a series of meetings to arrive at consensus demand and production plans that reflect the results of demand-side sensing and influencing activities and supply- and finance-side capabilities and constraints. Wallace and Stahl, authors of Sales and Operations Planning: The How-to Handbook, list the following meetings in S&OP: Data gathering Demand planning Supply planning Pre-meeting

Executive meeting Crum and Palmatier, in Demand Management Best Practices, discuss two additional meetings. The first is a product review after the data-gathering step, and the second is a financial review after the supply planning step. These meetings map to an overall S&OP process. The steps in this process are Reviewing performance Evaluating demand levels Evaluating supply capability Reconciling demand, supply, and financial plans. The sequence of processes and activities is shown in Exhibit 1-48.

Exhibit 1-48: S&OP Process and Meetings

S&OP culminates in a monthly executive meeting to gain agreement on a plan to balance supply with demand, but it requires two weeks or more of team member preparations and preliminary meetings. S&OP can be run on a different timetable, but monthly data collection, analysis, and meetings are typical. The results of the prior month’s meetings are used as the basis for the current month’s meetings; replanning is used in each review meeting as well as in the overall process. The purpose of these meetings is to give each area of the organization sufficient time to prepare tactical plans and study the plans submitted to them so they can assess what impact the plans would have on their area of concern. In this way, the S&OP process ensures that detailed reviews are occurring, that decision makers from each part of the organization get a reliable understanding of the organization’s current needs and capabilities, and that checks and balances are in place to give executives understanding of and control over the direction of the organization.

Reviewing Performance The product review meeting involves updating the status of new product developments, product changes, or other organizational process change initiatives that could affect supply or demand. This

meeting involves product and brand management, but other managers involved in process change initiatives could also attend as needed, such as involving an IT professional if the organization is implementing a new enterprise resources planning (ERP) system. Since a product or product feature’s time to market strongly impacts demand management activities, this meeting provides demand-side professionals with vital information on which to base their assumptions. The quality of this review rests on the quality of the data gathering that is done. Shortly after the end of the month, all the files necessary to develop the new statistical forecast should be updated. This needs to be done quickly to keep the process moving ahead on time. Timing the S&OP process to begin after the best data are available each month is a best practice.

Evaluating Demand Levels The demand planning phase includes a demand review meeting (or demand consensus review meeting), which is a meeting held between product and brand management, marketing, and sales professionals to agree to a single set of demand numbers and to document the assumptions used to make the decisions.

The highest ranking demand-side professional, such as the vice president of sales or marketing, not the demand manager, typically chairs this small, brief meeting between representatives of each department. The demand manager serves more as a facilitator in this meeting, such as by combining the individual plans of product and brand management, marketing, and sales into a single document prior to the meeting with recommended consensus numbers and areas with differences of opinion listed in the notes. The meeting is not intended to be a lengthy detailed review (this should have occurred prior to the meeting) but a way for the responsible and accountable leaders of each demand-side area to review the big picture and commit to a consensus view of demand that can be passed down to their subordinates and to the financial and supply sides of the organization. To keep the meeting brief, review is at the product family level; subfamilies are reviewed only on an exception basis. Other methods to promote brevity include reviewing only what has changed since the last meeting, focusing on validating assumptions, and reviewing only significant performance metric results. The rest of the meeting should be spent on what strategies can be employed to close any gaps between the demand plan and business plan revenue goals. The demand manager can facilitate these meetings by preparing

demand plan dashboards that consolidate the various departments’ plans, highlighting where significant disagreements exist. Exhibit 1-49 shows an example of such a dashboard for an 18-month demand plan in units. Note that the dashboard also lists examples of key performance metrics, assumptions, events, opportunities, risks, and decisions. Note also that a separate dashboard in monetary units would be provided to show the results of the unit plan in terms of its impact on organizational revenue.

Exhibit 1-49: Example of a Demand Plan Dashboard—Units

A key aspect of this and other review meetings is replanning. Since the plan is reviewed each month, replanning promotes consensus building. For example, referring to Exhibit 1-49, if there is significant disagreement over the amount or timing of the demand increase from the Period 6 TV ad buy, the demand-side leaders can agree to a number but also agree to revisit it the next month when new

information may be available to help clarify the issue. Participants could be assigned research tasks or be asked to communicate with others during the month so that they have better information for the next meeting. The success of the demand plan depends on the quality of the communication process. Finally, the demand review meeting is a place to review performance metrics in relation to demand and forecast accuracy. Organizations might set rules for exception review of performance metrics. For example, if the demand plan differs from actual demand for a particular product family for three months running, a detailed strategy review should occur to determine what can be done to improve results. Individual metrics could also be color-coded in the dashboard to show exceptions. Achieving consensus on what to produce can be contentious even between just the demand-side professionals. Setting the tone that disagreement between plan numbers should be an expected occurrence can keep participants from becoming frustrated with the process. Failure to acknowledge these differences or allowing each department to plan and act using its own set of numbers will generate far more conflict down the line because the supply organization will not know which set of numbers to use. This situation is far from rare, especially in an extended supply chain.

According to Oliver Wight colleague Ron Ireland, most supply chains operate with between 14 and 25 individual demand forecasts. Those that do use a single set of demand numbers typically have adopted the S&OP process. This step in the S&OP process results in product and brand management, marketing, and sales representatives issuing an updated medium-term demand plan for current and new products. The demand plan should be reviewed by a senior sales and marketing executive before being entered in the S&OP files. Sometimes this process is called a marketing/sales handshake, because it requires coming to an agreement on a request for product and coordinated demand-influencing activities. The consensus plan arrived at by the demand-side managers is used as the basis in both the supply planning phase and the financial reviews.

Evaluating Supply Capability The supply planning phase includes a supply review meeting, which uses the consensus demand plan to generate a production plan. The role of the supply management team is to identify any constraints that would prevent operations from being able to satisfy the demand plan. This process is sometimes called the operations handshake, because it requires operations professionals to agree on production plan recommendations that could best fulfill the demand plan while

keeping operations profitable. The supply review meeting is used to finalize supply plan recommendations. During this meeting, the feasibility of meeting the demand plan is discussed related to capacity and profitability constraints. If the demand plan can be met, the production plan will match the demand plan. The supply management team may need to alter the production plan and revise the S&OP data to meet the demand plan as closely as possible. If supply cannot match demand in total units or in product mix, then the meeting involves generating one or more alternative plans that propose solutions to the supply and demand mismatch, such as the following: Produce above demand for certain periods to meet later spikes in demand. Increase capacity by hiring, adding shifts, planning overtime, leasing new equipment, or outsourcing (or proposing the opposite to reduce capacity). Reduce the demand plan (as a last resort). Supply-side professionals should highlight any significant risks or costs involved with each alternative that is proposed.

S&OP Inputs and Outputs

Demand management has functional responsibilities and interfaces with other areas in the organization. For example, demand management serves as an intermediary between product development and brand management, marketing, sales, and operations so that all of these functions’ plans, communications, influences, and priorities are coordinated to maximize and satisfy demand. Let’s take a closer look at how demand management works with each of these functions.

Product Development and Brand Management Product development or design and brand management are typically long-term strategic tasks that can benefit from integration with demand management because it promotes the balanced needs of the supply chain. When demand management is allowed to influence product and brand management, products and services can be designed and branded to reflect what is valuable to the customer. Elements that are not perceived as a value to the customer should be eliminated from the design of the product/service package. (This is a principle of lean thinking.) Demand management can influence product development and brand management to consider each of the following:

Satisfying customer requirements on the basis of demand and eliminating features not sufficiently in demand Meeting customer requirements for product/service package quality (especially reliability and service responsiveness) and effectiveness of delivery (e.g., timing, convenience, and consistency) Meeting customer requirements for price by designing in organizational efficiencies (e.g., acceptable cost and profit) Designing production processes and equipment that can accommodate a certain level of increase/decrease in capacity or custom work without loss of profitability Creating a brand that expresses the value that the customer places on the product/service package Demand management can influence product and brand management to consider the processes throughout the whole supply chain, such as the ease and expense of a product’s sourcing (of raw materials), manufacturing, warehousing, transporting, displaying, servicing, repairing, returning, and reusing or recycling at the end of its life. Demand management can provide a collaborative venue for multiple departments or supply chain stakeholders to provide input, consider the feasibility of options or strategies, and, after some amount of

iteration, arrive at the product/service package and brand design with the highest potential for mutual profit.

Marketing Demand management relies on marketing because marketing must provide input to the demand plan. This input is necessary because marketing and sales are the people who are closest to prospects and customers. At some organizations, marketing and sales are considered to “own” the demand plan, while at others this is the role of the demand manager. At the very least, marketing and sales are typically considered responsible and accountable for forecasting. There is sometimes resistance on the part of marketing and sales to either own the plan or to provide detailed input because this takes away from the time that could otherwise be spent executing marketing and sales activities. The organization must define what inputs are really necessary from marketing and sales and also find ways to make the required inputs more efficient and less timeconsuming. Marketing staff are responsible for finding potential customers and identifying needs the company can solve, creating and maintaining customer demand with communications and promotions, helping to refine product design and packaging to meet customer needs, forecasting demand throughout a product’s life cycle, and pricing

products and services to be affordable and profitable at the same time. Marketing traditionally has had little understanding of the processes and requirements surrounding operations management. This lack of understanding works both ways and is the product of the traditional “silo” mentality of departments. Providing a formal demand management function at an organization can provide marketing with expertise on operations and vice versa. Because demand management fits into neither traditional “silo,” it is an ideal representative for both interests. Demand management interfaces with marketing in the medium and short term to tailor demand to meet available capacity. Tailoring demand from a marketing perspective includes setting existing and potential customers’ expectations regarding the types of demand that the organization will accept or consider. That is, if customers know the rules of the game, they will be more likely to happily work within those rules. This helps avoid situations such as frustrating a potential customer by having to reject an unprofitable customization request that likely took some time to prepare. Another way demand can be tailored is by raising or lowering prices either semi-permanently or through promotions. Price reductions can

stimulate demand in times of excess capacity, and returns to regular pricing can help when there is insufficient capacity.

Sales Sales departments work with customers on a daily basis and make delivery promises. The primary interface demand management has with sales is to implement the demand plan commitments regarding influencing or prioritizing demand. Another interface is to ensure that the demand plan supports the organizational strategy. For example, if the organizational strategy is to develop lifetime customers by maintaining excess capacity, it could be the role of sales staff to identify customers on the basis of potential for loyalty and make offers that may not be initially profitable while up-selling to existing loyal customers. Salespersons desire to eliminate order backlogs, which means sales staff is not typically interested in minimizing inventories. Their priority is to increase sales by providing the right quantity of supplies at the right place. For similar reasons, a high priority for sales is time to market, especially if the product or service must be ready for a particular selling season, be presented at a tradeshow or convention, or beat the competition to the market. Demand management can champion these requirements with product development, marketing, and operations.

Demand management can work with sales to manage demand in such ways as convincing product and brand management to raise or lower prices for ordering in bulk or for accepting delayed shipments (within the parameters set by marketing). Another role for demand management is to educate sales staff on the limitations of product development, marketing, and operations, for example, not promising to perform custom work without approval or to supply products in excess of maximum production capacity.

Operations Interfacing between the demand side of the organization and manufacturing planning and control is a vital task for demand management, because most operations professionals are highly specialized. According to research by Showalter and White, operations management literature “exhibits a pronounced lack of marketing perspective.” They also state that when the marketing perspective is included it is treated “simply as a complicating constraint on the production planning process.” A formal demand management function and/or a demand manager can represent product and brand management, marketing, and sales interests in operations-specific technical terms. Demand management can also facilitate the understanding between operations and the other parties at S&OP meetings, such as by

accommodating the requirements of profitable customer segments in production plans. It also plays a stronger role now than in the past due to the emphasis on replacing safety stocks of inventories with shorter lead times and manufacturing flexibility.

Reconciliation Here we discuss the process of reconciling demand, supply, and financial plans. This involves three final meetings: the financial review meeting, the pre-meeting, and the executive meeting.

Financial Review Meeting The financial review meeting analyzes the demand plan in dollars as well as any alternative production (supply) plans for their financial impact and feasibility. The key question that financial professionals will ask is to what degree the plan will achieve or fail to achieve the organization’s business and financial goals as stated in the business plan. The financial review meeting will also finalize projections on the revenues, profits, cash flow, or need for capital investments for each alternative and provide a recommendation for the plan that best meets financial goals as well as financial constraints such as budgets, cash flow, or capital expenditure limits.

Pre-Meeting

The pre-meeting, or pre-S&OP meeting, is a meeting between people from prior steps, at least one person from the finance area, the S&OP process owner, and the demand manager. Other preS&OP team members might include a number of key supply chain managers and other area managers, such as the plant manager, the logistics manager, the product and brand manager, the customer service manager, and the accounting manager. The team reviews the data and sets the agenda for the S&OP executive meeting. The purpose of the pre-meeting is to identify areas where consensus can be reached without needing executive input and to add the more contentious items to the executive review agenda.

Executive Meeting The monthly S&OP executive meeting involves the chief executive officer (CEO); the demand (sales and marketing), supply (operations), and financial executives; and other direct reports to the CEO. Executive sales and operations planning has its own definition in the APICS Dictionary, 16th edition: The portion of sales and operations planning that defines executive decision-making processes to balance supply and demand at the volume level in families, fully integrates financial planning and operational planning, and that provides a forum for establishing and linking high-level strategic plans with day-to-day operations.

The purpose of this meeting and its related processes is to provide executives with a broad understanding of supply and demand issues and to allow them to exercise control over the organization’s direction if it is not in line with business plan goals. The attendees review the plans from the prior meetings with the goal of arriving at a consensus demand plan that meets organizational revenue goals to the extent possible and that everyone agrees to support. To accomplish this goal, the meeting may involve reviewing performance metrics or scorecards, changes since the last meeting, new risks and opportunities, and other events. Executives will want to know whether plans are staying on budget, on schedule, and on scope; how well product mixes are performing; whether current strategies need modifying; whether capacity will be sufficient for the level of demand (at the resource planning level, such as hiring new staff if new products are experiencing high demand); and what decisions will need to be made and when. Decisions that need to be made during the current period are discussed and then finalized, and responsibilities are assigned to ensure execution. The assembled executives may accept the decisions and the numbers forwarded from the pre-S&OP meeting, or they may take another path. They will make decisions pertaining to each product family, authorize any decisions with significant financial implications,

and compare the demand plan to the business plan to see if actions need to be taken to bring them in line with each other (e.g., additional marketing activities). Communication of the agreed-upon S&OP plan is critical to all internal participants. For instance, it is critical for sales account managers to understand when material they have requested in the demand plan will not be supplied and therefore they should not make commitments to deliver the product to customers. If supply is available to meet demand, the sales account managers still need to be informed that their sales forecast has been accepted and they can sell against it. Remember, the success of the demand plan depends on the quality of the internal communication process.

Implementing S&OP Like supply chain management, sales and operations planning rests on the assumption that companies wishing to compete in the expanding global marketplace can and must break down the silo walls between functions and break through the barriers separating supply chain partners. In fact, S&OP is intended to be a planning and controlling tool not just for manufacturing but also for the entire enterprise. Breaking down those barriers, however, doesn’t happen quickly and easily.

The most important consideration is the understanding that the plan to generate enough capacity to match supply with aggregate demand must be created, executed, and monitored in collaboration with sales and other functional areas, not in isolation. We’ll look at three aspects of implementing S&OP: Getting buy-in on S&OP’s coordinating function Emphasizing what each party contributes to S&OP Building enthusiasm for S&OP among supply chain managers

Getting Buy-In on S&OP’s Coordinating Function Functional areas within a company and supply chain partners on the outside are accustomed to developing their own plans, controlling their own information, and determining their own actions. S&OP can’t function if those assumptions, and those barriers, remain in place. The basic premise of S&OP is that there should be one plan to unite all the major functions—sales, operations, and finance. Further, S&OP assumes that key players, including executives, will agree to the unified plan, carry it out tactically, and continuously monitor and adjust it in monthly S&OP meetings. The key to getting buy-in to S&OP is to emphasize that it is all about improving communications. As S&OP consultant and author Thomas F. Wallace puts it, “S&OP is as much about institutionalizing communications throughout the

organization as it is anything else.” If, as Wallace states, you “get all the facts on one sheet of paper” reviewed jointly by the key players monthly, communication has to happen, facts have to be recognized, even if they are negative, and decisions have to made, debated, and acted upon—before the next meeting. S&OP provides the following organizational benefits: Link between business planning and tactics. S&OP forms a link between the vision in the strategic and business plans on the sales side and the practical details of the tactical plans on the operations side. The executives of the company are responsible to investors and to one another for making the projections in the business plan a reality. S&OP brings the executives directly into the planning process. Opportunities to be proactive rather than reactive. The monthly meeting is a chance for executives to respond to changes in economic trends and market conditions as they are occurring. Definitive short- to medium-term plan. The sales and operations plan is the definitive statement of company plans for the near to intermediate term—typically 12 to 18 months or more. It covers enough time to enable planning for resources and to support the annual long-range business planning process.

Unified, cross-functional plan and process. S&OP brings together a planning team that reconciles all of the functional business plans—not just sales plans and marketing plans, but engineering and development, manufacturing, sourcing, and financing plans—into one unified plan and one unified process. Bridge between customer value and supply chain efficiency. The S&OP process integrates the tactical focus of the operations side with the customer orientation of the marketing and sales side. There is an inherent tension between the needs of the customer and the evolving quality standards of the supply chain. Reducing cycle times, squeezing out unnecessary inventory, paring down the number of partners, practicing lean manufacturing, and focusing relentlessly on quality may result in a swifter, more agile supply chain, but that can come at the expense of the end customer if marketing isn’t there to keep a close eye on the final product. In common terms, cheaper and faster are not always better from the customer’s perspective. After all, quality is “conformance to requirements or fitness for use” (APICS Dictionary, 16th edition). On the other hand, the perfect product is not always affordable from an operational standpoint. S&OP integrates the sales and marketing perspective with the operational perspective so the inherent tension between the two can become a creative force that drives the business.

Incentive to engage in continuous improvement. S&OP is not a static plan. S&OP’s (usually) monthly meetings incorporate replanning from prior months. This continuous review and improvement should incorporate appropriate metrics for evaluating results against plans. All functional areas involved in the sales and operations planning process should submit annual budgets for review by finance. The final plan should merge and reconcile all functional area plans and be reviewed by senior management. Budgeting is part of the annual update of the business plan.

Emphasizing Each Party’s Contributions to S&OP The specific contributions to S&OP represent the demand side, where sales and marketing take responsibility, the supply side, where operations does the capacity research, and finance, which does the financial goals analysis. The results are merged and reconciled so that aggregate demand and supply are in balance and meet business and financial goals to the extent possible. Product and Brand Management, Marketing, and Sales Contributions The following contributions go into the planning process from the demand organization for review by the full team:

Demand forecasts. S&OP receives time-phased (e.g., demand per month) forecasts of expected demand (customer orders) arranged by product family. Demand plan commitments. Product and brand management, marketing, and sales are responsible for developing and implementing realistic strategies and tactics to achieve the goals and revenue objectives stated in the business plan—for the near and medium term. For example, product and brand management may plan new product launches and determine the life cycle impact of events. Marketing sets pricing strategies and performs competitive analysis. Sales strategy includes number and type of salespeople, sales territories (by geography, product, customer type, etc.), and sales and marketing approaches. Demand plan numbers and assumptions. Along with customer order forecasts and commitments to action, the demand organization contributes estimates of the results of their efforts expressed both in units (e.g., volume, numbers, weights) and the revenue dollar equivalents, along with all underlying assumptions. shows how various audiences will use one or more of these reports. Exhibit 1-50: Demand Plan Estimates

Product and Brand Management

Unit of Measure

Marketing and sales

Units and dollars

Logistics

Units

Customer service

Units

Finance

Dollars

Market analysis. Marketing contributes research and analysis of market opportunities; selection of target market segments; development of strategies for capturing a share of those markets; and development, management, execution, and control of marketing plans, programs, and projects. Operations Contributions The organization’s sales and operations plan is implemented on the supply side of the organization through a production plan. The production plan is a high-level view of future production requirements over a planning horizon of 12 to 18 months. Sales and operations planning approaches tactics at the level of aggregate supply and demand. It deals with overall capacity in the system, gross volumes, and product families. According to the APICS Dictionary, 16th edition, a product family is

a group of end items whose similarity of design and manufacture facilitates their being planned in aggregate, whose sales performance is monitored together, and, occasionally, whose cost is aggregated at this level. Thus this level of planning is at a higher level than individual products and specific work centers. The mission of S&OP is to balance supply with demand, and this balancing act starts at the level of product families. Operations makes the following contributions to the plan, to be reconciled with the numbers and strategies from the sales and marketing side. Product families. For purposes of the S&OP, product families need to be established on the basis of similar operations capacity requirements. “Like-capacity” items are grouped together so that the resulting production plan can be used directly by operations. While each part of the organization may create its own product families for internal department planning purposes, such as sales creating families based on similar market appeal, the integrated nature of the S&OP process requires that everyone use the same product families. Output and resources. Specific output targets are identified for each product family during the planning horizon. These targets

include Overall level of manufacturing output and other activities to meet planned sales levels (The projections are generally stated as a rate of production, such as units per period of time.) Inventory levels Backlog levels (The APICS Dictionary, 16th edition, defines backlog as “all the customer orders received but not yet shipped; sometimes referred to as open orders or the order board.”) Required plant, equipment, labor, and material resources for each period in the plan. Operations constraints. Given a request for product in the form of a demand plan, a primary input from operations involves evaluating whether there is sufficient capacity over the planning horizon to meet the plan for each product family. Information on site and work center bottlenecks is provided as needed to support recommendations. Constraints can sometimes be alleviated by operating above or below optimal capacity or by altering operations strategies or supply-demand strategies. Operations and supply-demand strategies are discussed next. Operations strategies. The level of output for periods in the plan can be determined according to a level production strategy, a

chase production method (also called a chase strategy or chasedemand matching), or a hybrid of the two. According to the APICS Dictionary, 16th edition, a level production method is “a production planning method that maintains a stable production rate while varying inventory levels to meet demand.” This method aims for the same output in each period (e.g., each month). The level amount is based on the average of demand forecasts for each period with some modifications for desired inventory levels. For example, Porta Potty, a portable outhouse manufacturer, has seasonal demand spikes but produces the same number of units all year round. Leveling offers the benefits of simplicity and, from an operations viewpoint, predictability (no last-minute hiring of temps or layoffs). The tradeoff is the potential for inventory to pile up during periods of low demand or for stockouts if demand spikes upward. The Dictionary defines a chase production method as “a production planning method that maintains a stable inventory level while varying production to meet demand.” This results in demand matching, which aims to match production to demand for each period. For example, restaurants often use chase methods by maintaining a part-time workforce that can be

scheduled as needed and altering purchases based on projected demand. Manufacturers sometimes pursue this method by producing different goods for different seasons (e.g., K2 produces skis and in-line skates). The benefit, if the strategy succeeds in producing only what is demanded, is a reduction of inventory costs. On the negative side, resources must be ramped up during periods when demand is high, with increases in costs for overtime, additional hiring, training, etc. Layoffs may be necessary when demand falls, resulting in loss of competent, trained workers who may not be available for rehiring when demand picks up again. Finally, plant capacity has to be built up to produce at the highest level of demand rather than at an average level. A hybrid strategy combines elements of level and chase production. The plant runs near full capacity for part of the cycle, allowing inventory to build up, and then slows or shuts down to allow the inventory to shrink as customers buy the product. A large number of organizations use hybrid strategies. For example, Lego manufactures toy building blocks using one shift for the first half of the year and adds another shift in the second half of the year for holiday season demand.

Supply-demand strategies. For each product family there should be an operational approach for determining when to produce the product in relationship to customer orders (that is, before or after the order). Three strategies are make-to-stock, make-to-order, and assemble-to-order: The make-to-stock approach is defined by the Dictionary as a production environment where products can be and usually are finished before receipt of a customer order. Customer orders are typically filled from existing stocks, and production orders are used to replenish those stocks. The schedule for make-to-stock production is based on finished goods, which will be manufactured and sent to inventory. A make-to-stock product family usually contains a small number of items made from a large number of components. Consumer electronics, such as televisions, radios, and audio systems, are examples of this situation. Most make-to-stock environments represent high-volume, low-variety products. Make-to-stock is essentially a mass-market strategy that works well when demand is stable and products turn over rapidly. For slower-moving products or products with unstable demand, the risk here is inventory build-up and, in some cases, product

obsolescence. In the computer industry, for instance, components age rapidly toward obsolescence. The make-to-order approach is defined by the Dictionary as [a] production environment where a good or service can be made after receipt of a customer’s order. The final product is usually a combination of standard items and items custom-designed to meet the special needs of the customer. Make-to-order product families are at the opposite extreme from make-to-stock families, with a very large number of products made from a smaller number of components. Custom clothing provides a common example. In a custom business, each product is unique to the individual who orders it. If delivery lead time is not an issue, the product can be made to the customer’s exact specifications. Most make-to-order environments represent low-volume, high-variety products. It is dependent on the individual company strategy whether raw materials are kept in inventory in anticipation of customer orders. A similar approach to make-to-order is engineer-to-order (or design-to-order). Engineer-to-order products are defined by the Dictionary as

products [that] require unique engineering design, significant customization, or new purchased materials, depending on customer specifications. Each customer order results in a unique set of part numbers, bills of material, and routings.

Assemble-to-order (or finish-to-order) is “a production environment where a good or service can be assembled after receipt of a customer’s order” (Dictionary). Assemble-to-order products are partially manufactured and inventoried to await orders. This allows mass customization of products without long lead times and works well with products that can be tailored to customer taste by exchanging a limited number of modular components. The focus of master scheduling in assemble-toorder is on scheduling the manufacture of the modules or components and on final assembly. Like make-to-order products, assemble-to-order product families include a large number of end items, but in this case the number of components may be limited. Computers can be assembled to order. (Their components may be complex, but the final assembly of the computer itself uses a few basic components— hard drives, RAM chips, audio and video subsystems, case, power supply, etc.). Instead of being finished in all hues for delivery to stock, paint colors are “assembled-to-order” behind

the counter at hardware and home stores. The shelves are stocked with tint base, and a limited number of tints are combined by a computerized mixer for an exact match to hundreds of colors. In such cases, the efficient basis for the master production schedule is to schedule the limited number of components. One of the challenges of the assemble-to-order approach is the need to have “reasonably skilled” labor to do the assembly. Distribution centers are not always eager to train or hire workers to do assembly. A related concept, package to order , is “a production environment in which a good or service can be packaged after receipt of a customer order” (Dictionary). Package-to-order can be used to accommodate different numbers of units per package or customer language differences. Actual results and other data for performance metrics. Operations also provides data on actual production amounts per product family and other historical data such as information on actual capacity limits versus planned limits. Operations may provide other data for planning and feedback purposes such as changes to inventory metrics.

Finance Contributions Finance reviews the demand plan and the proposed production plan for financial feasibility and fit with business plan goals (especially financial goals) and may make a recommendation on the plan that makes the most financial sense if competing alternatives exist.

Building Enthusiasm for S&OP Among Supply Chain Managers With its focus on breaking through functional barriers, the S&OP approach to aggregate planning integrates perfectly with supply chain management thinking. Instead of the traditional practice of first developing a sales plan and then asking operations to develop tactics to implement it, S&OP brings together sales, marketing, operations, finance, and other key players to produce an integrated plan that incorporates and reconciles the views of all functional areas. For this reason, APICS considers S&OP to be a best practice.

Demand Management and Prioritization Organizations must manage and prioritize demand because sales will differ on a regular basis from planned demand in total volume and/or in product mix and because supply often cannot produce products in the exact timing and mix specified by the demand plan.

Since supply is often constrained or lacking, demand needs to be managed and prioritized to guarantee that the supply chain as a whole is well served and the organization uses its resources wisely so that operations lead to profitable business results. Demand management and prioritization starts at the level of master scheduling and also occurs at the material requirements planning level. Demand management and prioritization may include setting time fences to keep operations running on time and on budget once they are committed. A time fence restricts disruptive last-minute changes to a manufacturing production schedule by setting one or more change cutoff dates as one gets closer to the present. Each time fence has escalating levels of approval required to override the cutoff. Demand management and prioritization may also direct the allocation of supply, and this allocation process must be measured and managed to ensure that customer service levels are met. Managing and prioritizing demand requires an organization- or supply chain-wide view. It involves optimizing demand across the system as measured by optimum organizational profit, demand volume, sales revenue, and customer service (including customer retention). This is a management activity because it involves setting and enforcing policies to promote this optimization process; it is a

prioritization activity because it involves making judgment calls to decide what actions or customers are more important than others when capacity is limited. Management and prioritization can be based on customer segmentation strategies, such as fulfilling orders to the most valuable customer segments first. Another example is rationing supply so that each warehouse or retailer receives a portion of the full demand but no entity goes without a certain minimum amount. Managing and prioritizing demand could also involve prioritizing production to increase supply of certain items or prioritizing items within distribution systems to better distribute supply to meet demand. For service industries or for customer service attached to products, prioritizing demand can involve queues (waiting in line or waiting on hold). Exhibit 1-51 shows some situations in which managing and prioritizing demand is usually necessary. Exhibit 1-51: Situations Requiring Managing and Prioritizing Demand, with Examples Situation

Example

Situation

Example

When conducting sales and operations planning and the supply organization cannot meet the demand plan without changes

An organization with fixed capacity starts with high inventory demand for a hot-weather product. Rather than continuing to try to predict the weather far in advance, they prioritize how product is distributed so that only areas currently forecasting or experiencing hot weather are allocated more product, reducing capacity pressures and inventory.

When the demand plan overstates actual demand and plan changes will impact sales revenue and product costs

An organization resolves a situation of too much supply by establishing a series of decision points (time fences) for production activities such as purchasing so that some operations can be delayed until more accurate demand information is available. Demand that does not materialize prior to the decision points can be de-expedited (moved back in the production queue).

When the demand plan understates actual demand and plan changes will impact sales revenues and product costs

An organization resolves a situation of insufficient capacity by extending its planning horizon to give it more time to increase capacity. For current capacity issues, it provides incentives for substitute products and offers discounts for taking delayed delivery.

When a large, one-time sales opportunity arises that would impact regular orders, production costs, and profits

An organization prioritizes unusual demand by establishing a process of recognizing and reporting the demand as soon as possible to allow time for decision making. Both demand and supply organizations develop cost and profit margin projections for accepting and rejecting the order, including impact on customer service. Sales management determines how to prioritize other orders if the order is accepted.

Since demand management and prioritization often involve thinking beyond an internal department focus or beyond a single

organizational focus, successful implementation can benefit significantly by setting a clear prioritization policy and implementing it using a structured process.

Demand Management and Prioritization Policy A demand management and prioritization policy should clearly indicate who is allowed to manage and prioritize demand. Responsibility may be restricted to appropriate management levels in the supply organization based on the level of risk involved in the decision. The highest prioritization decisions involving strategic risks may be made at the executive level, while supply managers may be responsible and held accountable for lower-level demand management and prioritization decisions. A key policy best practice is to retain responsibility for these lower-risk decisions at the management level rather than delegating this responsibility to individual salespersons. Delegating to individual salespersons tends to create organizational conflicts because each salesperson will naturally be motivated to act in his or her own customers’ best interests rather than in the overall best interests of the organization. This policy should be documented and clearly communicated to the sales force.

Another possible policy is to retain the management and prioritization power in the demand side of the organization rather than delegating it to the supply organization. While the supply side will provide critical input to decisions regarding the cost of changing ongoing production activities, only the demand side has information on the most valuable customers and marketing and sales goals.

Demand Management and Prioritization Process A demand management and prioritization process rests on several principles. One is that the organization’s intent is to fulfill demand whenever it is feasible and will result in an increase in marginal profits, even when this demand comes from unexpected sources. The prioritization process involves finding ways to make the unexpected orders become profitable if they would not be otherwise. This may involve fulfilling the demand later than is requested, delaying other orders to meet the customer’s request date, or offering a substitute product. An order is declined only if these measures are not acceptable to the customer or the sales manager. Sales and customer service must be trained in such an exception process so that these orders can be analyzed as soon as possible, while multiple options still exist. Another principle is that when demand differs from supply within a time frame that allows for supply capacity or operations to be

changed without impact on costs or other operations, prioritization is not necessary. It is the supply organization’s responsibility to manage supply in this case. When there are cost implications to a supply and demand mismatch (such as when materials have already been purchased or work is in process), management and prioritization are necessary to match supply. The process should involve determining ways to delay commitments until the last possible moment so that prioritization is necessary for as few operations as possible. This is done by delaying decisions until a necessary decision point is reached, such as when raw materials need to be ordered or a batch process must be started to keep operations running smoothly and at acceptable cost. These decision points when they relate to operations are time fences. Decision points such as time fences should be set in consultation with both the supply and demand sides of the organization so that they reflect the optimum balance between production costs and customer service. Strategic decision points may include questions such as whether to increase capacity. Delaying such a decision until it is absolutely necessary to start the related capital projects will allow the organization to have the most current information on projected demand.

Collaborative Demand Management and Prioritization Tools for collaborative demand management and prioritization include sharing information on actual capacity or working with retailers well in advance of perceived shortage periods.

Customer Service Levels and Prioritization Customer service represents the supply chain’s role in fulfilling marketing objectives. A customer service strategy must identify and prioritize all activities required to fulfill customer logistical requirements as well as—or better than—the competition does. When developing a customer service strategy, the key question to ask is “Does the cost associated with achieving specified service performance represent a sound investment?” Comprehensive evaluation of competitive performance and customer response to service attributes can be used to formulate a basic strategy. The fundamental measures of basic customer service are fill rates, lead time monitoring, order status monitoring, and customer satisfaction.

Index A Assemble-to-order (ATO) [1] Asset management Cash-to-cash cycle time [1] Associative forecasting [1] ATO [1]

B Backlogs [1] Bias [1] Branding [1]

C Cash flows Primary cash flows [1] Cash-to-cash cycle time [1] Causation [1] See also: Correlation Change management [1] Chase production methods [1] Clockspeed [1]

Competitive analysis [1] Consumer goods [1] Correlation [1] See also: Causation Customer-driven marketing [1] Customer-focused marketing [1] Customers [1] Customer service [1] Cycles [1]

D Dashboards [1] , [2] Data gathering meeting [1] Deflation [1] See also: Inflation Delphi method [1] Demand [1] , [2] Demand communication [1] , [2] Demand forecasting [1] , [2] Demand generation [1] Demand influencing [1] , [2] , [3] Demand management [1] , [2] Demand managers [1] Demand patterns [1] , [2]

Demand planning [1] , [2] , [3] , [4] Demand planning meeting [1] Demand prioritization [1] , [2] Demand shaping [1] Depression [1] Deseasonalizing [1] See also: Seasonality Design-to-order [1]

E Engineer-to-order (ETO) [1] Environmental scanning SWOT analysis [1] ETO [1] Expansion [1] Expert judgment forecasting [1] Exponential smoothing [1] See also: Time-series forecasting Extended enterprise stage [1] Extrinsic forecasting [1]

F Finance [1] Financial metrics

Cash-to-cash cycle time [1] Finish-to-order [1] Forecast accuracy [1] , [2] Forecast error [1] Forecast errors [1] , [2] Forecasting Demand forecasting [1] , [2] Forecasting methods Qualitative forecasting methods [1] Quantitative forecasting methods [1] , [2] , [3] Forecasting process [1] Forecasts Mix forecasts [1] Four Ps Place (as one of the four Ps) [1] Price (as one of the four Ps) [1] Product (as one of the four Ps) [1]

G Global markets [1] Global supply chains [1]

H Horizontal integration [1]

Hybrid production methods [1]

I Industrial goods [1] Inflation [1] See also: Deflation Information flows [1] Integrated enterprise stage [1] Integration Horizontal integration [1] Vertical integration [1] Intrinsic forecasting [1] Irregular variation [1] , [2]

J Judgmental forecasting [1]

K Keiretsu [1]

L Lagging indicators [1] See also: Leading indicators Lateral integration [1] Law of demand [1]

Law of supply [1] Law of supply and demand [1] Leading indicators [1] See also: Lagging indicators Level production methods [1] Life cycle analysis [1] Linear regression [1]

M Macroeconomics [1] , [3] See also: Microeconomics MAD [1] , [2] Make-to-order (MTO) [1] Make-to-stock (MTS) [1] Managers Demand managers [1] Manufacturing environments Assemble-to-order (ATO) [1] Engineer-to-order (ETO) [1] Make-to-order (MTO) [1] Make-to-stock (MTS) [1] Package-to-order [1] Manufacturing supply chains [1] Marginal analysis [1]

Market conditions [1] Marketing [1] , [3] , [5] See also: Four Ps Marketing research [1] Market plans [1] Market research [1] Master planning [1] , [2] Mean absolute deviation (MAD) [1] , [2] Mean squared error (MSE) [1] Metrics [1] Microeconomics [1] , [3] See also: Macroeconomics Mixed-model production methods [1] Mix forecasts [1] Moving averages Simple moving average [1] Weighted moving average [1] MSE [1] MTO [1] MTS [1] Multiple dysfunction stage [1] Multiple regression [1] See also: Simple regression

N New product introduction (NPI) [1] , [2] NPI [1] , [2]

O Operations [1] , [2] Operations planning and control [1] Orchestrated supply chain [1] Order processing [1] Order qualifiers [1] Order winners [1] Organizational strategies [1]

P Package-to-order [1] Packaging [1] Place (as one of the four Ps) [1] Placement [1] Planning horizons [1] Pre-meeting [1] Pre-S&OP meeting [1] Price (as one of the four Ps) [1] Price elasticity [1] Primary cash flows [1]

Primary product/service flows [1] Primary product flows [1] Producers [1] Product (as one of the four Ps) [1] Product design [1] Product families [1] Product flows Primary product flows [1] Reverse product flows [1] Production leveling [1] Production planning methods Chase production methods [1] Hybrid production methods [1] Level production methods [1] Product life cycle [1] , [2] Product portfolio [1] Product portfolio management [1] Product review meeting [1] Promotion [1]

Q Qualitative forecasting methods Delphi method [1] Judgmental forecasting [1]

Quality [1] Quantitative forecasting methods Associative forecasting [1] Life cycle analysis [1] Time-series forecasting [1]

R Random variation [1] , [2] Real GDP [1] Real gross domestic product (GDP) [1] Recession [1] Regression analysis Multiple regression [1] Simple regression [1] Reseasonalizing [1] See also: Seasonality Resource planning [1] Resource requirements planning [1] Reverse product flows [1]

S Safety factor [1] , [2] Sales and operations planning (S&OP) meetings Data gathering meeting [1]

Demand planning meeting [1] Pre-meeting [1] Product review meeting [1] Supply planning meeting [1] SCM [1] Seasonality [1] , [4] See also: Deseasonalizing, Reseasonalizing Seasonal variation [1] , [2] Semifunctional enterprise stage [1] Service industries [1] , [2] Service industry supply chains [1] Simple moving average [1] Simple regression [1] See also: Multiple regression Specialized supply chains Service industry supply chains [1] Stakeholders [1] Standard deviation [1] Strategic planning [1] Strengths, weaknesses, opportunities, and threats analysis [1] Suppliers [1] Supply chain development Extended enterprise stage [1] Integrated enterprise stage [1]

Multiple dysfunction stage [1] Orchestrated supply chain [1] Semifunctional enterprise stage [1] Supply chain management (SCM) [1] Supply chains Global supply chains [1] Manufacturing supply chains [1] Specialized supply chains [1] Supply planning meeting [1] SWOT analysis [1]

T Time-series forecasting [1] See also: Exponential smoothing, Visualizing Tracking signals [1] Transportation stakeholders Customers [1] Trends [1]

V Value [1] Vertical integration [1] Visualizing [1] See also: Time-series forecasting

W Warehouse processes Packaging [1] Weighted average price [1] Weighted moving average [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Module 2: Global Supply Chain Networks This module starts with a discussion of supply chain design. This involves determining how to align the supply chain with organizational strategy and related business requirements, IT strategy, and cyber security requirements. Part of this process is deciding on whether the supply chain should focus on being efficient versus responsive. The focus on IT is needed these days to ensure that the supply chain enables end-to-end connectivity and visibility. Also addressed are various supply chain management technology applications, from enterprise resources planning (ERP) systems to warehouse management systems and more. Front end, middle end, and back end systems are discussed. The middle end enables integration and connectivity. Maintaining accurate and up-to-date supply chain master data is also covered, because timely and reliable data are vital for supply chain efficiency and effectiveness. The last major subject for this module is reports, analytics, and metrics. Measurement is key to proper management. SCOR® metrics, financial metrics, and operational metrics are covered, plus reporting tools such as dashboards and balanced scorecards.

Section A: Supply Chain Design and Optimization This section is designed to Explain how business strategy is translated into supply chain network design Explain how strategic decisions are made concerning customers and markets, technology, key processes, and sourcing Show how supply chain network optimization depends on a company’s stage of supply chain development and has implications for the types of technology a company can use Show how information technology can reduce friction in the supply chain by enabling new strategies and operational methods Show how the return on investment for an IT initiative is computed Explore how a nucleus firm can take the lead and help orchestrate the supply chain or bring it to a higher level of supply chain maturity. Supply chains need to translate organizational and supply chain strategies into reality. This is done using supply chain design and supply chain network configuration. A supply chain strategy can focus on efficiency or responsiveness, but the tradeoffs involved

prevent these from being equal priorities. Supply chains also need to be resilient. Requirements for IT need to be considered up front as a supply chain is being designed. Technologies need to be assessed for their costs and benefits and should provide a net value. A supply chain’s overall maturity is partly dependent on technology choices; the technology can enable or hinder a given supply chain strategy.

Topic 1: Supply Chain Design and Management When it comes to designing a supply chain, factors to consider include translating organizational strategy into supply chain design and configuring the network in terms of the location and size of facilities and transportation design. Collectively, the decisions made regarding each of these factors should always support the organizational strategy and the supply chain strategy.

Translating Strategy into Design An organization sets a strategy based on its capabilities and its assessment of how it will compete in its environment. Supply chain managers then determine a complementary supply chain strategy (as do other functional areas) that will support and enable that organizational strategy. For example, if the organizational strategy is

to compete on low cost for commodity items, the supply chain strategy will need to be designed to be as low cost and automated as possible rather than attempting to be the fastest or most responsive. Since strategies are by definition high-level, long-term plans, the next step for supply chain managers is to translate the supply chain strategy into a more tactical, granular level of planning: supply chain design and configuration. The APICS Dictionary, 16th edition, defines supply chain design as the determination of how to structure a supply chain. Design decisions include the selection of partners, the location and capacity of warehouse and production facilities, the products, the modes of transportation, and supporting information systems. After developing business, organizational, and supply chain strategies, the organization—or the trading partners collectively— need to support the broad strategies by defining measurable objectives for each manager along the supply chain. To borrow from the SCOR® model, the process is still in the plan phase, when objectives are defined. This phase sets the direction for all the other processes—source, make, deliver, return, and enable. Strategy and objectives are developed first at top management levels and filter down through the levels of management on each trading partner’s organizational chart.

It’s tempting to say that all decisions affecting the supply chain should be based on organizational and supply chain strategies. But it’s more realistic to say that the decisions and the strategy should be aligned, because this is analogous to the “which came first—the chicken or the egg” puzzle. Whichever way you look at the matter, however, priorities must be set strategically. We’ll look at the way strategic decisions are made in regard to customers and markets, technology, key processes and flows, and sourcing.

Customer and Market Decisions Supply chains should be configured to reflect customers’ needs as well as trading partners’ capacities. There is no universally appropriate supply chain strategy. One example of this variability is Inditex, which holds several fashion brands including Pull & Bear, Massimo Dutti, Stradivarius, Oysho, and notably the Spanish clothing brand Zara, with its two distinct supply chains: one for its more functional products and the other for its fashion products. A company with multiple product lines needs to conduct a careful market assessment and match multiple supply chains to the strategy that is right for each market.

Technology Decisions Since technology has become the powerful force that extends supply chain visibility across multiple tiers while providing world-shrinking

velocity, it deserves serious consideration as an aid to achieving strategic objectives. It’s beneficial to weigh the advantages and disadvantages of technology or conduct a benefit-cost analysis. Since technology is expensive to install or lease, sometimes difficult to learn, and, for some, downright threatening, it’s important to make informed choices. There is a lot to choose from, including technology that can increase the velocity and accuracy of information flows, cash flows, checkout processes, inventory tracking, production scheduling—virtually any process of any length inside the supply chain. Whatever the process you’re aiming to improve, technology has become a necessary component of that improvement. But it has to be selected by specialists who know what is current and can guide process stakeholders in choosing the appropriate technology infrastructure at the right initial and ongoing price to conform to overall strategy. The collateral effects of new technology have to be taken into account as well. The theory of constraints tells us that there is no point in buying expensive technology solutions to speed up the flow of information, materials, or payments if they will just be sent speeding into a bottleneck (or constraint) that will stop their progress. Most importantly, each organization needs the right technology applied to the right process by the right people.

Elsewhere we’ll look at technology architecture decisions that relate to supply chain design. Other important considerations in this area include Determining how frequently data should be transferred and analyzed Deciding how data will be cleansed, analyzed, and used Determining how to leverage the internet and e-commerce Designing and setting up infrastructure internally and between supply chain partners Integrating IT and decision support systems into competitive strategy.

Process Decisions and Inventory, Funds, and Information Flows A supply chain is a set of processes, and these processes can be fine-tuned to suit each customer segment. When planning improvement initiatives, select the processes that are central to the supply chain strategy, measure and benchmark them, and focus your attention on one process or a small manageable number of processes. The four basic flows in supply chains are the flow of information, the primary product flow, the primary flow of cash, and the reverse flow of products. Customer information flows through the organization

and the extended enterprise via orders, sales activity, and forecasts. As products and materials are procured, a value-added flow of goods begins. Understanding how these flows touch many internal and external parties helps supply chain managers determine who will be affected by a supply chain design and thus who needs to be involved in the design effort.

Sourcing The Dictionary defines sourcing as “the process of identifying a company that provides a needed good or service.” Sourcing involves complex, challenging decisions. Manufactured goods, components, and services can be acquired by purchasing from a company that delivers them by an arm’s length transaction or by outsourcing. The trend in the latter decades of the 20th century and early in this century has been toward contracting non-core activities to supply chain partners. These partners may be located near at hand or offshore. As supply chains grow in length and global dispersion, they can locate each partner in the country or region best suited by raw material proximity, customer proximity, climate, culture, resources, tax policy, etc., to support each specific activity. Outsourcing was initially a strategy in manufacturing supply chains. However, advances in computer hardware and software and global

broadband networking have enabled global outsourcing of service activities, such as help desks, accounting, and medical testing. Accounting activities, for example, can be carried out across multiple time zones. Working half a world away, a day-shift accountant can perform services during the customer’s nighttime hours.

Network Configuration Supply chain network configuration is a complex strategic decision that concerns the comprehensive organization of suppliers, production factories, distribution centers, and manufacturing resources. Supply chains should be configured to reflect customers’ needs and trading partners’ capacities. Planning a network that provides an optimal return on all investments requires long-term, strategic thinking. Each decision must be weighed based on its impact on the entire supply chain, not only on the single matter under consideration. Given information on customer demand, product and service requirements, and supply chain partner requirements, the optimal network configuration needs to consider the following variables: Location of plants and production capacities for each product Number, location, capacity, and capabilities of warehouses Transportation between all facilities

For example, supply chain managers in manufacturing enterprises consider the stocking of distribution centers with an optimal level of the right kinds of inventory and establish transportation links that ensure timely arrival at, and departure from, distribution centers. In the ideal network, raw materials, components, and resources might never be at rest in a warehouse. Instead, they would always be in motion until arriving, just in time, at each location along the chain. One reason this ideal state is difficult to achieve is the fluctuation in demand that occurs all along the supply chain, beginning with the ultimate customer. Unpredictable demand, along with other factors such as accidents and adverse weather conditions, means that maintaining some levels of inventory at various locations along the chain is generally necessary. The supply chain manager’s challenge is forecasting future demand as accurately as possible and keeping inventory as low as possible without disruptions in delivery to customers. Elsewhere you will learn more about planning and controlling inventories, the related cost categories, how inventory impacts an organization’s financial statements, and inventory management and control. Another example is warehousing for customer goods. Adding to the number of warehouses may have the benefit of putting goods closer to the customer and thus reducing delivery time. It may also have the drawback of adding to total inventory and increasing the footprint of

warehouse space necessary to store a given amount of goods. Up to a point, putting goods closer to retail outlets or within customer shipping zones tends to benefit the supply chain by reducing transportation costs. Transportation costs are a function of several variables, including total distance between production facilities, warehouses, retail outlets, or customers; bulk discounts for transport; and types of transportation required. To solve the optimization problem for the entire network, supply chain managers must rely upon the most powerful technology available to them. As supply chains grow in length and complexity, facilities may be spread out among numerous regions, countries, and continents. A variety of statistics demonstrate how global sourcing and offshore manufacturing can reduce supply chain costs. Employing skilled labor at relatively low wage levels, establishing worldwide or regional centers of competence near major specialized talent pools, savings on materials, and finding new sources of supply are examples. While global expansion is attractive, offshore expansion requires sufficient due diligence to help ensure success. Specifically, from a logistics perspective, there are many issues related to getting business done and getting a product shipped. This means being

aware of local infrastructure issues in the country being evaluated, as summarized in Exhibit 2-1. Exhibit 2-1: Infrastructure Considerations in Global Expansion Issue

Considerations

Port facilities, airports

Specific details on the size and quality of port facilities and airports

Highway conditions

The size and condition of roads as well as the extent of the highway system

Rail lines

The availability of routes that will minimize any delay in movement of products

Source: APICS Global Sourcing Workshop Series.

The condition and capacity of port facilities, airports, and roads can be major factors in getting goods and supplies shipped reliably and on a timely basis. Different rail track gauges and capacity issues can adversely affect lead times. Additionally, crossing borders involves high volumes of paperwork.

Topic 2: Business and IT Requirements

Translating business requirements into supply chain design starts with selecting between two basic types of supply chains: efficiencyfocused chains and responsive chains. Either type needs to be resilient in terms of its ability to recover from disruption. IT requirements for the supply chain can include freeing supply chain managers from tasks that can be automated so they have time to improve processes and relationships. Improvements can relate to supply chain velocity, demand volatility reduction, data management, relationship enhancement, and so on. Since cybersecurity is so vital, the NIST Cybersecurity Framework is discussed as a way to set common IT security requirements.

Balancing Efficiency with Responsiveness While Being Resilient Organizations often need to balance efficiency (least-cost manufacturing and supply chain) with responsiveness. A third element, resilience, is important for either type of supply chain. Responsiveness implies being responsive to changing customer requirements. This can take the form of investing in customer service and/or agility. Supply chain agility is measured in SCOR® using metrics for flexibility and adaptability, but they basically measure an

organization’s ability to ramp up or down in production volume without a major impact on cost or organizational disruption. Since customer focus, flexibility, and adaptability come with a cost, for example, redundant capacity, one cannot generally maximize both efficiency and responsiveness simultaneously. One also cannot ignore either factor entirely. An organization that competes on low cost will maximize efficiency but will still need some amount of responsiveness to mitigate demand risk. An organization that is adaptable to large fluctuations in demand or to disruptions in the supply chain will still need some efficiency or it will go out of business. The variables that differentiate efficient and responsive supply chains are inventory volume and demand uncertainty. As you review the following descriptions of the two types of chains, you may recognize and associate certain attributes that are integral to the production of different types of products. An efficiency-focused supply chain may have these attributes: Customer demand is stable and does not fluctuate significantly. (There is low demand uncertainty.) Forecasting error levels are manageable. There is little or no adaptation to changes in structures of markets. (That is, the locations of demand and vendors do not change.)

There is a long product life cycle. Product introductions are infrequent or are planned out well in advance. There is limited product variety. In an efficiency-focused supply chain, the supply chain manager works to proactively manage customer demand and may use timeseries forecasting methods to predict future demand. Customer orders are filled with inventory, and any unpredicted interruptions receive demand management attention to minimize their impact. A responsive supply chain may have these attributes: Customer demand is not stable and can fluctuate significantly. (There is high demand uncertainty.) Forecasting error levels can be significant. There is adaptation to changes in structures of markets. (The locations of demand and vendors may change.) It uses real-time systems for customer data and purchases. There is a short product life cycle. It may use multiple warehouses for close proximity to customers. It may maintain extra or redundant capacity in the form of geographically diversified operations or contracts with suppliers. It may use third-party transportation providers for speedy product delivery.

It may require its manufacturer(s) and suppliers to have a high degree of agility (ramping up or down without cost penalties). In a response-focused supply chain, the supply chain manager usually develops forecasts based on system flexibility and capacity cushions. (A capacity cushion is extra capacity that is added to a system after capacity for expected demand is calculated. It is also called safety capacity or protective capacity.) Extra capacity may also take the form of redundant manufacturing capabilities at different plants or contractually obligated backup suppliers to safeguard against supply failure risks or to shift capacity in response to demand. From a demand planning perspective, a responsive supply chain that has both high demand variability and sales volumes will probably focus on forecasting parts and components so that it can postpone final assembly until a customer order “pulls” production of the final product. Being solely focused on either efficiency or responsiveness has proven fatal for some companies. Most supply chains fall somewhere in between the endpoints of the efficient-responsive spectrum. As supply chains strive to improve their performance based on the metrics that are important to their key audiences, they should also evaluate their ability to strike the right balance between efficiency and responsiveness. A supply chain should identify the

appropriate level of service. Level of service is defined by the APICS Dictionary, 16th edition, as a measure (usually expressed as a percentage) of satisfying demand through inventory or by the current production schedule in time to satisfy the customers’ requested delivery dates and quantities.

Implementing Efficiency and Responsiveness How do you determine the best balance of efficiency and responsiveness for a specific supply chain? In the Harvard Business Review article “Triple-A Supply Chain” by Hau Lee, the author states that intelligent organizations tailor their supply chains to the nature of the product markets for the optimum manufacturing scenario and best distribution capabilities. Supply chain management needs to research and identify how to optimize the supply chain based on the types of products or product groups that are manufactured within the chain. What exactly do the customers value in terms of each purchase they make—low price, convenience, customizable features? This question should have been answered during market research. The success of the supply chains of Gap Inc. is a testimony that tailoring supply chains can be the right solution. Gap Inc., which owns three major brands—Old Navy, the Gap, and Banana Republic

—has three separate but overlapping supply chains on three different continents in order to fit each one to the types of products it produces: The Old Navy brand targets cost-conscious consumers, and therefore its manufacturing and sourcing are located in China, where labor and material costs are lower. The Gap, which caters to more trendy buyers with midpoint prices, has its supply chain in Central America, where speed and flexibility are most important. Banana Republic draws customers who want better quality and are willing to pay for it, so its supply chain is located in fashionable Italy, where there’s a plethora of finely made fabrics and fashions. Because it has these three supply chains, Gap Inc. does have higher overhead, lower scale economies for purchasing and production, and higher transportation costs than if it had just one supply chain. Since these brands require different strategies, Gap also uses different supply networks. These networks can provide backup for each other if any experiences a disruption. Supply chain managers need to determine which type of supply chain is most appropriate for a particular product. It may require some data analysis to do this accurately. Exhibit 2-2 shows how

supply chain types can be fitted to products based on volume and demand uncertainty.

Exhibit 2-2: Fit Supply Chain Type to Product

Organizations that focus primarily on efficiency may select a maketo-stock manufacturing strategy (goods are produced and held in warehouse/retail locations before customer orders are placed). Organizations that focus on responsiveness may use a make-toorder manufacturing strategy (goods are manufactured only after customer orders are placed) or an assemble-to-order strategy (product components or modules are produced based on forecasts and are assembled when customer orders are placed). In addition to efficiency and responsiveness, modern supply chains also need to be proactive in regard to disruption risks. Making either

an efficient or a responsive supply chain agile enough to respond to risk is called making it resilient.

Making Supply Chains Resilient Once you identify where a product falls in regard to the variables of volume and demand uncertainty, you can research and identify potential changes that will enhance the fit of the supply chain to the product. But some researchers don’t think that in itself will be sufficient. Author Lee states that although supply chain efficiency is necessary, it isn’t sufficient proof that a company will outperform its competitors. He argues that in order to develop or maintain a competitive edge, supply chains also need to become agile, adaptable, and aligned with other entities in the supply chain. In other words, they need to become resilient. Supply chain resilience is defined by the APICS Dictionary, 16th edition, as “the ability of a supply chain to anticipate, create plans to avoid or mitigate, and/or to recover from disruptions to supply chain functionality.” Authors Sheffi and Rice echo a similar message in their article “A Supply Chain View of the Resilient Enterprise.” They point out that a company’s resilience is determined by its competitive position and its supply chain’s ability to be responsive to changes or disruptions. Companies that respond successfully to unpredicted disruption will reinforce their competitive advantage and gain market share. They

can increase their resilience by building in redundancy or flexibility. Redundancy can also be created by establishing safety stock, using multiple suppliers (even when more expensive), and intentionally setting low capacity utilization rates. To increase an organization’s flexibility, mechanisms or indicators need to be put in place that can sense threats and react quickly and accordingly. Efficiency-focused supply chains may have to avoid some of the more expensive resilience initiatives, but they cannot omit all of them. In summary, no matter what type the supply chain is, if the appropriate metrics and key performance indicators are being used and the supply chain fits with the market and the product requirements for the company, that supply chain has the potential to create a sustainable competitive advantage.

Supply Chain IT Requirements The APICS Dictionary, 16th edition, defines information technology (IT) as the technology of computers, telecommunications, and other devices that integrate data, equipment, personnel, and problem-solving methods in planning and controlling business activities. Information technology provides the means for storing, encoding, processing, analyzing,

transmitting, receiving, and printing text, audio, or video information. Networking technology also plays a central role in enabling the transmission of information throughout organizations and among supply chain partners. The information system in a supply chain is not only a collection of data. According to the Dictionary, an information system (IS) is the interrelated computer hardware and software along with people and processes designed for the collection, processing, and dissemination of information for planning, decision making, and control. This definition’s focus on people and processes is the key to getting the most out of any information system. Technology should automate the flow of information and help network people together so they can share their knowledge efficiently and effectively. By using electronic documents , “the electronic representation of a document that can be printed” (Dictionary), people and automated systems can easily share data and information of every nature. Technology should help automate, control, and standardize processes so that people can focus more on the “why” and the social elements of transactions or on the exceptions to normal transactions. Finally, information systems not only help turn data into information by putting it in

context; they also help share and create knowledge by finding and highlighting new associations between data. These capabilities empower people and processes to continually improve. In other words, the key is turning data into information and then turning that information into action. Organizations can employ IT to aid supply chain management in many ways, including the following: To increase supply chain velocity, agility, and scalability. By enabling the efficient transfer of secure information among independent supply chain partners, IT supports the formation of virtual chains. Firms specializing in complementary core competencies can network together temporarily to develop new products and exploit fast-changing opportunities. To provide cost-effective global visibility of data. Rapid, inexpensive transmission of massive amounts of data through the internet enhances global supply chain visibility. The resulting improvement in sourcing and selling decisions is now a standard that must be met by other companies. To avoid the bullwhip effect. IT can be used to gather, integrate, and report logistical data to show actual supply chain activity and

avoid the bullwhip effect that occurs when partners forecast with incomplete data. To create lean, cost-effective supply chains by replacing inventory flows with information flows and moving from push to pull. Rapid data streams replace push systems with pull systems, in which real-time data sent from the point of sale allow planners to respond rapidly to actual shifts in demand. To gather, store, and analyze knowledge and share it among supply chain partners. Efficient networking and integrative technologies give each partner strategic and tactical capabilities that enhance everything from strategic analysis to logistics. To facilitate strategic, tactical, and operational planning and coordination. By giving all partners the same information, supply chain partners are empowered to improve the overall profitability of the supply chain rather than solely focusing on their own profits. To drive accuracy of data and provide straight-through processing. Data can be entered once, stored in one place, and used in multiple transactions without reentry errors. To facilitate new relationships. IT has removed many of the barriers (sometimes called “friction”) that locked organizations into less-than-optimal relationships. Thus it has enabled easier

formation of new supply chain partner relationships to exploit emerging global opportunities. To deepen trust in existing relationships. IT can help create greater trust among supply chain partners using real-time information sharing.

Topic 3: Technology Analysis and Optimization Technology analysis justifies investments in technology. Technology optimization is a key part of reaching a given stage of supply chain maturity and so is mapped here to the five stages of supply chain maturity. Advice on how to get to higher levels is also provided.

Supply Chain IT Benefit-Cost Analysis For all the potential uses of technology, IT investments should be undertaken only if they result in a net gain for the organization. As such, the first assumption to make in an IT justification is that this is a business decision, not an IT project. New technology should be matched to the organization’s or supply chain’s goals and should create a strategic supply chain advantage. Note that most IT departments will expect the recipient of the technology to perform

such a justification. The IT personnel can be used as expert resources but should not be expected to develop a business case. For supply chain technology, this is the supply chain manager’s responsibility. If technology is poorly chosen or installed without thorough project management, it can result in a huge financial drain without generating the envisioned benefits. Many organizations have assumed significant financial risk by poorly planning and/or implementing IT projects. Well-managed capital investments can generate returns in cost savings (in logistics, procurement, software systems, and overhead), greater market share, and new product and market innovations. Successful IT should make a company agile and resilient to change and disruption.

Tangible and Intangible Benefits Credibility is the key to any cost justification, and past success lends strong credibility to a proposed IT investment. However, the past is not always an accurate predictor of the future. Moreover, making only investments that previously proved successful can stifle creativity and hamper business growth.

Benefits of IT investments can be both tangible and intangible. Tangible benefits can be broken down into direct, day-to-day savings and increases in working capital or available cash resulting from reductions in temporary assets such as inventory and accounts receivable. Intangible benefits are difficult or impossible to quantify, so they may place some strain on credibility. Exhibit 2-3 displays some tangible and intangible benefits of successful IT investments. Exhibit 2-3: Potential Benefits of IT Investments Tangible

Intangible

Lower maintenance costs Faster implementation Increased sales volume Improved scheduling (fewer changeovers) Greater financial returns Lower overhead Reduced cash-to-cash cycle

Customer retention Customer service Visibility of order status Workforce redeployment Employee satisfaction and efficiency

When estimates are required to justify intangible benefits, the best method is to build a consensus rather than use an individual’s opinion. For example, IT that promises improvements in sales volume could include points such as

System visibility of order status increases responsiveness to customers. Quality controls result in fewer returns and more customer satisfaction. Faster processing increases transaction velocity, reducing lag times. Note that Exhibit 2-3 lists workforce redeployment as an intangible benefit. Cost reductions promised by the ability to lay off employees should be treated with caution. Besides lowering employee morale, many such estimates prove incorrect; the firm may initially reduce the size of the workforce but eventually increase overall staff. As a consequence, it is advisable to position this predicted benefit as workforce redeployment. Some nonfinancial benefits to consider include Greater customer satisfaction as determined by customer service measures such as number of service calls or returns Employee satisfaction measures such as reduced employee turnover (greater retention) and more positive responses to surveys Efficiency measures such as increased orders processed per hour Collaboration and visibility measures such as reduction of the bullwhip effect without an increase in stockouts.

Tangible and Intangible Costs On the cost side, tangible, direct costs are straightforward. These include the direct costs of the IT project and ongoing service and maintenance, plus estimates for consulting fees, staff training and change management, resources assigned to the project, and opportunity costs. However, many IT projects are significantly over budget because managers Overlook major cost items such as operational support costs. Use estimates that assume everything will go according to plan. Purposely underestimate costs to secure project approval. Fail to invest in change management and/or training, which creates risks of high costs related to quality and deliverable acceptance. If the initial estimates are optimistic and the project is over budget, both management and external investors will perceive the project as a failure. The three basic categories of costs are capital expenditures, onetime project expenses, and ongoing support activities. Capital expenditures are amortized over the expected life of the technology. If this amortization period exceeds the actual product life, the costs will be underestimated. One-time project expenses often contain hidden costs such as fees to investigate alternatives, training travel,

data conversion, or lost productivity when employees go through a learning curve. Ongoing support costs may include annual license fees or subscriptions, maintenance fees for vendor support, or internal costs for bug fixes, upgrades, taxes on fixed assets, and IT support staff. Analytical software may have additional costs such as the cost of generating mathematical or simulation models once the software is installed. Just because a salaried employee is a sunk cost (according to the APICS Dictionary, 16th edition, “a cost…that is not relevant to the decision…that is being made”) does not mean that the cost of reallocating employees to an IT project can be ignored in the justification. Employees should be used when the savings from longterm maintenance using staff are greater than the savings of using a seasoned consultant. A final cost to consider is the cost of not implementing the project. Sometimes the costs of acquiring a new IT capability are outweighed by the greater (but intangible) costs of not doing so. For example, if a competitor creates a new business model using technology, failure to adapt may risk business failure.

Benefit-Cost Analysis and ROI

Exhibit 2-4 presents a benefit-cost ratio as well as a return on investment (ROI) ratio for an investment. Assume that a company implementing a new version of an enterprise resources planning (ERP) system has estimated total benefits at US$345,000 in tangible and intangible savings and performance increases over five years. The company has also tallied US$259,000 in tangible and intangible costs for five years. Exhibit 2-4: Benefit-Cost Formula and Example

The benefit-cost ratio example indicates that for every dollar invested in the project over the five-year period, US$1.33 is returned. The ROI shows the same results from the perspective of net value created, which is 33 percent. Analysis time frames should be kept short due to the risk of technology obsolescence.

Technology Capabilities per Supply Chain Optimization Stage An organization can design optimization into its information system plans. However, optimization requires a dose of reality. An

organization’s staff may loyally and optimistically assume that the organization is at a high level of development, and this assumption may engender a failure to work toward optimization. Therefore, understanding what constitutes being in a particular stage of supply chain network optimization is critical. Supply chain network technology optimization can be mapped to the stages of supply chain evolution that exist on a continuum. The range goes from traditional disconnected companies with adversarial external relationships (stage 1) to orchestrated virtual networks of companies (stage 5). Supply chain optimization stages can be thought of as evolutionary rather than linear. Starting with basic material requirements planning (MRP), a supply chain continuously increases its sophistication in terms of manufacturing resource planning (MRP II) and enterprise resources planning (ERP), internal integration, supply chain planning, production scheduling, external integration, and so on. The top levels also assess process and human resources maturity, such as change readiness. An organization’s stage of supply chain optimization is important for benchmarking the supply chain against its competition. Note that different organizational divisions or an organization’s different supply chains may be at different levels of

maturity. A given organization or area may also be more mature in some capabilities than in others. Exhibit 2-5 and Exhibit 2-6 characterize the types of supply chain technology capabilities that should exist at a given stage of supply chain evolution. Exhibit 2-5: Technology Capabilities for Lower Stages of Supply Chain Evolution Capability

Stage 1: Multiple Dysfunction

2: Semifunctional Enterprise

3: Integrated Enterprise

Internet

Static websites

Online catalogs

Intranets across all functions

Integration

None; no teamwork

Batch

Internal process integration; design teams

Supply chain Little information planning exchange of any kind

Informal demand planning; inventory reduction; no coordination of initiatives

Formal global demand planning; enhanced warehousing, logistics, forecasting, etc.

Production scheduling

Basic MRP (timephased order point)

MRP II (manufacturing resource planning)

MRP—ERP

Integration with suppliers

Email/phone

EDI/email/phone; Electronic data low-price purchasing interchange (EDI) strategies with all large suppliers

Capability Customer delivery

Stage Research

Local inventory

Available-to-promise (ATP)

Exhibit 2-6: Technology Capabilities for Higher Stages of Supply Chain Evolution Capability

Stage 4: Extended Enterprise

5: Orchestrated Supply Chain

Internet

E-commerce

Responsive design; cybersecurity

Integration

Supply chain networks; process integration across entity boundaries

Gaps addressed; end-to-end visibility and process automation; blockchain, IoT, etc.

Supply chain Integrated global planning planning; supply chain vs. supply chain competition

Data-driven using supply chain analytics; crossorganizational teams (technology, people, and change expertise)

Production scheduling

Externally integrated ERP

Automated forwarding of end customer demand data directly to manufacturers and their key suppliers

Integration with suppliers

Vendor-managed inventory (VMI), online requests for quotation (RFQs)

Category strategies drive integration level; supply chain resilience

Capability Customer delivery

Stage Capable-to-promise Automated delivery (CTP) quotations (e.g., usually ships in X days)

Stage 1: Multiple Dysfunction At the multiple dysfunction stage, firms may have multiple disconnected legacy MRP systems performing various transactional functions. These divisions follow the departmental barriers within the company. Communication often requires paperwork and data reentry. Note that MRP indicates the simplest process for determining net component requirements—a bill of material, a master schedule, and current on-hand/on-order data, and nothing more. Drawbacks of stage 1 include multiple system bottlenecks, no supply chain leadership, minimal web capabilities, and little process flexibility. Systems cannot produce timely information, such as order status or lead time. Performance is either not measured, is inadequately measured, is measured but not applied, or is not aligned to company goals. Organizations at this stage should focus on standardizing internal processes, becoming internet- and mobile-device-capable, and leveraging past continuous improvement efforts. Phased approaches

are best, starting with the areas that can generate the greatest savings, such as procurement and logistics, each of which typically generates five to eight percent savings at this stage. Functional areas will resist change, so change management is a must.

Stage 2: Semifunctional Enterprise At the semifunctional enterprise stage, many companies have completed manufacturing resource planning (MRP II) implementation and can demonstrate cross-functional integration of planning processes involving automated capacity planning. Internal optimization and corporate excellence break down functional silos, leading to interdepartmental trust and cooperation. Some companies have outsourced areas outside their core processes, and these outsource providers are their main external ties. Stage 2 companies use documented processes and align key performance measures to goals. However, many companies at this stage have not leveraged their web capabilities. At most, they have functionally focused electronic business solutions such as an intranet site or trading in commodities and office supplies. To move forward, companies at stage 2 should appoint a supply chain leader with experience in external integration. This leader needs executive support and the authority to break down barriers.

The leader should start in areas that can be altered without reducing market performance, such as aggregating purchasing across the organization to receive volume discounts. Early successes will help when the leader is championing more painful but necessary process and culture changes. Optimization at this level usually focuses on lean strategies to cut transportation, warehousing, inventory, and equipment costs.

Stage 3: Integrated Enterprise At the integrated enterprise level, companies have started point-topoint planning integration with the extended enterprise. They share real-time or near-real-time information and collaborate on forecasts between multiple divisions and first-tier customers and suppliers. Interactions with trading partners are usually still on a one-to-one basis. Some share best practices and the risks and rewards of collaboration. They likely use ERP and may use customer relationship management (CRM) or supplier relationship management (SRM) or both. The firm brings functional areas together in processes such as sales and operations planning with a focus on companywide processes. Getting to stage 3 requires overcoming cultural and technical resistance to change. On the culture and process side, each party may view any ideas from external sources as inferior to internal

ideas. On the technology side, many managers don’t know much about the technology enablers and fear loss of key data and the difficulty of linking to multiple different legacy and ERP systems. To progress to and past this level often requires a visionary leader from a business unit to strengthen the efforts of the supply chain leader and the IT officer in developing these external integrations for the leader’s business unit.

Stage 4: Extended Enterprise In stage 4, the supply chain becomes more of a supply network. Stage 4 networks engage in e-commerce and have automated and seamless information sharing, linked competitive vision, and common business objectives. They may also use collaborative planning, forecasting, and replenishment (CPFR®) to make plans jointly and may employ vendor-managed inventory for components or finished goods. New products are brought to market faster. Partners in these networks have risk- and reward-sharing contracts and other safeguards to ensure that everyone is motivated toward common goals. End-to-end integration provides total visibility and allows the network to function as a virtual company. Companies at stage 4 use public or private internet exchanges to buy materials and services from and sell them to multiple sources.

Much of the trading is automatic and unattended. They establish more formal partnerships and share talent. Getting to this level requires sustained executive leadership and development of human and technological supply chain expertise. Another key to sustaining collaboration is a fully integrated performance measurement system that expresses the supply chain strategy and goals and can identify counterproductive elements. Technology links between partners should be seen as a continuous improvement initiative, and adaptable and scalable software solutions should be used when possible.

Stage 5: Orchestrated Supply Chain In an orchestrated supply chain, talented cross-organizational and cross-functional teams determine a cohesive supply chain technology strategy and use their technical expertise as well as mature processes and well-trained people to ensure that prior and new technology investments are fully leveraged. Change management in particular is well-established, and teams receive the support they need, including through executive championship. The goal is true end-to-end visibility. Automation of repetitive processes should enable people to focus on exceptions, improvements, and relationships. While the prior stage also has many of these integration elements, reaching this stage means that the supply

chain is realizing a competitive advantage from its supply chain technology investments, likely because, relative to competing supply chains, its technologies are better integrated and are state-of-the-art (e.g., use of blockchain and the Internet of Things for asset traceability). For internet maturity, the supply chain’s web presence now uses improvements such as responsive design (i.e., site automatically scales to make mobile device use convenient). Comprehensive standards for cybersecurity are followed by all partners. Integration and supply chain planning now routinely occur at the strategic and tactical levels. At the strategic level, supply chains harness big data and data analytics (especially predictive analytics) to provide decision makers with insights so decisions can be datadriven. These planning improvements also reach the tactical level. For example, many more suppliers now automatically receive end customer demand data so they too can improve their planning horizons and right-size their inventories. Organizations can now also drill down into tier 2 and tier 3 supplier information systems, such as to ensure supply of a difficult-to-source or restricted material. A category strategy can also be used for suppliers; this is basically an assessment of how much you need a given category of supplier and how much they need you. It is used to determine the appropriate

levels of relationship and integration. Suppliers who cannot collaborate or integrate at the desired level may be given assistance or be replaced.

Supply Chain Network Optimization Strategy Many companies become bogged down in their evolution through the stages of optimization. While companies may find it easy to see the value of working toward internal integration, they may be unwilling or unable to make the leap of trust involved in external integration. Different divisions or businesses within a supply chain may be at different levels. Many companies move one or two business units into the next level and move more of the company or network only if successful. The lowest common denominator in the network may become the bottleneck preventing the system from advancing to the next level. For example, most large organizations now have ERP systems and other supply chain systems such as a warehouse management system, but this alone may not be enough to place an organization at a higher level. Rather, a majority of the items must be present to reach a higher stage of optimization.

To move between stages, companies must continually refine their strategies and develop new technologies. Optimization and innovation are never-ending goals. Competitive analysis may play an important role in motivating continued investments in supply chain network optimization. As supply chains attain new stages of sophistication, the collaborative capacity of cross-enterprise management teams will mature in proportion to their stage. These teams will be better at soft skills such as building consensus as well as the technologies involved. This maturity cannot be gained except through experience. Because of this, and because of the great complexity involved in the planning and execution required to pass from one stage to the next, supply chains cannot skip stages. The higher the collaborative capacity, the greater the demand for more enabling technology and new processes such as for transparency. Recognizing and responding to this demand drives further collaboration. It may be that the next opportunity for collaboration lies beyond linking the network and will only be clear when more companies have reached stage 4 (extended enterprise) or 5 (orchestrated supply chain). Evolving a company into one of the higher stages begins with top management’s deciding to permit exchange of pertinent information

across the supply chain. The starting point for getting to stage 4 is often one partnership that points the way toward the completely networked system. Internal resistance to change must be broken down. Only then can the company approach prospective partners with an inter-enterprise strategy. If other prospective members are also willing to explore collaboration, they establish a technical infrastructure. Members then work together over time to reach stage 5. Strategy is set in several steps: 1. Determine the goals and the desired end state of the supply chain. 2. Create cross-functional and cross-business teams. 3. Organize the supply chain’s operational processes and IT’s mission. 4. Design in change management and training with stringent timetables for all parties. Measure results and provide feedback. 5. Create a conceptual model that will adequately explain the process and all of its elements. 6. Establish technical infrastructure. Because cross-functional or ad hoc teams will be making more decisions, a culture shift and a shift in individual employee skill sets must occur. Supply chain network optimization requires that centralized and decentralized approaches be mixed to optimize the

decision-making process. Teams perform collaborative centralized planning, but execution will be decentralized. Multiple management levels create integrated organizational structures. Organizations wishing to form a strategy to get to the next stage first need teams to stay abreast of supply chain technology developments. This thinking should include how the technology would benefit them if they had it as well as if a competitor had it first. Second, organizations wishing to move to an inter-enterprise strategy must build a wide and deep knowledge base of all members of the supply chain network. Third, team-building training should stress a holistic viewpoint; that is, they should think of all members of the supply chain as if they were all in the same lifeboat. When crossfunctional teams come from different nationalities and cultures, supply chain managers may need to educate team members to show proper sensitivity to cultural differences.

Role of Nucleus Firm and Cross-Functional Teams Moving between stages is often facilitated or orchestrated by a nucleus firm or channel master. Because the nucleus firm is most likely the best-known name in the partnership or has its name on the products, it is ultimately responsible for customer satisfaction. Therefore, the nucleus firm will champion the cause, contact

potential partners, perform a technology audit, and form teams with qualified partners across both functional and enterprise boundaries. This firm must also measure, monitor, and manage the supply chain across companies to make it appear seamless. Common cross-functional and cross-business teams formed to support a supply chain management initiative include the following. Executive team. The executive team led by the nucleus firm sets the pace and strategic goals for collaboration and examines mutual strategies for market penetration. Technology team. The technology team examines requirements for databases, networking, software, and configuration, especially as regards communications and security for safe collaboration. It should be the first team formed, because the team must agree on methods of connecting systems and make these connections before other teams progress past the conceptual stage of network planning. The technology team works with the other teams to find types of information that would build mutual advantage. They analyze existing systems to determine actions to support strategic goals. This team should have representatives from the general IT functional areas (not just supply chain technology specialists) due to the need for cybersecurity and networking expertise.

Buying team. This team examines leveraging combined network purchasing, procurement, and sourcing strategies. Making team. The making team examines collaborative improvements to manufacturing. Members may feel that their process is already optimal, and incremental steps must be taken to show the benefits of production collaboration. Selling team. The selling team examines marketing, sales, and customer service synergies to reduce cycle times and optimize order fulfillment and safety stock. Each partner’s customer base and segments reveal potential for cross-selling. Inventory team. The inventory team determines optimal total inventory and inventory turnover to show the benefits of collaboration. Delivery team. The delivery team examines total space against actual inventory. The team builds a consensus on logistics best practices, total asset use, use of Just-in-Time (JIT) or other inventory strategies, and network safety stocks. External relationships will start out with collaboration meetings, followed by partial or pilot endeavors, and then standing and/or project-based team development. Relationships will move forward

only when the technical foundations are in place and each party is given reasons to trust the others. Once the initial connectivity project is complete, the network is at the beginning of stage 3 (integrated enterprise). Thereafter, the teams work toward continuous improvement. At stages 4 and 5, teams see the results of their labor, as real-time network communications are actively used by all cross-functional teams.

Section B: End-to-End Connectivity and Visibility This section is designed to Show how IT fits in a comprehensive supply chain management system Appraise key application tools for their use in supply chain management, including Enterprise resources planning Advanced planning and scheduling Supply chain event management Warehouse management systems Transportation management systems Classify information system infrastructure: databases, networks, software, and configuration Understand how the information system architecture is designed at multiple levels: organizational strategy directs information strategy, information content requirements direct information

policies and controls, and so on, down to the detailed levels of design and change planning Discuss how electronic business enables visibility and information sharing Describe various processes for enhancing visibility and information sharing, including distributor integration (DI), vendor-managed inventory (VMI), and collaborative planning, forecasting, and replenishment (CPFR®) Discuss the need for timely and accurate master data through the use of master data management over a data life cycle and the use of data cleansing and normalization Understand how automatic identification technologies such as conventional and 2D bar codes and RFID help reduce data errors and increase information velocity. Key technology applications for supply chain management discussed in this section include enterprise resources planning (ERP), advanced planning and scheduling (APS), supply chain event management (SCEM), warehouse management systems (WMS), and transportation management systems (TMS).

Customers and suppliers now expect fast and informed responses to questions and real-time visibility into events, market intelligence, and point-of-sale transactions. Better knowledge of demand has allowed (and required) product life cycles to shrink. Faster life cycles mean that products may enter growth and maturity faster, which will speed the time to profitability, but, conversely, it may also mean that products enter decline sooner and need to be replaced, meaning that organizations must be increasingly flexible. Technology can be a source of competitive advantage for a business.

Topic 1: Supply Chain Technology Applications Supply chain technology applications discussed here include broad, organization-wide systems such as enterprise resources planning (ERP) and advanced planning and scheduling (APS) as well as supply chain–specific systems including supply chain event management, warehouse management systems, and transportation management systems. First, an overview of these applications is provided.

Technology, Connectivity, Visibility/Sharing, and Legal Road

Map A technology road map for supply chain management is presented next, followed by an overview of the other subjects discussed in this area: connectivity, visibility or information sharing, and the legal implications of visibility and information sharing.

Technology Road Map Exhibit 2-7 provides an overview of a comprehensive supply chain management technology system from the perspective of a manufacturer, focusing on the key application tools as well as on customer relationship management and supplier relationship management. Notice how each partner has their own versions of many or all of the systems.

Exhibit 2-7: Comprehensive Supply Chain Management System (Manufacturer’s Perspective)

Many of these systems are also used by other supply chain members, and their supply networks and technologies would appear to be centered on them. Note the three categories at the top of the exhibit: Process value supply chain. This part of a supply chain translates demand channel information into products or services. Process efficiency and effectiveness are critical. Value delivery supply chain. This part of a supply chain is configured to deliver the service component of a product-service package as defined by what the demand channel values. Some chains will have more or fewer partners as strategy demands. Demand channel. From an IT perspective, the demand channel exists to collect, analyze, and disseminate market intelligence and information on actual customer demand. Rather than thinking of a supply chain as a monolithic entity, technology has allowed supply chains to continually reinvent and regenerate themselves by forming new chains for different products or customer segments. Viewing a supply chain as a set of modular components helps demonstrate this flexibility. A modular system , as defined in the APICS Dictionary, 16th edition, is

a system architecture design in which related tasks are grouped in self-contained packages. Each package, or module, of tasks performs all of the tasks related to a specific function and advances in functions can be implemented without affecting other packages or modules because of the loose coupling with other modules. One example is a multitiered architecture in which application business rules are separated from the data management rules. Another example is a client-server architecture in which user interface tasks are separated from the application software.

Connectivity Road Map Connectivity is enabled by the organization’s and its supply partners’ information system architectures. This includes databases, networks, software, and their configuration choices (such as a cloud). Supply chain managers need to know how these elements can help or hinder the goal of better connectivity among partners. It is also important to know how these elements can be designed to enable the organization’s supply chain strategies to succeed.

Visibility and Information Sharing Road Map Enhancing visibility and information sharing is how supply chains become more mature and integrated. In addition to solving the technical hurdles, supply chain managers need to sell the idea to the

persons involved, both within and external to the organization. Building up trust is critical.

Legal Requirements Road Map Visibility and information sharing create risk. This includes risks of supply chain disruptions, risks of loss of intellectual property, data privacy risks, data residency rules (the nation in which the data resides, which is especially important for cloud systems), and risks related to cybersecurity. Trade disruption and cyber insurance are options. Getting supply partners to adopt common standards is another response.

ERP Systems The APICS Dictionary, 16th edition, defines enterprise resources planning (ERP) as a framework for organizing, defining, and standardizing the business processes necessary to effectively plan and control an organization so the organization can use its internal knowledge to seek external advantage. An ERP system provides extensive databanks of information including master file records, repositories of cost and sales, financial detail, analysis of product and customer hierarchies, and historic and current transactional data.

ERP software is a modularized suite of business applications that are seamlessly integrated to provide automated interactions and a common source of data. ERP systems are built around a large database with shared access to data and include a number of transactional modules (for example, planning, manufacturing, purchasing, human resources, finance, sales, logistics). ERP systems are common in large and mid-size companies and are being adopted by smaller firms. Even in companies already set up for enterprise resources planning, however, there is room to enhance the system’s capabilities and to add new modules. Moreover, there is the evolving challenge of linking the ERP systems of supply chain partners. Without vision or direction, ERP is just a set of applications; with them, ERP will provide the visibility and efficiency needed to see where the business is going and where it can be steered. Exhibit 2-8 shows how an ERP system supports multiple business functions and can be extended to include more advanced systems such as advanced planning and scheduling.

Exhibit 2-8: ERP System Functionality

ERP Database and Shared Master Data A key feature of ERP systems is a shared central database. ERP databases provide a single storage location for all types of data. This minimizes data redundancy and enables the various modules to create, access, and modify the same data. The ERP data warehouse contains a number of files or categories of data; the following are relevant to supply chain management: Customer files contain all information on individual customers, including terms of sale, records of transactions, and customer

service notes. Product-price files contain all data on the firm’s products and services, including quantity discounts, standard costs, and physical characteristics. Supplier files list all suppliers for the organization, allowing the organization to consolidate suppliers and find economies of scale. Open order files contain all current or potential product orders from multiple channels, including special shipping or handling requests. Purchase order (PO) files are all open orders to suppliers, including MRO (maintenance, repairs, operations). Bill of material (BOM) files list product components and raw materials. Inventory files show, by location, all available raw materials and finished goods and forecasts of when work-in-process (WIP) inventory will be available. Order and PO history files show past purchases and sales for forecasting and budgeting. These master data are shared among the transactional modules. For example, information in a vendor master file may be used by purchasing, finance, and planning. Material master information may be used by purchasing, planning, and logistics. Location information may be used by planning, purchasing, logistics, sales, human resources, and others.

ERP Transactional Modules The ERP transactional modules are where all user interactions with the system occur, such as placing orders, moving inventory, billing customers, or paying suppliers. These modules are numerous, and companies can implement one, many, or all of them and may implement them sequentially or all at once. Decision makers use the ERP planning module to gather input data and analysis when developing tactics aligned with strategy. For the supply chain, this includes research and development, funding and required returns, product line decisions, and marketing strategies. Analytical and forecasting tools in this area use ERP data as well as external market intelligence. The strategic goals set in this area are translated into department-specific goals. Sales and operations planning is a key tool that works to synchronize supply with demand, allowing strategic plans to be regularly adapted to current circumstances. (S&OP is discussed in more detail elsewhere.) S&OP decisions feed into master production scheduling, material requirements planning, bills of material, scheduling, capacity, and other planning methods. The results of S&OP are also fed into other modules, including sales, manufacturing, purchasing, finance, and logistics.

Each of the other modules shown in Exhibit 2-8 will have a range of functions from the strategic to the transactional. Review the exhibit to see some of the functions of these transactional modules.

ERP System Evolution to Advanced Systems Most ERP systems originated as material requirements planning (MRP) systems that grew over time to include manufacturing resource planning (MRP II) functions and then continued to add modules. Therefore, these supply planning functions are often described as the core of ERP. The outer ring of Exhibit 2-8 shows that ERP systems are continually evolving and adding new functionality such as CRM, SRM, SCEM, TMS, WMS, engineering change control (ECC), or APS. ECC, also called engineering change management or engineering change order, is a way to ensure that product designs follow a change authorization procedure. Advanced systems may be part of the same ERP system, but often they exist within separate systems. These systems will link back to the ERP system and leverage the shared ERP data. They may send instructions back to the ERP system for processing. For example, an APS system may determine an optimized production plan/schedule,

but it will not execute that plan; it will send the plan back to the ERP system to process. Even older ERP versions provide value, such as automating processes to increase efficiency and reduce errors. ERP systems incorporate best practices in their conceptual models, which enables process improvements but also means that an upgrade is required to use innovations such as moving from a product-oriented push model to a customer-oriented pull model. More advanced versions shift the focus from internal optimization to external relationships and efficiencies such as collaborative commerce and supply chain management. With advanced versions of ERP software, supply chain partners are able to Make better decisions by relying on data transformed into business knowledge Link management pay to supply chain performance through builtin performance measurement tools Adopt operational methods such as build-to-order, direct-tocustomer, and lean manufacturing Connect one ERP system to others in the supply chain and use web-based, open, and component-based systems to regularly adapt the business model

Provide global access to operational data for all supply chain partners Free up capacity and resources to pursue new business opportunities Perform collaborative planning using cross-industry and industryspecific ERP systems.

ERP Versus Best-of-Breed Systems There are several ways to construct an ERP system. All modules can be purchased as a package from one vendor, some modules can be purchased from one vendor with other modules added, or “best of breed” modules can be bought from multiple vendors. When an application is available from both a best-of-breed vendor and an organization’s ERP vendor, which should be chosen? The advantages of using a module from the ERP vendor include the following: Simpler and better integration Leveraged ownership of enterprise data Shorter user training Fewer vendors to work with Included in existing support contract Lower total cost of ownership (most of the time)

Vast development resources, including large development (industry-specific) staffs On the other hand, many best-of-breed vendors have come up with industry-specific or otherwise highly tailored and cutting-edge solutions with the following advantages: Faster to market with innovative functions and services Targeted industry expertise Niche market applications (e.g., oceangoing vessel management) May have more expertise in a specific functional area such as warehousing, while an ERP vendor may have little expertise in this area and their module’s functionality may reflect this shortcoming The best-of-breed companies will likely have the most innovative technologies first, and if the company is looking to use the technology to create a competitive advantage, such a purchase can differentiate the company until the technology becomes mainstream (by ERP adoption). Also, if the business case requires a niche application, a more generic alternative offered by an ERP vendor may not suffice. Ultimately, the selection should come from a detailed analysis of the needs of the business versus each option’s capabilities.

Upgrades, New Releases of ERP, or New Modules

When a technology audit reveals a gap between current and required technology, the company may be able to get to the desired supply chain stage by implementing an upgrade or new release of its ERP system or by purchasing a new module from the ERP vendor. Any of these changes has significant costs and should be justified by a positive return-on-investment analysis proven with measurable results. If the upgrade supports the top issues that the company would like to address and if it satisfies key profit, performance, functionality, integration, time to market, and human resources criteria, then the upgrade will likely be a good investment. Other indications of a worthwhile upgrade include providing the following: Better open architecture than the current system, easing supply chain communications and the process of later upgrades or addons (Unlike a proprietary architecture, an open architecture is software coded using certain standards to make its parts more interoperable and interchangeable.) Better business information or metadata (data about data) such as not only knowing in-stock inventory but also lead time for new stock, stock locations, and capable-to-promise

Faster learning curve and user-friendly abilities to speed acceptance Full integration with currently disjointed systems Increasing cost of maintaining old versions (lack of vendor support) Upgrades take longer when the system infrastructure is heterogeneous and multiple duplication of effort is required for each different system. Multisite coordination is also a factor in the speed and complexity of the process. Upgrading only the sites that will benefit from the change is an option, especially if communication between the versions is already part of the plan. Tracking the cost of each subsequent upgrade or release allows companies to assess the lifetime cost of the system. This cost should be measured by spending as well as time to delivery. ERP upgrades that can come into service quickly provide the most differentiation from competitors. An alternative to purchasing ERP software and periodically updating it is to use software as a service (SaaS). Many companies are starting to offer SaaS directly to their customers. Another advanced feature that organizations may want to add through the use of upgrades is cloud computing. Cloud computing would allow a geographically dispersed organization to maintain

servers and databases in multiple locations while having them function as a single virtual system and database that can be accessed from anywhere. Note that cloud computing may use an SaaS model or purchased software.

Configuration Versus Customization For a software purchaser, configuration is adjusting system parameters from a process view without reprogramming the software’s code. Configuration is typically a necessary step that results in entry fields and lists being populated with the organization’s cost centers, transaction codes, customer codes, and so on. Configurable software is flexible and cost-effective but has limitations, so the software must still be a close match. Customizing is reprogramming the software’s code or adding on to the software’s code to get the application to do what it was not originally designed to do. ERP vendors create systems by interviewing thousands of firms and, in general, design the systems to cover the top 80 percent of requested functionality. Costs tend to rise quickly if software is selected below the 80 percent threshold level, partly due to the increased need to customize the software.

Customized ERP systems are inflexible, and customization beyond a few minor and necessary adjustments has many costs and pitfalls. Customization to meet the remaining 20 percent of strategic goals can be worthwhile but should never be applied to the 80 percent that does fit. Customization should be used only to enable meeting indispensable business requirements, and, in practice, far less than 20 percent of a system should be customized. A firm is generally better off upgrading current hardware, databases, software, and business processes to best-practice standards rather than customizing ERP to fit existing systems. A similar argument against customization could be made for many types of software.

Advanced Planning and Scheduling Systems According to the APICS Dictionary, 16th edition, advanced planning and scheduling (APS) refers to techniques that deal with analysis and planning of logistics and manufacturing over the short, intermediate, and longterm time periods. APS describes any computer program that uses advanced mathematical algorithms or logic to perform optimization or simulation on finite capacity scheduling, sourcing, capital planning, resource planning, forecasting, demand management, and others.

The key use of APS is to help make sourcing and timing decisions when multiple facilities are available to provide the supply required to meet demand. As Exhibit 2-9 illustrates, APS is an intermediary to enterprise resources planning (ERP) systems that feed it.

Exhibit 2-9: Advanced Planning and Scheduling Systems

APS applications use analytical tools such as modeling, optimizing techniques, and simulations. APS usually includes user-friendly planning tools such as interactive scorecards and drag-and-drop functionality in its interfaces. These advanced tools help plan at the strategic, tactical, and operational levels: The strategic level is where high-level decisions and system design occurs. At this level, APS systems may perform logistics supply chain network design. For a manufacturing company, this

would involve determining the location of factories, warehouses, and distribution centers, including which aspects of the supply chain will be owned and which will be contracted from a third party. The tactical level is where strategy is refined into discrete plans and optimization occurs. At this level, APS helps optimize production, distribution, and inventory across the supply chain. The operational level is where plans are refined to the most granular level and then executed. At the operational planning level, APS creates demand forecasts, demand plans, inventory plans, transportation plans, and optimized daily production schedules. For example, at this level it may include finite scheduling software that sends optimized work order loads to manufacturing equipment. Note, however, that while APS supports planning at each of these levels, it does not execute transactions itself. Exhibit 2-10 shows how APS systems have four modules that take data from the ERP systems, provide planning and optimization, and then provide the results back to each ERP system’s master production schedule.

Exhibit 2-10: Advanced Planning and Scheduling System Modules

The four modules comprising APS are described as follows: Demand management. This module takes data on actual orders, order history, customer data, seasonality, and scheduled marketing events and performs organizational or extended supply chain forecasting for production and transportation. Resource management. This module coordinates the capacities and constraints of resources across the supply chain. Inputs include planning objectives, demand management output, system constraints, customer data such as location, and costs, descriptions, and physical characteristics of products and resources. Requirements optimization. This module analyzes demand and resource management results and generates and evaluates

multiple planning options. It considers customer service and cost, recommending the optimum systemwide solution for procurement, manufacturing, transportation, and storage. It also allows planners to simulate the effect of changes in demand, capacity, etc. Resource allocation. Once planners review and release the optimized requirements, this module sends requirements to each ERP system’s master production schedule. It also provides sales/customer service decision support, such as Available-to-promise (ATP) . Information on the visibility of uncommitted finished goods inventory plus work-in-process inventory allows sales channels to quote reliable delivery dates. The APICS Dictionary, 16th edition, further explains ATP as the uncommitted portion of a company’s inventory and planned production maintained in the master schedule to support customer-order promising. The ATP quantity is the uncommitted inventory balance in the first period and is normally calculated for each period in which an MPS receipt is scheduled.

Capable-to-promise (CTP) . If supply chains are fully linked, the availability of materials for production can be added to ATP data to quote a reliable delivery date.

The Dictionary defines CTP as the process of committing orders against available capacity as well as inventory. This process may involve multiple manufacturing or distribution sites. Capable-to-promise is used to determine when a new or unscheduled customer order can be delivered.

Profitable-to-promise (PTP) . This combines CTP with a profitability analysis to determine how profitable a particular order would be after all costs are considered. The optimized supply chain master plan feeds a detailed sequence of events to the transactional systems. It ensures the availability of materials and capacity and synchronizes their flow using scheduling. Feedback from these plans helps continuously improve supply chain planning.

APS Benefits APS systems remove pressure from bottlenecks in systems. In a multiplant environment, when the same item can be manufactured at different facilities, APS optimizes and accelerates the use of available materials, labor, and plant capacity. At the same time, it satisfies business objectives to create schedules for what should be

produced, when and where production should occur, and the sequence of events that should occur. APS creates holistic supply chain plans that incorporate long-range aggregate planning and short-term detailed scheduling. APS also makes tradeoffs between conflicting objectives as determined by the strategic priorities of the firm. One such tradeoff is performing mass customization while keeping costs down. The combination of several ERP systems with an APS system makes the most of current ERP investments while opening up a new stage of supply chain development for a firm. The APS system derives an optimal solution for the supply chain network and provides each ERP system with production requirements and optimal start dates for production runs, and it leaves the ERP system to work out the details of how it will meet this high-level plan. Note that the benefits of APS systems can only be achieved if input data are complete and accurate.

Supply Chain Event Management The APICS Dictionary, 16th edition, defines supply chain event management (SCEM) as a term associated with supply chain management software applications, where users have the ability to flag the

occurrence of certain supply chain events to trigger some form of alert or action within another supply chain application. It can be deployed to monitor supply chain business processes such as planning, transportation, logistics, or procurement. SCEM can also be applied to supply chain business intelligence applications to alert users to any unplanned or unexpected event. The alerts mentioned in the definition are often called exception reporting. SCEM software simulates, controls, and responds to unplanned events and exceptions to planned events. It uses supply chain visibility to link the extended supply chain and track inventory movement. It can help reduce or eliminate customer service errors such as late deliveries or incomplete orders by inputting data into performance management systems so that the root causes of the errors can be seen and corrected. In other words, it shows why a problem occurred. SCEM also allows users to set parameters based on business rules that trigger notification to the appropriate parties when events in the system occur or when exceptions to those events occur. Managers set workflow-enabled business rules and can spend their time on exceptions instead of sifting through events. Decision makers using SCEM are able to quickly develop and possibly even automatically

implement alternate plans. Therefore, SCEM helps mitigate business risk, makes processes more harmonious, and enables collaboration. Use of SCEM will help a supply chain reach the highest stage of development by enabling interactions between their functional systems such as ERP, advanced optimization tools, and trading exchanges. SCEM can also trigger downstream activity. For example, when a surgeon writes an order (prescription) authorizing a specific procedure, this event may trigger a number of activities at the hospital, such as allocation of nursing resources, operating and recovery room space, pharmacy needs, and meals.

Active Visibility SCEM provides active visibility, meaning it can perform the following functions: Monitor events such as demand, shipments, orders, production, fulfillment, and inventory and distribute the information throughout the supply chain. Measure events against key performance indicators to improve forecasts and decision making. Notify decision makers when exceptions occur, such as a shortage, so they can make alternate plans in time to avoid costly

consequences. Simulate real or projected exceptions to gauge their impact and recommend solutions. Help control events by providing timely and simple methods for reversing previous system choices when an exception indicates that a change could prevent a problem or be less costly (e.g., ship from an alternate source). Active visibility in SCEM means providing real-time data to internal users and external supply chain members by capturing data from each supply chain partner and dynamically updating distributed databases across the extended supply chain. With SCEM visibility, customers using the company’s website can see dynamic order status or get the same information from an email, call center, or salesperson. These systems usually save the company money in customer service because an email to customers makes them less likely to call about the status of their order, saving call centers for more complex issues. For managers, the system may include global track and trace functions and may provide data not only on picking, packing, shipping, transit, and delivery status but also quality reporting and performance data. Instead of making calls to find the status of an incoming order, managers simply check the system, at a much lower

cost per transaction. Active visibility may also benefit other systems, such as transportation management or warehouse management, for example, when optimizing or making available-to-promise quotes. Visibility provides SCEM the ability to measure and report on supply channel performance, including information on customer demand patterns, shipments, order location and lead time, and inventory levels by location. SCEM collects information from external sources to add to business intelligence. For demand management, SCEM provides the ability to manage supplier stockouts or delays. It helps buyers and sellers plan for seasonality and promotions and quickly update demand forecasts with the latest information. For supply planning management, SCEM supports dynamic inventory allocation and postponement. Sourcing can be sorted into multiple tiers for various levels of speed versus price. Global supplier shipments can be redirected at the port of entry rather than sorted at a central distribution center.

SCEM Benefits SCEM benefits include the following: Faster response times to changes in supply and/or demand Ability to receive exception notifications on portable devices

Earlier marketing and sales demand reaction (less waiting for systems analysts) Improved order accuracy, tracking, and cycle time Less management time devoted to shipping and receiving Reduced inventories and safety stocks across the supply chain Greater labor efficiency and productivity Better forecasting and business planning for a flexible response to demand Reduced total supply chain costs Enriched collaboration by allowing it to occur in a decentralized way Increased customer responsiveness and decreased product returns Improved real-time communications with ad hoc partners

Use of SCEM in Trading Exchanges Some online trading exchanges provide SCEM capabilities as software as a service (SaaS). They coordinate procurement or sales activities and manage documentation and information distribution needs. On the buy side, exception alerts can notify appropriate personnel of a need to buy a type of good, or the system can be set up to automatically bid for items based on constraints such as cost and supplier rating. On the sell side, shortages in supply can

dynamically influence trade exchange demand, such as by promoting an alternative item.

Warehouse Management Systems As defined in the APICS Dictionary, 16th edition, a warehouse management system (WMS) is a computer application system designed to manage and optimize workflows and the storage of goods within a warehouse. These systems often interface with automated data capture and enterprise resources planning systems. WMS software takes the output from the enterprise resources planning (ERP) systems and order entry and executes the daily operations of the warehouse or distribution center, performing tasks in an ordered sequence based on predefined parameters. To gain productivity improvements, the WMS, the warehouse layout, and all enabling technologies for automating data capture and inventory movements should be thoroughly mapped in advance. For example, if mobile devices for scanning bar codes are to be located on forklifts, this needs to be included in the mapping. While WMS was initially only for warehousing, its role has expanded to include areas such as light manufacturing (postponement) and transportation, labor, and order management. This functional overlap

makes selection more complex and integration more challenging. However, a WMS selection should hinge on three key areas: directed picking, directed replenishment, and directed put-away. WMS performs these tasks by tracking and analyzing item, quantity, location, unit of measure, and order data.

WMS Functions A WMS incorporates feedback to improve workflow by continuously simplifying and optimizing operations, especially with warehouse personnel and equipment. It directs management attention to anticipated or existing problem areas in warehouse activity by continuously profiling performance and then creating exception reports for activity levels, productivity, warehouse order cycle time, storage density, and shipment and inventory accuracy. WMS should perform continuous cycle counting for inventory. The WMS should have a flexible location system, including definable put-away and storage logic methods such as zone logic (defined storage zones), nearest location, fewest locations, or pick-to-clear (using smallest quantities first to maximize space). Specific WMS functions include the following: Receiving—automatically matches and routes POs with advanced shipment notifications (ASNs) and blind or traditional receipts;

notifies staff of incoming ASNs and upgrades backorders or rush orders Storage location management and optimization—creates put-away algorithms and determines location by type, size, volatility, and velocity Cross-docking—allows for opportunistic or planned truck-to-truck transfers, including timed merging of items for a customer’s order Inventory control—performs cycle counting and creates audit trails to track the time, person, and place of movements, inventory levels, and lead times Quality control—tracks items by batch or lot, notifies management of quality issues, places rejects on hold, and ensures quality compliance Order selection and task management—forms a pick plan by picking type, allocates items for specific orders, and shows order status Automated replenishment—automatically creates a shipment order when an internal or external partner’s system signals the demand Security—interfaces with security by requiring WMS records for all releases at controlled points, rotates work assignments, etc. Returns—manages reverse logistics for repairs, returns, and recycling

Today’s WMS supports automatic identification technologies and wireless data collection devices to make the warehouse manager’s job easier, more efficient, and less prone to error. Automatic communication and presentation devices such as radio frequency data communications, synthesized voice, pick-to-light, carousels, sortation systems, virtual displays, and other pick signals tell warehouse staff what needs to be moved where without creating paper records.

WMS Interfaces or Portals Some vendors offer WMS with web-based interfaces or portals. Portals allow visibility and control because users can push data and inventory to supply chain members or they can pull the data and inventory themselves. Such portals can be available as purchased software or software as a service (SaaS). WMS interface functions include merge-in-transit and crosscompany sharing of warehouse space, freight consolidation, or complementary commodities. The web can provide real-time visibility to these collaborative activities such as by providing warehouse status or brokerage clearance data.

Benefits of WMS

Implementing a quality WMS can significantly improve productivity and reduce the frequency of errors or fraud in comparison to traditional methods. In traditional systems, stock pickers may find the wrong item in a location or may find that an item is out of stock. Salespersons with old data may promise what is unavailable, leading to rush orders. Special orders may wait instead of being crossdocked. Fraud or theft may occur (e.g., deliberate over-picking). Other WMS benefits include the following: Offers competitive advantage, such as faster cycle times through cross-docking or automated checking replacing manual checking Satisfies retail requirements such as by adding automatic identification technologies Improves accuracy by automating put-away and pick location verification Supports high transaction processing capacity for global ecommerce Satisfies complex international handling needs Increases distribution efficiency, for example, coordinating pallet sizes and bulk discounts (e.g., 80 items per pallet = 80-item order for discount) Reduces safety stocks Optimizes use of space

Provides for system design, selection, training, and change management that can mitigate risk

Transportation Management Systems As defined in the APICS Dictionary, 16th edition, a transportation management system (TMS) is a computer application system designed to manage transportation operations. These systems typically offer modules focused on specific functions, such as intermodal transportation, import/export management, fleet service management, and load planning and optimization. Transportation management systems automate the planning and operations involved in moving goods between any points in the supply chain, including shipper and mode selection, optimizing routes and loads, and fleet maintenance. TMS has become an integral part of supply chain management partly because of the impact of e-commerce on order size and frequency. Online procurement favors the lowest bidder. Both businesses and consumers are finding it cost-effective to have smaller, more frequent orders. Business models such as Just-in-Time and build-toorder, direct-to-customer also require smaller shipments with tighter lead times. Thus the profit margins are still tight, but the expectations for shipping to manage capacity, costs, and congestion are growing.

In such an environment, TMS must be able to optimize transportation across the entire supply chain. Transportation costs amount to a significant percentage of a company’s total expenses. Furthermore, organizations commonly use thousands of transportation suppliers. Transportation optimization has room to leverage cost savings by using key partnerships with a smaller number of suppliers for most activity and transportation marketplaces for exceptions. Any TMS package must be able to provide the following: Visibility. Gives transportation managers, salespersons, customers, and shipping personnel access to timely information. Centralized control over shipment planning. Holistically optimized routes and shipping modes, freight cost, lead time, and customer service levels. Integration between transportation planning and order fulfillment. Increases cost control, customer service, and automation. Execution control. Ensures that the plan is being followed. Automation. Increases efficiency and reduces errors, e.g., integrating TMS with conveyor belt systems, automatically marking billed loads, or converting documentation to PDF format for international shipments.

TMS Functions TMS generally includes the following functions. Transportation Network Design This strategic phase maps out the transportation network using tools and optimizers. This process would be completed when starting a company or undergoing a major shift in strategy such as collaborating with supply chain partners in transportation network design or determining distribution center locations. Shipment Planning Shipment planning optimizes the transportation network using modeling and simulation. At the tactical level, it evaluates routes and carriers. At the operational level, it optimizes daily transportation plans. Shipment planning includes carrier capacity planning, which matches capacity from a supply plan with demand from a demand forecast. Planning takes into account national regulations such as hours-of-service limits to prevent driver fatigue. Routing Routing must be able to deal with various transportation modes. For example, truck shipments are shipped by truckload (TL) and less than truckload (LTL). Mode-switching tools optimize the movement of goods across multiple modes, such as air-to-ground, parcel-to-LTL,

or courier-to-air-to-courier. Routing guides allow users to define rules for shipment routings, and the TMS can automatically select carriers. Dynamic routing services can interface with global positioning (GPS) devices to avoid traffic congestion. Specialty applications exist for modes such as routing containerships. Private fleet management. Private fleets can be managed using tools such as dynamic routing and real-time dispatch. Fleet management dispatches the least number of routes over the least distance to maximize capacity. A vehicle maintenance module schedules maintenance and tracks costs. Carrier selection. Multiple carriers such as owner-operator trucks, common carriers, agents, and package services can be managed and selected using transportation procurement applications and transportation marketplaces. Both methods can electronically distribute and collect data from requests for quotation (RFQs) on price and capacity. The systems also track carrier broker profiles and contracts. Load Matching and Optimization TMS provides better visibility to the resources available so that the system can find optimal locations from which to fill orders based on

availability and inventory and delivery costs. Common load matching/pooling functions include cross-docking and LTL consolidation. Load optimization includes handling of special materials (e.g., refrigeration, hazardous materials). Special applications exist such as for bulk replenishment (e.g., gasoline tankers). Freight Rating Rate tariffs can be entered, and loads will be automatically rated by cost and reliability. The selection process uses carrier service level ratings that are updated based on past performance measurement of cost, on-time delivery, and number of errors or damaged goods. Each owner’s tariff is used to calculate demurrage (payment for delay to load or unload) and per diem rates. Manifesting Manifesting is the process of creating all required shipment documentation. TMS automates the process, printing shipping labels and pick slips. Load Tendering and Delivery Scheduling Each load lists carriers in order of preference, and each carrier is attempted in order until coverage is obtained. The delivery is

automatically scheduled if the location is set up to receive advanced shipment notifications (ASNs). Shipment Tracking and Settlement Managers can view the actual cost of shipments based on actual charges through real-time updates of proof of delivery, freight bills, and import/export documentation. The TMS generates invoices and bills of lading. For global shipments, managers can view certificates of origin, global settlement and billing information for freight, and customs information. Settlement includes auditing of freight bills, minimizing payment errors, and automating payment. Visibility Tools Visibility tools allow companies and their suppliers and customers to view inbound and outbound shipments, in-transit inventory levels, and exceptions to expected shipments. These tools improve customer service because they provide the same information to all channels, including self-service channels, make replenishment cycles more reliable, and help supply chain members reduce safety stocks by showing sources of stock and delivery times. Post-Shipment Analysis Managers can print reports on freight bills, total landed cost, and loss and damage claims and their filing status.

TMS Interfaces or Portals Transportation management systems often have web-based interfaces or portals that allow centralized control and automate information distribution across multiple sites. Portals are available in purchased software or as software as a service (SaaS). They have dynamic databases of transportation information that can immediately be used for optimization of transportation methods, such as by allowing carriers on the network to indicate their availability to ship to a particular location or accept backhauls from a location. Many SaaS TMS applications have thousands of carriers and thousands of TMS subscribers in their networks, meaning that there are no compatibility issues between network members and that automated requests for proposal (RFPs) can be sent to a large selection of carriers. For example, Ace Hardware used its SaaS network to send an RFP to almost 500 carriers, helping it save US$3.9 million or approximately 4 percent of its transportation costs. Since shipment and fuel costs; road maps and routes; carrier availability; road, traffic, and weather conditions; and many other transportation factors change dynamically, it makes sense for data of these types to be located in a web-based environment where they can be updated in real time. Managers can use web-based TMS to

change destinations on shipments while in transit and receive a notice of consignment and statement of revised charges.

Global Track and Trace Common carriers and private fleets can install global track and trace using cellular-enabled GPS. Global track and trace allows tracking of shipments by location and by receiving status from booking to proof of delivery. Concerned parties can check the information on a dynamically updated website. Global track and trace can also be used to manage field personnel and keep fleets in constant communication, such as finding the best time to pass a toll if the rates change by time of day. The ability to measure driver performance and efficiency allows shippers to manage these factors. Therefore global track and trace systems are a key element in any effort to optimize transportation routes. When web-based transportation information services are coupled with automatic identification technologies, this information can automatically keep the TMS up-to-date on the status of a shipment without any manual intervention. Because the TMS gets near realtime updates on order shipping status, the system can be proactive in planning next steps and notifying appropriate parties of information such as pickup requests or claims status. Shipments

have unprecedented visibility because the TMS allows access by container, bill of lading, PO, order, and other numbers.

Collaborative Transportation Management Principles Collaborative transportation management has become possible because of robust web-enabled technologies such as use of transportation marketplaces for collaborative shipment management. Shippers and carriers can collaborate on load planning, optimize costs, and consolidate shipments for lower overall transportation costs. Members of a collaborative supply network can optimize all network assets such as by matching loads with multicompany internal assets before resorting to common carriers.

Benefits of TMS Benefits of TMS include reduction of overall transportation costs by reducing deadheading, demurrage, and time spent waiting to load or unload. Companies can aggregate volumes between locations or companies to reduce freight costs. Capacity procurement reduces cost variability by anticipating demand and making better use of all internal and contractual transportation resources. Linking of communications reduces billing errors and gives networks more time to strategically plan shipments.

In general, a TMS should Minimize transportation costs Communicate with carriers, vendors, and others using web-based tools Make faster and better transportation decisions Enable intelligent sourcing decisions by sharing accurate, realtime costs Reduce shipment delays from paperwork, errors, or capacity bottlenecks Centralize operations to reduce administrative and support costs Create distributed data access to reduce information bottlenecks Increase supply chain visibility.

Topic 2: Connectivity, Visibility/Sharing, and Legal Connectivity involves getting the organization’s information systems (IS) to talk to the information systems of the organization’s partners. Understanding connectivity requires understanding how the IS architecture needs to be designed to enable this connectivity. Prior to addressing design, there is a discussion of IS architecture components to clarify the basics of an information system. Next, we address what connectivity provides: visibility and information sharing

capabilities. Finally, legal and regulatory requirements related to information sharing are addressed.

Information System Architecture Components The APICS Dictionary, 16th edition, defines the information system architecture as A model of how the organization operates regarding information. The model considers four factors: (1) organizational functions, (2) communication of coordination requirements, (3) data modeling needs, and (4) management and control structures. The architecture of the information system should be aligned with and match the architecture of the organization. The core technologies of the information system architecture can be summarized as databases and their management systems, networks, software, and configuration.

Database and Database Management The core of information system architecture is the database, which is a structured repository of data serving a specific need, such as a transaction record or an employee file. When enterprise resources planning systems are used, they provide a pre-built database

structure that can be leveraged. Databases require a database management system (DBMS) , which is defined by the Dictionary as software designed for organizing data and providing the mechanism for storing, maintaining, and retrieving that data on a physical medium (i.e., a database). A DBMS separates data from the application programs and people who use the data and permits many different views of the data. Related terminology includes data manipulation language (e.g., structured query language [SQL]), which is the language used to query and manipulate a database, and data dictionary , which, as defined in the Dictionary, is (1) a catalog of requirements and specifications for an information system; (2) a file that stores facts about the files and databases for all systems that are currently being used or for the software involved.

Networks The Dictionary defines a network as the interconnection of computers, terminals, and communications channels to facilitate file and peripheral device sharing as well as effective data communication.

Linkage between computers and servers is usually through a local area network. The Dictionary defines these terms as follows: Server : A computer, or software package, that provides a specific kind of service to client software running on other computers. Local area network (LAN) : A high-speed data communication system for linking computer terminals, programs, storage, and graphic devices at multiple workstations distributed over a relatively small geographic area such as a building or campus. Wireless LANs use radio waves to transmit data. Wireless systems are less expensive to set up since they require no wiring, but they do require higher security to prevent unauthorized interception and use of data. Companies use wide area networks to share information between geographically dispersed facilities. The Dictionary states that a wide area network (WAN) is “a public or private data communication system for linking computers distributed over a large geographic area.” A virtual private network (VPN), a low-cost internet-based secure transmission method, can allow secure communications with individuals and organizations in various locations. VPNs use

encryption to ensure secure communications. External VPN users see the system as if they were in the facility using the LAN. Two other network terms from the Dictionary are intranet and extranet. Intranet : A privately owned network that makes use of internet technology and applications to meet the needs of an enterprise. It resides entirely within a department or company, providing communication and access to information, similar to the internet, with web pages, and so on for internal use only. Extranet : A network connection to a partner’s network using secure information processing and internet protocols to do business.

Software Software describes programs that create, display, modify, process, and analyze the data in databases in various ways. Types of software include operating systems and applications. According to the Dictionary, an operating system (O/S) is a set of software programs that control the execution of the hardware and application programs. The operating system manages the computer and network resources through storage management, disk input/output,

communication linkages, program scheduling, and monitoring system usage for performance and cost allocations. Familiar operating systems include Windows, Unix, Linux, and the Mac O/S. Application software is controlled by an operating system and fills various computing needs such as to plan, make, source, account for, deliver, and return products and services. Software can be judged by its relative cost, its reliability (failure rate), its relevance (usefulness and time until obsolescence), its scalability (bandwidth or number of users it can accommodate), and its maintainability (relative cost to create, configure, or upgrade). In the conventional software application model, the user purchases a software package and license, paying a one-time or annual fee. The user owns the software, and the vendor or developer provides support and updates according to the terms of the licensing agreement, which may require paying an annual maintenance fee or separate fees per upgrade. An alternative to this is software as a service (SaaS) , defined by the Dictionary as computer services…provided by a third party that keeps all of the software and hardware in its place of business and

the company using the services accesses them via the internet. With SaaS, the software is not downloaded to the user’s computer or server. The organization effectively rents the software; SaaS software licenses are still used to indicate the number of authorized users and so on, but the license is in force only so long as the subscription (usually monthly) is kept current. SaaS eliminates time required for installations and upgrades. For example, Google’s word processing and spreadsheet tools fulfill the basic criteria of a SaaS application: A vendor (Google) Logic and data stored in a central location End-user access to data and software, run and used over the internet This example can be classified as one broad category of SaaS— customer-oriented services. Business-oriented SaaS applications are often “lines of business services,” or business solutions for processes such as supply chain management, customer relations, and others. Exhibit 2-11 summarizes some basic advantages of SaaS for users and vendors.

Exhibit 2-11: Key Advantages of SaaS User Advantages

Vendor Advantages

Lower initial costs—no large licensing fee reduces barriers to use; no IT investments Immediate use—no long implementations Upgrades are automatic—the vendor makes improvements and fixes to the active version Smaller storage requirements— storage is the SaaS provider’s responsibility Fewer personnel—reduced need for internal IT people for installation, monitoring, maintenance, and updates

Continuous stream of income— ongoing subscription fees typically exceed the traditional one-time or annual software licensing fee Usually only one active version to support (Some vendors deliberately maintain older versions.) Reduced software piracy and unlicensed use as well as fewer losses associated with such activities

Certainly SaaS does not come without challenges. Vendors must constantly reaffirm that SaaS solutions are lighter, simpler, more intuitive, and more agile. Users are looking to vendors to facilitate easier deployments and provide more robust integration strategies that recognize the heterogeneous environments that most customers now run and will run in the near future. Application areas where functionality is fairly standardized and commoditized (such as customer relationship management, security, sales support, and the IT help desk) are thus far the most prevalent uses for SaaS. Gaps in

customization and integration capabilities make SaaS less appealing in areas requiring specialization or complex, real-time integration.

Configuration Configuration from an information system architecture standpoint refers to how the actual hardware, operating system, application software, and networks are arranged. The most common configuration is a client/server system, where the clients are personal computers (PCs) or devices and the servers may be mainframe systems. The operating system runs the clients and the servers. The client/server concept involves distributing processing tasks so that the client takes care of local, low data demand tasks and the server/mainframe performs general, high data demand tasks for the company. The extended chain of suppliers and customers operates primarily over the internet, which is a distributed form of the client/server structure, or a network of networks in which the web browser is the client connected to a web server. Another option for configuration with supply chain partners or other internal offices is cloud computing, described in the Dictionary as “an emerging way of computing where data is stored in massive data centers that can be accessed from any connected computers over

the internet.” Cloud computing allows authorized members to have virtual access to a network of remote servers, databases, or software no matter their actual location. It is a network of data centers enabling computing resources to be accessed and shared as virtual resources in a secure and scalable manner. Cloud applications are accessed on a web browser and are offered as software as a service (SaaS), or users can purchase or develop software and upload it to the cloud. Similarly, organizations can eliminate their owned platforms or infrastructure and lease platform as a service (PaaS) or infrastructure as a service (IaaS). SaaS providers may be PaaS customers, and PaaS providers may be IaaS customers. That is, while cloud computing is often advertised as a way to connect with external service providers, it can also be used internally as a way to focus on core capabilities and outsource technology management. Standards and high adoption rates have made cloud computing mainstream. (In a 2020 Statistica survey cited in an article by Hunter Lowe, 87 percent of organizations indicated they used a hybrid cloud strategy.) An example of a cloud computing standard is ISO/IEC 17788:2014. (This standard was reviewed in 2021 and needed no update). It provides an overview of cloud computing and its terminology. Many SaaS cloud-based systems can interface with an

organization’s enterprise resources planning systems. Many ERP systems have enhanced their delivery methods using cloud- and web-based access, and cloud-only ERP systems such as NetSuite or Plex also exist. Supply chain software lends itself well to cloud-based applications due to the need to integrate so many partner systems. According to a Supply Chain News article by Bridget McCrea, the cloud portion of the supply chain management software market grew 2.5 times faster than the overall market in 2019, a year in which cloud software represented 34 percent of supply chain management applications. Supply chains want to use clouds both to reduce costs and to increase agility. Here are some other benefits of using cloud versions of supply chain management software from the Lowe article: Supplier quality management can track the same metrics across the chain and help ensure that specific materials are used by providing bill of material visibility/control. Delays or early completion data can be shared automatically with supply chain partners to reduce cycle times. Metrics on overall equipment effectiveness (OEE) and availability can be more easily integrated into higher-level decisions, not just the shop floor.

Some regulatory forms can be automatically created, such as a device history record required by the U.S. Food and Drug Administration on batch, lot, and unit data. Real-time track and trace is more achievable and scalable with cloud-based partners. Application programming interfaces (APIs) are becoming more common and the cost of integration is falling, allowing existing applications and specialty clouds to be leveraged quickly rather than reinventing them. Cloud-based warehouse management systems can automatically aggregate inventory at various network levels. Pricing/quoting, customization requests, and approvals can be automated, reducing errors. Some systems can integrate early life cycle tools such as for new product introductions into production planning systems to provide readiness reviews. Exhibit 2-12 shows the technology components of information system architecture, including the connection to external system(s) over the internet or via cloud computing.

Exhibit 2-12: Information System Architecture Components

Information System Architecture Design Information system architecture is like any type of architecture in that it consists of the detailed plans, drawings, and standards that carefully define the structure of the things being designed. An information system architecture maps out the specifics of how information is gathered, stored, shared, used, and updated/retired. A well-designed architecture enables a high velocity of information. The velocity of information is the ease and speed involved in creating, compiling, transferring, understanding, analyzing, and using

information. Poor velocity of information constrains the degree of efficiency and effectiveness a supply chain’s functions can achieve. The definition of the information system architecture states that it should reflect the architecture of the organization. This implies that if the organization wants to change its basic architecture, say, from a department focus to an extended process focus, its information system architecture will also need to change. If it does not, older technology architectures could prevent the changes from succeeding. Therefore, supply chain managers review an organization’s information system architecture at a high level so they can assess if it needs to be changed or upgraded to facilitate a specific supply chain strategy. Supply chain network design and configuration include information flow design and major sourcing decisions. A key goal of network design and configuration is to promote efficiency. This is done by positioning and managing inventory effectively and using resources appropriately. Since the information system architecture enables various departments and external partners to become a unified whole, supply chain information system architecture design is addressed here at the big picture or “road map” level. A technology road map is a brief document (or white board) that sets out overall priorities and high-level plans for a given large-scale process such

as supply chain design. The various elements can be reprioritized or changed as needed. Some road maps include graphical representations showing the current state and the future state. Specific parts of the road map then are enacted using project management. Since information strategy is closely tied to overall network design and configuration, we will show how organizations may go in different directions with their information systems depending on whether their competitive basis is efficient (i.e., cost-basis or lean), responsive, customer-focused, and/or some other mix of priorities.

Information System Architecture Exhibit 2-13 provides a road map of how the elements of the information systems are designed in parallel to the organization’s strategic and tactical plans for the organization and extended supply chain.

Exhibit 2-13: Organizational and Information System Architectures

Let’s look at each of the categories in Exhibit 2-13 more closely.

Organizational Strategy Like all other parts of the supply chain, supply chain design for all information systems and technology should be based on, and align

with, the organization’s overall strategy. If a company’s focus changes, the information system architecture should then be changed or upgraded to facilitate the new supply chain strategy.

Information Strategy The information strategy translates the organization’s strategy into commitments to treat information systems as strategic investments, and it sets guiding principles, priorities, and common goals for network design. The results of the information strategy are reflected in a high-level end-to-end vision of the information system structure. Similarly, the extended supply chain strategy is translated into a strategic vision for the extended supply chain. A gap analysis is performed with key willing partners to compare the existing systems of supply chain partners with what is envisioned, and a model for the extended enterprise is developed in consultation with partners to resolve existing gaps.

Information Content Definition Information content definition involves making decisions on what data need to be collected, how they will be collected, how their accuracy will be maintained, and how they will be stored, accessed, controlled, analyzed, and retired. For the extended supply chain it involves business modeling, which maps the dynamics and interactions of each supply chain partner. Extended supply chain

business modeling includes decisions such as what market segments are being targeted, how performance will be measured, how profits will be shared among partners, and how products will be distributed. Supply chain infrastructure is evaluated based on these decisions; this includes determining The appropriate number of facilities (warehouses, plants) The size and location of each facility The allocation of space for products within the facility Sourcing requirements Distribution strategies.

Information Policies and Controls Information policies and controls are the agreed-upon methods to be used in information infrastructure design, daily operations, and continual improvement initiatives to ensure that the organization’s data and software systems perform as expected. Information systems use data and cost collection to see if the supply chain is an efficient channel for product or service distribution. Controls provide oversight against system misuse and assist with auditing. Governance of information systems and policy compliance will require training and ongoing management support.

For the extended supply chain, the issue is enabling the desired levels of communications and security. Collaboration between partners involves coming to agreement on how networking and data sharing will occur by settling on common information policies and work processes. It also involves determining the roles of partners in establishing data repositories and communications methods. Plans should be designed to be reviewed and adapted as situations change.

Information Infrastructure Design Information infrastructure design involves determining how to translate policies and controls into a cohesive and cost-effective information system that minimizes data duplication and errors, provides access to information at all necessary internal and external points, and supports effective analysis and efficient transaction processing. This is the level at which detailed decisions are made on how to perform networking, what software to use to best achieve strategic goals, and how to configure the hardware and software for optimum flexibility and growth. Decisions may include how to leverage existing systems; analysis of the costs and benefits of leasing versus purchasing, upgrading, or replacing software; and decisions on the use of interface devices and communications tools.

Databases, Networks, Software, and Configuration Specific decisions on databases/clouds, information networks, software, and configuration are made following design approval, including use of existing systems, decisions to upgrade or add technologies, specific vendor search and selection, etc. Decisions on databases and database management systems (including clouds) are critical to the ability of the organization to maintain the integrity, availability, and usefulness of data for decision making. Data for extended supply chains must allow fast access while remaining synchronized. Depending on how databases are designed, they can enable or hinder internal and external integration and external collaboration. Quality data repositories can be a true source of competitive advantage; poor data or poor access can cause users to distrust and discredit otherwise useful systems. Similarly, networking, software choices, and configuration decisions should be selected to fulfill business requirements while providing a positive return on investment.

Information Infrastructure Change Supply chain network design should include plans for continual system change and improvement for the internal and extended

supply networks.

Action Plan, Schedule, and Prioritization The results of regular strategy update sessions, tactical system improvement sessions, and operational gap analyses should result in IT action plans for both the organization and the extended supply chain. These plans should prioritize development efforts and expenditures, create projects and tasks, and include feedback mechanisms to assess project success. Specific cross-functional teams should be responsible for these plans.

Data Communications Methods and Middle End Data communications methods are the computer languages and methodologies that enable systems to intercommunicate and act as a seamless whole. Ideally, communications between supply chain partners have two features: They should be easy to link or unlink, and, when linked, they should be tightly integrated. The more tightly integrated the communications are between supply chain partners, the more the supply chain can act as though it were a virtual organization. The value of communications methods that enable efficient interbusiness

links depends on how businesses make use of the data. If they manage the process properly, they can increase the visibility and accuracy of information, speed transactions, and reduce duplication of efforts. These efficiencies can reduce cycle times, inventories, and capital expenses and increase return on investment and customer service. While the communications themselves need to be tightly integrated, the method of achieving that integration should be easy to create, change, and maintain. This is accomplished using a middle end that resides between the user interface and the back end server and database systems. Here we cover two types of middle end systems, middleware and application programming interfaces (APIs). Middleware is more complex and requires more investment in programming but can connect to multiple tools, while APIs are direct one-to-one connections that are easier to develop. First, we clarify where the middle end fits in the overall information system architecture.

Front End, Middle End, Back End Front end, middle end, and back end are ways of describing conceptual roles of software as well as areas of specialization for software developers:

Front end. This is the user interface, and, in a client-server scenario, this would be the software on the client end. A web browser and web pages are another example. Front end programmers are concerned with the quality of the user experience, minimizing data entry errors, and accommodating various use cases. Middle end. This is the “glue” that holds the front end together with the back end. It is essentially a translation service for various applications to enable them to converse. Middle end programmers are concerned with automating data requests or data transmissions, and the key is to ensure that the interface is simple to program, simple to document, and simple to modify or scale upward. An example of scaling upward is that the middleware does not become the bottleneck when the front end and back end could handle more traffic. Back end. This is the server and the database (which could be in the cloud). Back end developers are concerned with ensuring fast access to the right data and for keeping that data accurate, well organized, and secure. Here we take a closer look at the middle end. These systems are intended to overcome a major obstacle that stands in the way of creating visibility and automated transactions between supply chain

partners: getting incompatible hardware and software to communicate automatically and securely without great expense or development time. The middle end is important because it helps to integrate the supply chain, enables systems and companies to share information, eliminates duplicate and inconsistent data, and breaks down organizational silos—in short, it enables an optimized and collaborative supply chain. The middle end also enables secure transactions through authentication (preventing unauthorized users from gaining entry) and authorization (users can only perform authorized transactions or access their own data). Middle end systems are often needed because some software systems may be inherently incompatible or reside on different hardware platforms and thus require a middle end to share their functionality. They may also use different operating systems, database types, or computer languages. Sometimes legacy systems may be involved that are no longer supported and may be virtually impossible to modify. A legacy system is defined in the APICS Dictionary, 16th edition, as a computer application program that is old and interfaces poorly with other application but is too expensive to replace. It often runs on antiquated hardware.

While many of the methods discussed next are becoming dated through the continual advancement of the field, the expense of upgrading to newer methods means that many organizations are still relying on some of these older methods.

Middleware Middleware is “software that interconnects incompatible applications software and databases from various trading partners into decisionsupport tools such as ERP” (Dictionary). Subtypes include content-level middleware (i.e., electronic data transfer), data-oriented middleware, and process-oriented middleware. Content-Level Middleware: Electronic Data Transfer (EDT) Content-level middleware specifies a shared format for standard forms and each of the data fields. The parties involved must agree upon the shared format that will be used. Each may need to translate their data to work with this common format. It is more like an electronic version of sending someone a paper invoice or other document without requiring data reentry. It cannot automate multiple system interactions. Content-level middleware is also called electronic data transfer (EDT).

EDT refers to any transfer of information using electronic means. Originally, EDT could take place only through proprietary electronic data interchange and electronic funds transfer (EFT). Electronic data interchange (EDI) is “the paperless (electronic) exchange of trading documents, such as purchase orders, shipment authorizations, advanced shipment notices, and invoices, using standardized document formats” (Dictionary). EDI and EFT systems were effective in sending data between two locations if each location was set up using the same standards. Distributed, open standards for EDI plus the internet have enabled much more fluid EDI transfers. Funds transfers have their own standards and are necessarily very restricted. (EFT is vital for supply chain payments but is outside the scope of this text.) EDI is primarily internet-based today, including via mobile devices. Newer EDI methods should take these cellular device needs into account by providing fast, simple data transfers in self-contained small packets that keep interruptions from corrupting the data. Also, because wireless transmissions are easier to intercept, data security is paramount. Messages can be sent through a private network or a web-based EDI. (The latter type is much less expensive.) Under either method, EDI requires that special software (proprietary software or some type

of middleware) be installed at each end of the transaction or that a third-party value-added network manage the transaction for a fee. The Dictionary defines a value-added network (VAN) as “a network, often supporting EDI, providing services additional to those provided by common carriers.” ERP systems may also perform this service. EDI data standards include internationally agreed-upon extranet protocols for transmitting data between companies. In this way, EDI can connect systems that do not run the same applications or ERP systems. While newer methods to be discussed shortly have replaced EDI in many cases, EDI remains a common method of connecting supply chains for basic transactions such as customer orders, advanced shipment notifications, and invoices. Because of the expense of implementing EDI, the fact that it often needs to be batch-processed, and the need to agree on one of the various EDI data formats, newer web services–based offerings (discussed below) or cloud native formats are taking over this space. Many of the more complex messaging requirements involved in supply chain management such as supply chain event management (SCEM) are too complex and too expensive to implement with EDI. Data-Oriented Middleware

Data-oriented middleware involves large system-to-system linkages that require extensive customization. Each connection usually requires a great deal of configuration, as all the shared data fields must be mapped out one by one. For example, when one system sends information with a “product number,” the receiving system knows that “product number” is what it calls “Finished Good ID#.” If you decide you now want to link to a third application, or upgrade to a new version, you have to start from scratch. Therefore, this option is expensive and can become obsolete fast. Process-Oriented Middleware Another approach to middleware is process-oriented middleware, also called business process management software. The Dictionary defines business process management (BPM) as a business discipline or function that uses business practices, techniques, and methods to create and improve business processes. BPM is a holistic approach to the use of appropriate process-related business disciplines to gain business performance improvements across the enterprise or supply chain. It promotes business effectiveness and efficiency while striving for innovation, flexibility, and integration with technology. Process-oriented middleware is smart middleware that manages entire conversations. The linked businesses first map their

processes; then the process-oriented middleware runs the processes and sends the data to the relevant systems as dictated by the process map. Once the process is mapped out, different companies with various types of ERP, legacy, and best-of-breed applications can apply the process map to their systems and communicate effectively without attempting to make systems congruous. It requires businesses to focus on processes and therefore has a side benefit of process simplification. However, process-oriented middleware may not be as simple to integrate with existing systems as advertised. Other features of process-oriented middleware include Firewalls between partners Customized processes for each partner Internal integration preceding external links Integration with automatic identification technologies.

Application Programming Interfaces (APIs) An application programming interface (API) is middle end programming code that resides nearer to the front end systems than middleware. It enables simple one-to-one interactions with the back end. Internet traffic from other systems, IoT devices, and mobile devices are sent to the API, which translates the data into a format useful to the web server and ultimately to its database. Data returned

from these queries (requests for information) is translated back into the format required for the other application. The API enables an authorized system to query the database automatically and frequently. Newer forms of APIs (e.g., JavaScript Object Notation [JSON]) are lightweight, meaning they are easy to create and update. APIs are developer-friendly, platform-independent, and easily scalable. APIs are also used for large-scale applications such as ERP systems that need to talk to their back end systems. APIs can be for public use, for specific partner use only, for internal use only, or a combination. They can enable real-time transactions and real-time analytics. APIs are typically used with software architectures that break the software into small modules that can be programmed independently of one another. (Older systems were monolithic.) Each module is one software function, such as a credit card processing function. This type of framework is called web services. The Dictionary defines web services as a common internet or intranet framework that enables the movement of data from one application to another, without the requirement for a direct connection between two supply chain applications and without regard to the underlying operating system for those applications.

The standards are open, meaning that all developers can access and use the same standards and communications can be performed across operating systems, application platforms, and computer languages. The advantage of web services is that they save time and money by cutting development time, especially for integration. For example, if an airline develops its flight check-in software using web services, it could build the application using the best available database search engine from one vendor, the best seat assignment application from a different vendor, and their own pricing application. Web services make use of only the specific data elements that are made available for sharing. The components would work together as one application, but just a portion of the application could be upgraded independently. Two types of APIs are SOA and microservices. SOA Service-oriented architecture (SOA) is an approach to software design (“architecture”) in which applications are assembled from reusable components (“services”) to allow for widespread and flexible sharing of supply chain partner services. A service could be a credit check or matching an invoice with a purchase order, or it

could be more elaborate, for example, a rule to reroute trucks automatically based on traffic data. SOA has two main goals: to achieve loose coupling among services and to separate applications from their data so they achieve universal functionality. The loose coupling of modules could be compared to the round connectors on Lego® building blocks that make them easy to reconfigure. Universal functionality requires that all messages contain all data necessary to complete processing (rather than assuming that the data can be looked up). This allows the best service provider in each area to offer its service without offering the whole package. A consequence of loose coupling is that services can run anywhere on a network without being restricted to a specific hardware or software platform or programming language. In contrast, tightly coupled systems have interoperability issues. The results of using SOA are a dramatic decrease in application development time because many portions of an application can be reused. Applications are by nature more adaptable, interoperable, and scalable. Microservices

Microservices are newer cloud-native interfaces that require the same loose coupling of services as SOA. While SOA is used to help multiple applications talk to each other, microservices help various services within a single application talk to each other. There are a number of other differences from SOA that are of interest to programmers related to ensuring the efficiency and resilience of the code, but the gist is that while similar to SOA, microservices are a different programming style. One model used in microservices as well as in some other types of middleware is called publish/subscribe messaging. In this model, the publisher creates one or more categories of interfaces or other types of messages and publishes them. Any number of organizations or persons could then subscribe to receive these publications as soon as they are released. The publisher is in effect creating some standard templates, and it is up to the subscriber to get their end to communicate with the given template.

Optimizing Visibility Visibility means being able, figuratively, to see what’s happening in the supply chain. The APICS Dictionary, 16th edition, defines supply chain visibility as

sharing information throughout the supply chain to create transparency among supply chain partners. For example, the ability of supply chain partners to access demand and production information from trading partners. In traditional, functionally oriented companies, silo walls obstruct “horizontal” visibility outside one’s own department. (“Vertical” visibility also tends to be limited. Management may be able to see downward to activities at the tactical level, but visibility upward may be limited to information framed as directives and performance reviews.) The more visibility supply chain partners have to see through functional walls and also upstream and downstream into the activities taking place in other tiers of the supply chain, the greater the chance they all have of synchronizing their operations to produce value for the customer. For example, with global positioning, satellite communications, and the Internet of Things (IoT), logistics managers can track individual items as they are shipped across the world to customers in foreign countries. In fact, anyone in the supply chain with the necessary technology, including the customer, can be given access to this information. This real-time visibility into customer shipments gives logistics managers the ability to react to difficulties long before they could have just a few years ago.

One obstacle to visibility along supply chains has been the unwillingness of partners to share information. Consequently, implementing process improvement requires building trust across the functions and partners who are party to the process involved. A small-scale pilot project can be helpful in demonstrating trust and honest communication. Once partners see that data sharing can work to their advantage, they are more willing to provide that allimportant visibility into their operations. And, most appropriately in the present context, data used to measure supply chain performance against key indicators can be made much more easily available to continuous process improvement teams. Visibility is one key to successful improvement initiatives.

Information Sharing Using E-Business Information sharing typically takes the form of e-business these days. Electronic business (e-business) “is conducting business processes on an electronic network, typically the internet” (APICS Dictionary, 16th edition). E-business is a collection of business models and practices enabled by internet technologies that network customers, suppliers, and productive capabilities in order to continually improve supply chain performance.

Electronic commerce refers to that part of e-business that has to do with conducting electronic transactions. The Dictionary defines electronic commerce (e-commerce) as “the use of computer and telecommunication technologies to conduct business via electronic transfer of data and documents.” There are several electronic business models: business-to-consumer (B2C), business-to-business (B2B), consumer-to-consumer (C2C), consumer-to-business (C2B), and business-to-business-to-consumer (B2B2C). All are considered to be types of e-commerce. Since the focus of electronic business is on improving the information sharing performance of the extended enterprise, our focus is on the B2C and B2B models. Today, some level of electronic business is required for almost all organizations, and not only B2C but also B2B companies engage in e-commerce (e.g., industrial products) to extend their supply chains. Not all organizations will be able to sell their products or services on the internet, but almost all should engage in brand awareness and marketing using at least a website, even if the site is just informational rather than interactive. Modern websites use responsive design, which detects the type of device the user is using to access the site and then automatically reformats the information for optimal display on a phone or tablet, in addition to enabling

touch-screen capabilities as needed. In addition to this, some organizations will benefit from developing a downloadable app. The goal of all supply chains should be a network that functions as if it were a single well-run company. The boundaries, even when geographically dispersed, should be invisible to the customer. The internet has made this feasible, if still challenging. Internet-enabled supply chains—those in which all partners share data through the internet—have specific characteristics that distinguish them from less advanced supply chains. They exhibit these characteristics in different degrees, depending upon the sophistication of their strategy and use of internet technology. An internet-enabled supply chain realizes the following benefits: Visibility and efficient, responsive networks. Internet-enabled supply chains can realize the benefits of integration. Global reach. Instantaneous communication through the internet eliminates distance and time-of-day constraints on buying and selling. Improved financial position. The internet provides increased revenue and profit margin through global sales with fewer intermediaries, increased customer loyalty through personalized contact, speed to market, and reduced costs.

Exhibit 2-14 shows how the traditional and electronic business supply chains differ. Exhibit 2-14: Traditional Versus Electronic Business Supply Chain Characteristic

Traditional Supply Chain

Electronic Business Supply Chain

Ownership model

Own the supply chain. Vertically organized. Mergers and acquisitions.

Own the core capabilities. Virtually organized using collaborative processes and IT. Outsourced business processes.

Competitive advantage

Big dominate the small. Barriers to market entry: high market share and many physical assets.

Fast dominate the slow. Physical assets become barriers to change and are tied-up costs. Agile companies find new business models that dominate industry.

Who is channel master/nucleus firm?

Firm closest to customer: retailer for consumer goods, manufacturer for industrial goods.

Firm with most brand equity and most efficient model: even small firms get global reach from internet.

Characteristic

Traditional Supply Chain

Electronic Business Supply Chain

Trading interaction

Rivalry; each party seeks the best deal at the expense of the other. Terms dictated by channel master. Much friction in interactions.

Collaborative arrangements that share the risks and rewards. Terms set by mutual agreement. Fluid interactions.

Working with competition

No interaction with rivals.

Same party can be buyer, supplier, rival, and/or trading partner, depending on mutual gain. Where no mutual gain can be found, rivalry still exists.

Production focus

Economies of scale and scope.

Engineering competitive supply chain.

Collaborative stage

Internal organizational silos. Cross-functional cooperation. Proprietary, expensive networking. Batch processing.

External trading partner silos. Cross-company cooperation. Open, inexpensive networking. Real-time and batch processing.

Characteristic

Traditional Supply Chain

Electronic Business Supply Chain

Suppliers

Fixed industry structures: number of suppliers limited by buyer relationships, e.g., over the phone. A few long-term partnerships and a moderate number of commodity and/or adversarial relationships.

Open competition via electronic marketplaces and auctions. Collaboration allows faster partner integration, so firms have many continuously reconfigurable relationships at every level.

Customer service

Purely reactive, narrow view. Narrow product/service offerings. Little feedback used.

Proactive, broad view. Segment-specific product/service. Better use of feedback.

Intermediaries (brokers, distributors, freight forwarders, dealers)

Fixed, often vertically integrated relations.

Business models may avoid some intermediaries entirely. Some reintermediation as these channels find way to add value.

B2B and B2C Strategy B2B and B2C are defined in the APICS Dictionary, 16th edition, as follows:

B2B—Business-to-business commerce : Business being conducted over the internet between businesses. The implication is that this connectivity will cause businesses to transform themselves via supply chain management to become virtual organizations—reducing costs, improving quality, reducing delivery lead time, and improving due-date performance. B2C—Business-to-consumer sales : Business being conducted between businesses and final consumers largely over the internet. It includes traditional brick and mortar businesses that also offer products online and businesses that trade exclusively electronically. B2B commerce includes exchanges and direct collaboration technologies. Exchanges are intended to decrease the costs of procurement, resource management, and fulfillment by providing access to a larger market and by lowering transaction costs through automation. Objectives of B2C are to create a wider customer and revenue base, build customer loyalty through tailored offerings and shopping experiences, and create an ever-expanding source of customer information. B2C focuses on retail sales and includes things such as banking, shopping, product downloads, travel, and insurance. It may also simply include providing corporate information to customers or

collecting information on customers through incentives such as surveys, product samples, games, or prizes. Business-to-business-to-consumer (B2B2C) is a collaborative ecommerce model that involves two or more B2B companies each collaborating to provide enhanced value to the end consumer. A common example is of two organizations that share sales leads with each other and cross-promote each other’s products to consumers. The Amazon Marketplace is another example. B2B, B2C, or B2B2C may include virtual service providers, a broad category of companies that own no assets but direct the actions of many companies and may provide capital as needed to produce, transport, and/or sell goods or services. Virtual hybrids own a relatively small number of assets. Often what these companies provide is expertise in supply chain coordination for those with a particular core competency. Electronic business was initially so popular that it gained market support even without financially sound business models. Eventually, businesses unable to sustain profits failed. A primary cause of this failure was lack of a valid business strategy and a valid electronic business strategy. Both must exist and must be tightly integrated, and they must be guided by a realistic vision communicated and

accepted throughout the extended supply chain by involving these partners in strategic planning. The electronic business strategy should enable collaboration with the extended supply chain, including integration of customers and suppliers. Traditional business strategy still needs to be robust to allow the efficient sourcing, manufacturing, and fulfillment of orders that satisfy actual customer needs. Company and e-business strategy needs global reach. E-business strategy indicates how the firm intends to connect with partners. The link between business strategy and e-business strategy is enhanced by optimization, visibility, and shared planning tools.

Potential Costs and Challenges with E-Business Implementing e-business solutions requires a formidable investment of time and money for the ongoing discovery of IT capabilities, contract and request for proposal development, benefit-cost analysis, infrastructure costs, training, change management, consultant fees or opportunity costs for staff time, customization, configuration, and ongoing maintenance. Some of the necessary costs of doing e-business include the following:

System security. Security maintains an agreed-upon level of access, authentication, and identity management. The firm must determine what information will be shared. Increased outbound transportation costs. While inbound transportation can be optimized or centralized, outbound transportation volume and cost increase because some customers no longer pick up the goods, requiring shipping (often smaller quantities of a wider variety of products more often) anywhere in a short window. Increased materials-handling costs. Handling costs are higher because actions typically performed by the customer now must be performed by the company (e.g., product returns, picking orders from shelves, unique packaging or labeling). E-business analysis tools weigh the risk of a lost sale against decreased profitability. Reliance on outside suppliers. Companies may need to rely on other suppliers to perform actual delivery. Late deliveries directly affect customer satisfaction. Reliability has forced many virtual models to adopt hybrids that include physical distribution centers. Global reach requires global localization. The company will need to tailor its offerings to each country or region. While it may not need infrastructure in each country, it does need to translate its

web offerings to accommodate local languages, culture, and currencies and local and national regulations, laws, and commercial practices. Accessibility and ease of use. Significant effort must be made to advertise and to provide easy methods of searching for e-business services. A website can have a much greater variety of goods for sale than a typical retail location, but if the site does not provide an easy way to find what is needed, such as by intelligent product recommendations, this variety becomes cumbersome.

ROI Justification for Electronic Business Initiatives Justifying a particular e-business strategy requires consideration of its costs and benefits. External factors, such as the economic environment, market turbulence, and the competition’s capabilities and stage of supply chain sophistication, must also be examined. Comparison of the cost of maintaining old technology plus the opportunity cost of lost capabilities versus the cost of implementing a new technology can help make the choice clear. In general, if an electronic business strategy increases competitive advantage, it will tend to decrease inventory, facility, and transaction costs while increasing transportation and technology costs.

Another choice is whether to outsource the e-business technical functions or to maintain the IT internally. The cost of monitoring an outside arrangement must be added to the direct cost of outsourcing. Failure is a real possibility if the balance between benefits and costs tips the wrong way. However, some level of investment in ecommerce is now a required cost of doing business. Strategy should focus on finding the investment level that is appropriate for the organization and the supply chain. No project will succeed unless it has cost controls in place. Management must also incorporate a review process to improve future project budgeting.

Examples of E-Business Ventures The global COVID-19 pandemic has changed consumer behavior related to the likelihood of using traditional versus online channels. While e-commerce has been a priority for most organizations for a very long time now, the pandemic forced many organizations to make immediate e-commerce investments to survive at all. A Harvard Business Review article by Kathy Gramling et al. indicates that the pandemic has resulted in a lasting shift in B2C consumer behavior, with significantly more people still planning to shop online for things they traditionally purchased in retail stores. Many retail

stores themselves turned into miniature distribution centers for online sales. The article cites research by the EY Future Consumer Index that indicates the retail locations likely to re-engage consumers and get them back in physical spaces are those that offer consumer experiences, not just products. Being price-competitive with onlineonly competitors is also vital as is an option to buy online and pick up in store. In these tumultuous times, different industries and business models have experienced different levels of success from the use of electronic business. Three companies have historically used it to spur incredible growth: Amazon, originally just an online bookseller; Dell, a pioneer in direct sales of assemble-to-order computers; and Alibaba, owner of several Chinese e-commerce juggernauts. This discussion describes their origins and the direction they each have taken in terms of their use of e-business. Amazon was founded in 1994 by Jeff Bezos. It went online in 1995 as Amazon.com and originally sold only five product types: compact discs, computer hardware, computer software, videos, and books. Its original supply chain started out longer than that of traditional brick-and-mortar book retailers.

It invested heavily to maximize its servers’ capacity to handle peak traffic during holiday shopping periods. It added its own distribution functions across North America, Latin America, Europe, Africa, and Asia. It has its own software development centers. (Some are run by an Amazon subsidiary.) It located its automated fulfillment centers in select cities around the globe, often near airports. It turned its first profit at the end of 2001—one cent per share. It is now the largest online retailer, with net sales in 2020 topping $386 billion, a $100 billion increase over the prior year, making it a pandemic success story. Dell, originally a maker of personal computers, was founded in 1984 by Michael Dell, a college freshman at the University of Texas. It designed and built its first computer in 1985 and differentiated itself with risk-free returns and next-day at-home product assistance. It manufactured the industry’s fastest-performing PC and opened its first international subsidiary in the U.K. in 1986. It debuted its online website in 1996 and sold $1 million of product per day within six months after the site was launched. It climbed onto the Fortune 500 list in 1992.

It provided customers with at-the-time innovative online technical support via the internet. It sold $40 million a day of online product, which made it one of the highest volume e-commerce sites in the world in 2000. It expanded its product portfolio to include printers, projectors, and consumer electronics. It launched free product recycling and a blog, Direct2Dell, enabling fast two-way communication with customers, in 2006. It created an investor relations blog and participated in social media. It offered its customers high-tech end-to-end IT services and cloud-based enterprise solutions. It became a privately held company again in 2013 and offered enterprise-class IT capabilities to small businesses and remote offices. It established Dell Ventures, which supports new businesses that align with Dell’s expertise and future vision for the cloud, big data, next generation data centers, storage, mobile, and security. Alibaba is the dominant e-commerce site in the world’s largest ecommerce market, China. Its largest website, Taobao.com, can be thought of as a giant Chinese bazaar that is part B2C with direct deliveries like Amazon, part middleman like eBay, part PayPal with its Alipay payments processing (it also protects buyers if sellers fail

to deliver), and part Google with its fees for advertising and promoted search results (it doesn’t charge sellers to list merchandise). You can even buy real estate on the site. Its Tmall.com website is for larger retailers, such as Gap, Nike, and Apple. It also supports B2B e-commerce, connecting manufacturers with overseas clients, which was actually its primary purpose when it was founded in 1999. Other companies have had slower starts. Mega-retailer Walmart’s online sales accounted for only two percent of its U.S. revenue in 2012. However, Walmart grew online revenues at 79 percent for its fiscal year 2021, and for Q4 of that year e-commerce made up 6.2 percent of its comparable sales growth, excluding fuel. It has also been competing with Amazon Prime with its Walmart+ e-commerce membership. So what does it take to be successful in e-commerce?

Requirements for Success in E-Business E-business must maximize the efficiency of all channels. Retailers must be prepared to serve customers across all channels even when they seemingly may compete against each other, such as sales of televisions via the web versus an in-person visit to a traditional retailer.

Other requirements for success in e-business include Order visibility that extends to the customer to reduce inquiries and complaints about fulfillment status Shipping methods consistent with profitable sales (using a transportation management system [TMS]) Sensible warranty and return policy (customers cannot see merchandise until received) Reevaluation of wholesale or retail locations on the basis of site profits

Information Sharing Using ECommerce E-commerce was born when websites could be made interactive rather than static. This enabled internet transaction processing and payment acceptance. B2B (business-to-business commerce) is characterized by automating traditional business transactions such as formal sourcing, so it took off when the internet became viable for automated data transfer in two directions instead of only one and when smaller businesses could participate due to the low cost of the internet. Exhibit 2-15 shows how B2B commerce facilitates faster and cheaper links in the supply chain.

Exhibit 2-15: Business-to-Business Commerce (B2B)

E-commerce software includes sell-side, buy-side, content management, and B2B collaboration applications. Prior to addressing these types, the layers of B2B and B2C e-commerce are introduced.

Layers of B2B and B2C E-Commerce The internet structure can be seen as a series of layers (based on a study sponsored by Cisco). The layers can show where investments are needed. Foundation layer. The foundation layer includes all physical means of transmitting data over the internet plus all necessary networking and interface devices. This layer also has security

systems such as firewalls. It includes assets both in and out of the company’s control. Application layer. The application layer includes all web-specific applications and tools for creating interactive websites. Applications include web directories (“a list of web pages structured hierarchically,” APICS Dictionary, 16th edition), catalog builders, web shopping carts and billing, multimedia tools for streaming audio or video or virtual classrooms, search engines, and web development tools. Many of these tools simply enable internet commerce. Therefore, companies that outsource their web development can outsource all of these costs, too. Aggregation layer. The aggregation layer consists of applications designed to take information and services from various locations and package them for easier access and consumption. This layer includes portals and intermediaries such as brokers and service providers. Hosting is generally expensive, and many companies have formed consortia to control costs and form a user community. Business layer. The business layer includes all exchanges and involves all buying and selling activities over the internet. If the level of sales is expected to be quite large, a huge investment in both setup and maintenance at the foundation layer is required to handle the traffic. Therefore, many businesses become members

of an exchange or they outsource its creation and management to specialists such as via the cloud.

Sell-Side E-Commerce Sell-side e-commerce applications and services help sellers present their products and automate sales and customer relationship building. These applications must include presentation (right product at the right time to the right audience), automation (order entry, tracking, and settlement), and administration (nontechnical staff can maintain the site). Exhibit 2-16 shows the steps of an adaptive sell-side e-commerce website.

Exhibit 2-16: Adaptive Sell-Side E-Commerce Website

Note that sell-side e-commerce and customer relationship management applications are often offered as a single system or cloud-based service.

Buy-Side E-Commerce Buy-side applications help firms purchase goods and services. These applications save employee procurement time, especially in the request and approval process. They generally automate the categorization, requisition, sourcing, negotiation, and contract phases as well as supply and payment. Open exchanges provide access to the worldwide market; this can, however, lead to risks involving unknown suppliers. Membershipbased exchanges (often on an extranet) prescreen members to mitigate risks. B2B can be performed globally, which has helped to create the process of supply chain management.

Content Management E-Commerce The Dictionary defines content management applications as follows: Supports the evolutionary life cycle of digital-based information and makes information dynamically updatable online; includes the ability to publish content to a repository and support access to digital-based content.

Content management applications can include, for example, catalogs for product data, databases for customer data, contract information, and advertising content. Buyers want to see only items specific to their strategic sourcing needs and restrictions, so these applications stress content repurposed by buyer or seller perspective while preserving brand image, pictures, and other content.

B2B Collaboration As supply chains grow more complex due to flexible supply chain configurations, virtual organizations, outsourcing, and virtual service providers acting as intermediaries, collaboration acts as the glue that binds the network. B2B collaboration facilitates the multiple connections necessary in a real supply chain. Exchanges (also called B2B marketplaces) provide a common place to trade and exchange information. Hundreds of separate links are replaced by a single hub with spokes going out to each node. One example is the popular QAD supplier portal for the automotive vertical.

Supply Chain Integration Methods

Quick-response programs, distributor integration, continuous replenishment, vendor-managed inventory, and collaborative planning, forecasting, and replenishment are powerful business tools. These inclusive supply chain management methodologies each integrates point-of-sale (POS) data and forecasting in its own way to reduce lead times, lower inventory costs, and smooth out the bullwhip effect. Note that each also requires building partnerships— and trust—along the supply chain. Partners must be willing to share information (and do it quickly). This could mean collaborating in developing a single forecast and agreeing to carry out their supply functions according to the forecast. The goal is to replace estimates with data reflecting customers’ buying patterns.

Quick-Response Programs Simply sharing information between customer and supplier is one of the earliest and most basic types of supply chain alliances. This is often called a quick-response program (QRP) , defined by the APICS Dictionary, 16th edition, as a system of linking final retail sales with production and shipping schedules back through the chain of supply; employs point-of-sale scanning and electronic data interchange and may use direct shipment from a factory to a retailer.

In a QRP, the customer still typically submits the individual orders. The supplier uses the POS data as the basis for scheduling production and determining inventory levels to improve synchronization of supply with actual demand. Simply having the same information as the retailer doesn’t necessarily mean that the supplier’s forecasts will be the same as the retailer’s. That requires another level of cooperation. Nevertheless, the QRP can achieve significant reductions in lead times.

Distributor Integration Distributor integration (DI) occurs when distributors are integrated using information systems so the expertise and inventory located at one distributor are available to the others, such as sometimes exists between auto dealerships. Distribution systems can be integrated for better inventory control and customer service. In inventory-related DI, each distributor can check the inventories of other distributors to locate a needed product or part. Distributors gain flexibility without having to carry excess stock. The total system inventory is lowered, and a side benefit is that customer service levels are also raised. Examples include Participants that share connectivity, warehouse order entry, and integrated demand management systems to improve supply chain efficiencies

Companies that work to facilitate multicurrency capabilities. In service-related DI, individual distributors build expertise in different areas. When a customer request comes in, it is routed to the distributor with the most expertise (application support, assembly, etc.). The experience improves the customer’s perception of the distributor’s ability. An example in this area is restaurant services where procurement systems and strategies are automated. An obstacle to DI is ownership of inventory. When the distributors are all owned by the same company, there is no problem. However, when distributors are independently owned, there may be no existing relationship between them and they may not want to provide access to the information. A solution is to allow the manufacturer to act as a middleman to the independent distributors. For example, beer manufacturer Sam Adams has access to its independent distributors’ inventory levels. Sam Adams then brokers deals between distributors when inventory shortages or surpluses occur. Another challenge to creating a DI alliance is that distributors may doubt the benefits of participating in such a system. Service-related DIs may shift certain responsibilities and areas of expertise away from some distributors and concentrate them in a few. The excluded distributors may feel marginalized or may worry about losing these skills and abilities. Distributors must feel certain that the DI is a long-

term alliance. Organizers must work hard to build trust among the participants. The manufacturer may have to provide pledges and guarantees.

Continuous Replenishment Continuous replenishment (CR), or rapid replenishment, also relies on sharing of POS data by retailer and supplier. According to the Dictionary, continuous replenishment is a process by which a supplier is notified daily of actual sales or warehouse shipments and commits to replenishing these sales (by size, color, and so on) without stockouts and without receiving replenishment orders. The result is a lowering of associated costs and an improvement in inventory turnover. Suppliers are notified daily of actual sales or warehouse shipments and commit to replenishing inventory without allowing stockouts or needing to receive replenishment orders. The supplier uses the POS data to prepare shipments at intervals determined in partnership with the customer. The goal of this strategy is continuous reduction of inventory levels at the store as the forecasts become more accurate. Lost sales due to stockouts are avoided, and inventory turnover is improved. These forecasts can be based on complex formulas that correct for demand

variations such as in-store promotions, seasonal swings, and longerterm trends.

Vendor-Managed Inventory In the vendor-managed inventory (VMI) model, the vendor, through mutual agreement, has access to the customer’s POS inventory data for items they supply. The vendor is responsible for maintaining the inventory level required by the customer and performs actual resupply. The inventory is counted, damaged or outdated goods are removed, and the inventory is restocked to predefined levels. The vendor obtains a receipt for the restocked inventory and accordingly invoices the customer. Procter & Gamble, for example, took over management of the inventory of P&G diapers at Walmart to straighten out the bullwhip effect in their supply chain. Although this successful partnership is now a part of business history, the VMI concept continues to expand as other supply chains adapt it to different situations. Manufacturers of snack chips, bread, and soft drinks now routinely send their representatives to stock items at grocery and convenience stores. Specific VMI Functions In the traditional relationship, the customer stocks its shelves with products bought from a supplier, basing orders on demand forecasts.

The customer controls all decisions relating to the storage, display, sale, and replenishment of goods. The supplier, in turn, bases its forecasts and inventory levels on past customer orders; once it sells the products, its responsibility ends. In a VMI arrangement, by contrast, the supplier takes over multiple inventory functions. For instance, the supplier may do all or some of the following: Determine how the inventory will be stored and displayed. Provide the bins, vending machines, or other storage units. Replenish the inventory on a schedule it determines based on POS data. Maintain inventory records. Handle the delivery, receiving, stocking, and counting functions. Provide a permanent vendor representative at the customer’s premises (e.g., automotive plant) to perform the resupply and reorder functions. Vendors can also use historic data and predictive models to forecast stocking demands. The accuracy of the forecasts is carefully monitored and compared with actual data so that the forecasting model can be refined. Inventory levels may be based on sophisticated models that change the appropriate level based on seasonal demand, promotions, or changing consumer demand.

Forecasts of demand guide the creation of the master production schedule and the material requirements plan. Work orders are released from the master production schedule to meet the projected demand plus safety stock. Who Owns the Inventory—and Who Benefits? In early instances of VMI, the customer continued to purchase goods but the supplier took over inventory management in whole or in part. As the VMI strategy has evolved, some partners have adopted a VMI-consignment arrangement in which the supplier continues to own the inventory as well as manage it. Consignment in relation to inventory is defined in the Dictionary as “the process of a supplier placing goods at a customer location without receiving payment until after the goods are used or sold.” Consignment is sometimes called vendor-owned inventory (VOI). There are four possibilities of how VMI and consignment can be combined, as shown in .

Exhibit 2-17: VMI and Consignment Combinations

In the traditional relationship, the customer has an incentive to keep inventory lean by placing small, frequent orders. To ensure that it maintains an acceptable fill rate with its customers, it may expect the supplier to bear the costs of maintaining larger inventories of safety stock to respond to unexpected demand. When the customer enters into a consignment or VMI-consignment relationship, it benefits from reduced inventory costs or inventory management costs by transferring one or both to the supplier. On the other hand, with either type of VMI, it loses some degree of control over the inventory —such as deciding the amount and frequency of orders. When the supplier takes over management of inventory in its customer’s location, its incentives also change. The supplier now determines the size and frequency of orders, and if the customer

buys inventory upon transfer it may be tempted to transfer as much inventory to the customer’s stockroom or shelves as possible. In this way, it keeps its own inventory costs low and, not incidentally, takes up space that might otherwise fill up with a competitor’s products. Conversely, consignment arrangements may tend toward optimal inventory since the supplier owns the inventory no matter its location. However, as more total inventory is owned, ordering and carrying costs of inventory will be higher for the supplier. Consignment ownership of inventory (raw materials, components, finished goods, etc.) in a VMI partnership may be required to compete for business. Large retailers, for example, may represent so great a percentage of a supplier’s revenue that they exercise considerable control over the relationship. In some cases, the retailer may want to share some of its own cost savings with the supplier as an incentive to enter a VMI partnership. Getting Started Setting up a VMI relationship can be done in various ways. The customer and the supplier may go directly into a full-scale VMI alliance, or they may take it a step at a time. At the beginning, the customer may exercise thorough oversight of the process, accepting vendor policy changes only after careful review. The ultimate goal of

many VMI arrangements, however, is for the supplier to control the ordering process. Steps in the process include the following: 1. Contract negotiation to decide such matters as when to transfer ownership of the inventory, terms of credit, and performance metrics 2. Integration of information systems between the partners to ensure quick, complete, and accurate transmission of data 3. Joint development of replenishment logic 4. Development of a shared forecasting process 5. Development of logistical support tools to coordinate transportation, management of inventory, and so on 6. Hiring or training personnel to manage the system effectively Measuring VMI Success Adopting VMI involves a tradeoff between control and inventory management costs for customer and supplier. The metrics for tracking the success of a VMI relationship should reflect its potential benefit to both parties, not just one. Some customers develop VMI supplier certifications. Specifically, the partners should track the following measures of success: Reduction or elimination of the bullwhip effect Reduced inventory costs in the supply network as a whole

Reduction or elimination of stockouts or spoiled product on shelves Reduction of lead times for deliveries and more on-time deliveries Increased inventory turns

Collaborative Planning, Forecasting, and Replenishment Collaborative planning, forecasting, and replenishment (CPFR®) is a way to integrate the components of demand management among supply chain partners. CPFR® is an evolving set of best practices, process standards, organizational standards, and technology recommendations. The APICS Dictionary, 16th edition, defines collaborative planning, forecasting, and replenishment (CPFR) as (1) A collaboration process whereby supply chain trading partners can jointly plan key supply chain activities from production and delivery of raw materials to production and delivery of final products to end customers. Collaboration encompasses business planning, sales forecasting, and all operations required to replenish raw materials and finished goods. (2) A process philosophy for facilitating collaborative communications. CPFR® Model

®

shows the activities and tasks in the CPFR model. The activities are Strategy & Planning, Demand & Supply Management, Execution, and Analysis. The collaboration tasks appear in the center column; the enterprise tasks appear in the left column (manufacturer tasks) and the right column (retailer tasks). The model can be expanded to include other partners, such as distributors, who can play the buyer or seller role. The idea is to formalize collaborative tasks while reducing redundant work by specifying what work is best done by each supply chain partner. For example, market planning is the responsibility of the manufacturer, while the retailer takes care of category management. Exhibit 2-18: CPFR Model Manufacturer Tasks

Collaboration Tasks

Retailer Tasks

Strategy & Planning Account Planning

Collaboration Arrangement

Vendor Management

Market Planning

Joint Business Plan

Category Management

Demand & Supply Management Market Data Analysis

Sales Forecasting

POS Forecasting

Demand Planning

Order Planning/Forecasting

Replenishment Planning

Production & Supply Planning

Order Generation

Buying/Re-buying

Logistics/Distribution

Order Fulfillment

Logistics/Distribution

Execution

Manufacturer Tasks

Collaboration Tasks

Retailer Tasks

Analysis Execution Monitoring

Exception Management

Store Execution

Customer Scorecard

Performance Assessment

Supplier Scorecard

The model starts with strategy and planning, where the primary tasks are to decide on how collaboration will proceed and to develop a joint business plan. The joint business plan identifies significant events such as promotions, inventory policy changes, store openings and closings, and product introductions. The model proceeds in the other three activity categories in similar fashion, with joint sales forecasting being an important part of demand and supply management. Again there is a division of labor as the manufacturer analyzes market data and conducts demand planning while the retailer forecasts POS numbers and does replenishment planning to determine order and shipment requirements. The execution activity, also known as the order-to-cash cycle, involves placing orders, preparing and delivering shipments, receiving and stocking products at the retail site, recording transactions, and making payments. The manufacturer does production and supply planning, while the retailer conducts the

activities associated with buying. Both parties conduct logistics and distribution on their ends. In the analysis activity, the supply chain partners monitor planning and execution activities to identify exceptions. They also aggregate results and calculate key performance metrics, share insights, and adjust plans as part of continuous improvement. Technology CPFR® is not fundamentally a technology solution. Rather, CPFR® is at heart about developing effective business processes to synchronize supply chain operations across enterprise boundaries. Nevertheless, the success of CPFR® depends upon willingness to work with shared data efficiently in real time. CPFR® software solutions might go by various names but include systems that allow enterprise partners to Share forecasts and historical data Automate the collaboration arrangement and business plan Evaluate exceptions Enable two-way, real-time conversations, revisions, and commentary. These solutions must be able to function on any existing enterprise software and hardware. CPFR® is generally described as internetbased, with each enterprise feeding data into shared servers for

immediate joint web-based access. This allows for low-cost connections even with very small trading partners. CPFR® Scenarios CPFR® scenarios are case studies of the experiences of enterprises using the CPFR® model. Examples of some of the scenarios that can be found on the GS1 US website through our Resource Center include ways to collaborate on retail events, distribution center replenishment, retail store replenishment, and assortment planning. CPFR® Challenges Instituting CPFR® may require meeting several predictable challenges. Increased costs. There may be costs in money and time required to acquire and train users on the technology to share data externally. Resistance to data sharing. CPFR® needs a single, jointly developed business plan that incorporates one set of shared forecasts. Although there are risks, without shared data, there is no CPFR®. Bridging internal functions. Successfully establishing CPFR® requires the partners to build bridges between internal functions so as to speak with one voice to its trading partners. Yet this internal challenge cannot be underestimated.

Legal and Privacy Requirements for Information Sharing Information sharing can result in exposure to risk. Liability, data privacy, and cybersecurity risks and protections are addressed more next.

Legal Liability and Protections Information sharing with the extended supply chain or with government entities creates risk for organizations, and some of these risks could leave the organization liable for damages sought by other supply chain partners, customers, or investors. Here are some of the risks related to information sharing along with some potential responses in the form of insurance: Trade disruptions caused by information system failures could be mitigated using trade disruption insurance for lost profits, continuing and expediting expenses, and contingent losses. (Trade disruption insurance is broader than business interruption insurance, which addresses the loss of use of physical property.) Political risk from government expropriation of intellectual property can also be addressed to some extent using trade disruption insurance. Customer or trade partner liability risk can come from failure to adhere to privacy laws related to the collection or use of data; this

is addressed more below. Cybersecurity risks can create liability from breach of data. Cyber insurance or use of a cybersecurity framework can help, as is also addressed more below.

Data Privacy Risks and Laws While privacy refers to the right to be left alone and free from surveillance by various parties, data privacy instead relates to an individual’s right to have a say in how one’s personally identifiable information is collected, used, and handled. This includes control over who can access the information and how it can be amended, changed, or deleted (including the right to be forgotten). Personally identifiable information (PII) is a legal term. For example, the U.S. Department of Labor defines it as follows: Any representation of information that permits the identity of an individual to whom the information applies to be reasonably inferred by either direct or indirect means. Further PII is defined as information: (i) that directly identifies an individual (e.g., name, address, social security number or other identifying number or code, telephone number, email address, etc.) or (ii) by which an agency intends to identify specific individuals in conjunction with other data elements (e.g.,

indirect information). These data elements may include a combination of gender, race, birth date, geographic indicator, and other descriptors. Additionally, information permitting the physical or online contacting of a specific individual is the same as personally identifiable information. This information can be maintained in either paper, electronic, or other media. Cybersecurity is particularly important for data privacy due to the potential for sensitive information being acquired. Health records, financial information, legal records, information on membership in organizations (e.g., churches, unions, political parties), and racial or ethic group membership all require higher levels of protection. Big data or data analytics systems have additional privacy implications because data from multiple sources is being aggregated. Data privacy laws and regulations exist in numerous jurisdictions. While these laws apply to those jurisdictions, an organization wishing to have data on customers in those locations will need to abide by those restrictions for its customers in those locations even if the organization does not otherwise operate in those jurisdictions. Also, since adherence to different regulations for different customers can be cost-prohibitive, many organizations adopt the most stringent set of data privacy laws or regulations for all of their customers as a gold standard. Examples of more stringent data privacy laws include the

California Consumer Privacy Act (CCPA) in the U.S. and the General Data Protection Regulation (GDPR) in the European Union. For example, the GDPR gives individuals the following rights over their data: Right to be informed of how organizations are using their data, such as through a privacy policy Right to access one’s personal data Right to correct errors in one’s personal data Right to be forgotten (deletion of personal data) Right to get a copy of personal data (data portability) Right to opt out of future data collection Similarities and differences exist in various data privacy laws, so legal review is needed. For example, in the GDPR, the organization or its embedded third-party processors needs to obtain prior consent for the collection and use of EU citizens’ data, including the purpose, extent, and duration of the data processing (which is why websites now commonly ask you to accept cookies prior to using this information to personalize ads and more). The CCPA does not require this but does allow people to opt out. Another issue with data privacy laws is data residency, or requirements for storing data within the physical borders of the country that passed the law. While the GDPR does not address data

residency, many other laws do. Germany’s Data Protection Act, for example, requires data residency for the accounting data of German organizations and individuals filing taxes in Germany. Laws of this sort have implications for clouds, as the data could conceivably be stored anywhere. Such laws have led to national clouds, where the cloud guarantees data residency within the jurisdiction.

Cybersecurity Risks Maintaining certain standards for cybersecurity may be a regulatory requirement in certain jurisdictions, and it also creates reputation and liability risks for the organization related to breach of personally identifiable information. It can also be a form of trade disruption. For example, a ransomware attack shut down a key U.S. East Coast pipeline in May of 2021 and resulted in panic buying of gasoline by consumers, as discussed in the New York Times article by Michael D. Shear et al., “Colonial Pipeline Paid Roughly $5 million in Ransom to Hackers.” Cyber insurance is one option for addressing cybersecurity risks. This form of coverage is basically a type of trade disruption coverage. The impact of cyber risks on suppliers and customers one or more tiers out may also need to be considered when negotiating this type of insurance.

IT requires robust security due to the numerous cyber threats that exist, and this is especially the case for supply chains that integrate with numerous partners, since this creates more attack vulnerabilities. One way supply chains can reduce these risks is by getting all parties to agree to use a common security framework. Two examples are the NIST Cybersecurity Framework and the MITRE ATT&CK® framework. NIST Cybersecurity Framework The National Institute of Standards and Technology (NIST) is a U.S. government agency and a contributing member to the ISO. The NIST Cybersecurity Framework, version 1.1 (2018), has been well accepted in the U.S. and internationally as a foundation for developing cohesive cybersecurity processes and policies intended to provide information systems with resilience. The framework outlines cost-effective best practices that can be tailored to the need and properly prioritized. The framework includes A framework core. The core presents cybersecurity activities called functions, their expected outcomes divided into categories (e.g., for the “protect” function, one is identity management and access control) and subcategories (e.g., “Remote access is managed.”), and informative references (e.g., relevant standards).

The following functions operate as a cyber risk management life cycle: Identify: Business context, resources needed, risk identification, and risk management strategy Protect: Preventive controls including training and maintenance Detect: Continuous monitoring and anomaly detection and related processes Respond: Planning and communicating responses and improvements Recover: Plans for resilience and recovery after failures A set of implementation tiers. These are maturity levels for implementation of cybersecurity that go from partial, to risk informed, to repeatable, to adaptive. A framework profile. This area provides guidance on generating a cybersecurity road map aligned with the given industry, organizational strategy, best practices, and legal or regulatory requirements. An organization with several supply chains may have separate road maps per chain. The profile includes an “as is” and a “to be” state for gap analysis. MITRE ATT&CK® Framework

The MITRE Adversarial Tactics, Techniques, and Common Knowledge (MITRE ATT&CK®) framework is a curated framework that categorizes adversary behavior and maps out the life cycle of cyber attacks. It provides a common frame of reference for types of attacks and presents related defenses. There are three versions, one for enterprise (Windows, Mac, Linux, and clouds), one for mobile devices, and one for “pre-exploit” adversarial behavior, such as reconnaissance. Categories of adversary tactics include resource development (command and control of attacks), reconnaissance, initial access (e.g., phishing), execution, persistence (trying to stay in the system), privilege escalation (getting higher levels of access), defense evasion (detection avoidance), credential access (stealing user IDs and passwords), discovery (determining what they can control), lateral movement (gaining access to other systems), collection (determining what data to steal), command and control (using seemingly normal traffic to communicate with the compromised network), exfiltration (data theft), and impact (a malicious attack such as ransomware).

Topic 3: Supply Chain Master Data

Supply chain master data include static files such as customer master files. Maintaining these master data is vital to the efficiency and effectiveness of supply chain networks. After discussing master data and their management, we address data acquisition and management, including automatic identification technologies and point-of sale systems, data analysis, and maintenance and cleansing of data.

Master Data and Their Management Master data are a type of data (other types include unstructured data, transactional data, metadata, and hierarchical data) that describe the organization’s core business elements, including customer data, supplier data, product or item data, engineering data, and logistics data. Each of these categories has many subcategories. Master data also include reference data, which are data that help place master data into categories, link them to transactional data, or relate them to external sources of information. Unlike transactional data, master data do not change frequently. They are static information (though they can be maintained). However, they are referenced in transactional data. Without accurate and timely data, no other aspect of supply chain management can be achieved.

Master data management (MDM) is a discipline that works alongside the IT discipline to coordinate the creating, updating, cleansing, and retiring of master data across an organization’s systems or the systems of an extended set of entities to ensure stewardship, accuracy, consistency, completeness, and timeliness of those data among all parties. It involves governance (oversight), methodologies (process specifications and metrics), policies, procedures, and related technologies. The concept of a life cycle can be applied to master data management to help organizations be holistic in how they govern and manage their data. There are numerous master data life cycle models, and the steps differ among them. Exhibit 2-19 shows one example of a master data life cycle.

Exhibit 2-19: Example of Master Data Life Cycle

In the plan phase of this cycle, the organization determines what master data it needs, how the data will be created and processed, and any policies, processes, procedures, and technologies that need to be in place for each type of master data. This step often can leverage a common data model, which is a best-practice model that offers standards for how organizational master data should be approached. Major database, enterprise resources planning, and cloud vendors offer such models. The last step, reassess, is a continuous improvement step where gaps in the master data management methodology or any feedback on specific issues are addressed. The steps that need to be done more frequently are reviewed next: Create and process. The expected use of the data should be a primary driver of the data to be collected. This step can include manual data entry, automated data capture through organizational devices or systems, or acquisition of data created outside the organization. Processing can include manual data entry restrictions or checks and automated formatting steps to get the data ready for their intended use. Analyze, use, or transfer. The data are put to their intended uses, which can include support for transactions, analysis to generate business insights, or analysis to find potential new uses

of the data. Data can also be shared outside the organization. An audit trail is a vital control for this step. It tracks who made what changes and when they occurred. The audit trail itself needs very high security. Maintain and store. Maintenance and storage includes ensuring security in transit and in storage, cleansing the data (such as removing duplicate records), providing security, and backup and recovery processes. Archive. Data that are not needed for current transactions can be put into long-term storage if they need to be maintained for regulatory compliance or other reasons. The data are no longer subjected to regular maintenance but are secured. Destroy or repurpose. Data that are no longer needed and are slowing down the system or that must be deleted for legal or regulatory compliance (e.g., compliance with data privacy laws) need to be systematically purged from every system within which they reside. Destruction typically occurs mainly to data that has been archived for a time (such as to comply with records retention regulations). Repurposing involves finding a new use for a type of data.

Types of Master Data Important to Supply Chain Managers The types of master data used will vary between department, company, supply chain, and industry. The most important master data for analysis include Customer and supplier master files Product/item/stock keeping unit (SKU) master files Manufacturing master data such as bills of material or standard costs/time (a “should cost” amount or time period for things like direct materials or direct labor) Purchase orders for raw material cost and spend analysis Orders for demand analysis, customer profitability, and customer service Inventory data for economic order quantity calculations (e.g., annual demand volume, unit value at cost, inventory carrying cost percentage, ordering cost, and partial or full load transportation costs), working capital, customer service costs, and obsolete or excess inventories Logistics data, including shipment data for network optimization, transportation spend analysis, carrier performance analysis, and transportation rate negotiations Engineering data.

Master data exist for every department and area of a company. For example, customer data include the customer master file. (Related transactional data include customer order history or point-of-sale data.) From these basic sources, one analysis might query sales by customer and customer location, further broken down into sales by pallets, cases, or pieces or by weight, cube, product lines, or frequency. Similar queries could be run for sales by SKU or other measures. Such information results in customer activity profiles, SKU activity profiles, customer by SKU profiles, and customer order profiles, each broken down by sales amounts and volume. From these data, managers can determine customer segments, better classify SKUs, set customer response measures, and determine an optimal customer service strategy for each customer segment. For engineering data, a key data element is an effectivity date, or the date upon which an old engineering document is superseded by a newer version. The bill of materials (BOM) or product structure includes effectivity dates, both “from” and “to,” to indicate when the information is valid. This allows engineering changes to be proactively scheduled. Material requirements planning (MRP) notes these dates and plans accordingly. In the event that a BOM is changed—for example, a new component with a new number is introduced—an engineering change notice can alert the MRP when

to shift from the old part to the new part. This allows production to use up existing inventory first if this is feasible/allowed.

Creating Data Cost-effective processes need to be set up to capture and transmit data to the database accurately. Once set up, data capture is primarily a tactical or operational problem, but the setup of methods, policies, and procedures for capturing data is a strategic decision.

Considerations in Data Capture Specific considerations in data capture include the following: Data volume. Depending on how sophisticated the company’s data capture processes are to start with, the volume of data captured may vary. Incremental improvements may be the best policy, because each increase in the amount of data captured can immediately be put to use in improving the bottom line. An accurate inventory system is a good place to begin. Many companies have moved to cycle counting—counting inventory periodically, several times a year. Done correctly, this improves the accuracy of the inventory. Working with accounting, this can avoid the annual physical inventory counting.

Having partial data is better than having no data. Even if a company’s strategic goal is to have complete visibility across the supply chain network, it has to start somewhere. Partial data can provide incremental improvements and the ability to see what data are necessary for the next improvement in analysis. Capture at the source. When possible, capturing data at the source is far better than entering them later. Data capture tools: manual versus passive. Passive or automatic data capture increases productivity, is more likely to occur every time, and is more likely to be accurate than manual processes. Capture ancillary data when possible. In a networked supply chain, it can be difficult to know what data will be important. Data mining and decision support systems can find hidden patterns if enough data are available. If a particular type of data is deemed important in the future, it is many times more valuable if those data have been captured continuously since some point in the past. Systems design should acknowledge the desirability of capturing ancillary data. However, as the term “big data” implies, organizations can become overwhelmed by too much data. More data than are

needed may simply hinder analysis or hide the true indicators of change. Therefore, even when the additional data are stored, use cases for data should be developed to indicate how the extra data could help prior to their being included in metrics or analysis. Real-time versus batch data. Engineering true real-time access to data can be many times more expensive than engineering near real-time access. Sometimes using near real-time data has no real impact on usefulness. For example, transmission of production counts each minute rather than each second does not make the data less useful and saves considerable expense. Oftentimes an organization has both a transactional system for real-time data checking as well as a reporting system for when near real-time or historical data are sufficient.

Data Capture Challenges and Possible Solutions Fast-paced, hostile, or multilingual environments pose a particular challenge to accurate data capture: Fast-paced environments. Local management may be resistant to adding any steps that would slow a process down, so the best solution may be to incorporate hands-free data capture such as a bar-code or radio frequency identification (RFID) reader. Package

shipping companies use multiple readers from different angles so packages passing on conveyor belts can be quickly read. Hostile environments. Dangerous, noisy, hot, crowded, or otherwise physically hostile environments require special solutions. It should be determined where measurement is required in the process so that a minimum number of durable sensors can be used. Language or training issues. Employees who do not speak the same language as their managers or are illiterate or technically illiterate need simplified environments such as those that use barcode work cards with multilingual or pictographic instructions.

Data Capture Methods Data capture methods include automatic identification and point-ofsale systems.

Automatic Identification Systems The APICS Dictionary, 16th edition, defines an automatic identification system (AIS) as “a system that can use various means, including bar code scanning and radio frequencies, to sense and load data in a computer.” Devices used for an AIS are sometimes called automatic identification and data capture (AIDC)

devices. These devices identify items and track the movement of goods across the supply chain automatically, leaving employees to handle just the physical movement of goods. The key benefits of an AIS are faster information visibility and increased transaction accuracy and processing speed. AIDC devices have two key features: automatic classification and automatic identification. The automatic classification process applies the object’s class to some of the numbers in an identifier, reducing the complexity of the numbering process and increasing identification speed. An item that can communicate its class allows optimization of groups of objects. In the warehouse, these items can be stored in optimal locations. In transportation, available shipping space can be planned. In retail, shelf space can be planned. Automatic identification means that unlike just having a serial number on an object, an AIDC device can communicate the object’s presence. Instead of trying to keep all product data on a tag, or even in a static database, the product data can be stored on the internet so that classification and identification occur on a network. Global identification requires that the identifiers for objects be unique so the internet will yield only one match per item. Bar codes do this to a certain degree, but radio frequency identification (RFID) is more

thorough. Both, however, can be used to update the transactional database when changes occur. Automatic identification systems are used in many places where the physical world must connect with the world of data, as shown in Exhibit 2-20.

Exhibit 2-20: Automatic Identification System (AIS) Interface Points

The cost of purchasing, implementing, and maintaining automatic identification technologies should be offset by the benefits, especially if paperwork can be eliminated. The movement from paper-intensive activities to automated data capture systems improves productivity. Workers spend less time looking for and processing paperwork, writing numbers, and entering data. These devices reduce errors by eliminating numeric transpositions, missing or incomplete information, and lost or damaged paperwork. Bar-code and RFID scanners can now be embedded or attached to cell phones for real-time data input at any location. Wireless POS

devices with cellular technology can accept immediate customer payments. Handheld scanners allow workers to concentrate more on moving items. RFID devices are even better, because workers don’t have to place items with their bar codes in a particular alignment. These systems improve customer service levels by reducing stockouts, especially when dealing with promotional or advertised items. The inventory database is more accurate, and supply is matched more closely to demand, leading to added profits because fewer sales are lost and variability is reduced. Enriched product information also benefits the consumer because such data will be more easily available from multiple synchronized sources. Even consumer data can benefit, such as an affinity card showing a pattern of buying certain products in a supermarket on certain days. Automated replenishment signals can occur when inventory is tracked accurately. Accurate inventory reduces shrinkage from employee theft, lost inventory, or spoiled goods and enables functions such as vendor-managed inventory. In other words, automated data capture significantly improves inventory visibility. Visibility and dynamically updated product data help plan space in warehouse and retail locations more effectively. Finally, quality assurance can be improved by tracking where problems have occurred.

The following content looks at automatic identification technologies including warehouse automation systems, bar codes and bar-code scanners, RFID, smart cards, magnetic stripes, and vision systems. Warehouse Automation Systems Warehouse automation systems are physical devices that interface with warehouse management systems (WMS) to provide information to distribution center employees on how to pick or put away items while they are on the move. These devices may be handheld, handsfree, mounted on a forklift or other vehicle, or built into the warehouse floors or racks. The key benefit of these devices is that they can be integrated with optimizing applications to ensure employee efficiency. Hands-free devices are especially good because they do not hinder manual tasks. Warehouse automation systems include the following: Wireless radio data terminal (RDT). This data interface device involves a display, an input mechanism such as a keyboard with special function keys, and either a bar code, an RFID reader, or both. The RDT receives commands from a WMS and directs the actions of the employee for picking or put-away. Synthesized voice. A WMS directs this hands-free synthesized voice system to tell an operator what to do. The operator may

wear a microphone to indicate when a job is finished. These systems require little training. Pick-to-light. These systems highlight a path through the warehouse and/or an item to be picked using physical indicator lights or lit alphanumeric displays installed at each inventory location or on a carousel. Heads-up displays. Heads-up displays present a virtual image of the warehouse over the employee’s actual view for hands-free direction. Bar Codes and Bar-Code Scanners A bar code is a machine-readable code that identifies, at a minimum, the product manufacturer and the stock keeping unit (SKU). Some bar codes may also contain lot and batch information and/or a serial number. Bar codes assist in the correct identification of products and also operators/staff, store shelves, pallets, and pallet racks. For example, warehouse orders can be picked and placed in reusable baskets, each with a bar code. The operator scans the basket’s code, and the warehouse system indicates what to put in the basket. The bar-code system is heavily integrated in all areas of the supply chain. It will continue to coexist with other methods of data scanning such as RFID because bar-code labels are very inexpensive

compared to RFID tags. Most RFID labels have a bar code on the outside of the tag for use with either system. RFID and bar codes can be complementary; when an RFID tag has interference, the barcode tag can be scanned. Components of a bar-code system include Bar-code printers Bar-code labels Bar-code readers (portable or stationary) Hard-wired or radio frequency (RF) communications links between the bar-code readers and an application (enterprise resources planning [ERP], transportation management system, WMS, or point-of-sale capture) Applications to process the data collected. shows a typical bar-code label.

Exhibit 2-21: Bar-Code Label

Bar-code labels list data in a format of bars with intervening spaces of varying thickness. A reader shines lasers at the bar code and captures the reflection in an optical scanner. The scanner takes up to 100 looks at the code to measure the width of the black bars and the white spaces. Each group of black bars and white spaces represents a character (letter or number). Start and stop characters tell the scanner which direction it is reading from and allow the reader to read information omnidirectionally. Large industrial scanners can read bar codes in a wide viewing field for high-speed sorting. shows only a single character; a complete bar code would include a number of characters to identify the manufacturer, etc. A very common bar-code standard is the Universal Product Code (UPC), one type of which is shown in , representing the number 123456789012. (A 12-digit number is the maximum information for

this type.) This number is typically used to identify the manufacturer and SKU only; it does not normally identify a product by its serial number or other unique identifier. UPC codes are heavily used for checkout at cash registers.

Exhibit 2-22: UPC Bar Code (UPC-A)

There are a large number of other bar-code standards, many of which do support identification down to a unique identifier. Some may use the 12-digit UPC code as the unique identifier. Once the UPC code is scanned, the unique identifier can be run through a WMS, TMS, or POS to link to and retrieve an abundance of data— SKU, date made, location in a warehouse, ERP system part number identifier, and all possible combinations of data captured in a data collection system. Most readers are designed to read multiple barcode formats. A popular type of bar code is the 2D code. A 2D bar code can be scanned by mobile devices for automatic redirection to mobilefriendly websites. 2D bar codes include standards such as the QR (quick response) code and PDF417, a code found on the back of

every U.S. driver’s license. shows an example of a QR code. The chief advantage of such a code is that it stores data both horizontally and vertically rather than just in one direction, so more data can be stored in a small space without sacrificing scanner readability. 2D codes can identify an item by its serial number.

Exhibit 2-23: 2D Bar Code (QR Code)

Bar codes are not smart tags. They are simply a hard-coded number or alphanumeric information that identifies a product, a website, or other information. When the type of bar code used does not identify a product down to its serial number, this can be an issue for product defects and quality assurance, especially for medicine and packaged foods. In some cases, one or more additional bar-code blocks (not using UPC coding) carry the serial number, lot number, or other scannable data. In other cases, a single bar code (e.g., a 2D code) contains the manufacturer, SKU, and serial number. Bar-code data are often batch-processed, for example, when a mobile scanning device is placed back into its cradle, which is linked

to the network. According to the APICS Dictionary, 16th edition, batch processing as it relates to computer processing is “a computer technique in which transactions are accumulated and processed together.” For example, in a warehouse, the operator will be given a series of tasks to perform, and, when these tasks are finished, the operator will send the information to the system in a batch before receiving a new set of commands. While batch processing is low in cost, the advantages of a real-time bar-code system include better data for salespersons quoting availability, onthe-fly correction of operator errors, and systems that can add or change tasks during a job. RFID The Dictionary defines radio frequency identification (RFID) as “a system using electronic tags to store data about items.” The electronic tag is a tiny microchip with an antenna whose signal is automatically picked up by a reader/interrogator. The reader can be combined with a cellular/GPS device for in-transit updates. The information on the tags is more robust with RFID than with other forms of AIDC. Associated data are stored on the internet, data capture is entirely automatic, and tags can be read even when the item is under other packages.

A significant feature of RFID tags for supply chain applications is that the tags are available in a read/write configuration that allows tag and reader to communicate back and forth. The information on the tag can, in other words, be altered from a distance, unlike with bar codes. Applications for the supply chain could include updating the tag with its current location to provide a chain of custody for a pharmaceutical drug or dynamically changing the description of an item as value is added during manufacturing. EPCglobal’s electronic product code (EPC) is the most widely accepted set of standards for RFID tag data and has been mandated by numerous retailers. The Dictionary defines EPC as “codes that are used with RFID tags to carry information on the product that will support warranty programs.” The EPC has the same manufacturer/SKU information as a UPC bar code, plus a unique serial number and a link to interactive transaction data. The item’s creation location, distribution points, and point of sale can be known down to the specific cash register and salesperson. EPCglobal’s EPC Generation 2 (Gen 2) interface protocols specify how information is communicated between tags and readers. EPC Gen 2 is recognized by the International Organization for Standardization (ISO) as the ISO 18000-6 class of standards.

The EPCglobal Network is a standards-based method of locating and verifying EPC codes. It creates an intelligent value chain for products. Trading partners use the web-based network to locate EPC codes and view the manufacturer’s secure item website for additional product data. EPCglobal tag data standards add security. For example, drug companies can use the network to track their products through the supply chain and guarantee that nothing was illicitly introduced, guard against counterfeits, and issue targeted product recalls. Although a counterfeiter could make a tag with someone else’s company and product SKUs, only the EPCglobal’s object naming service can issue tag headers. Because the product identifier is checked against this online registry, counterfeit tags would be immediately detected. Gen 2 also has password capabilities to lock portions of a tag. There is a vast variety of types and costs of RFID tags. Simple and cheap tags are used to record an EPC, while more sophisticated tags are used as a mobile database (e.g., recording temperature, pressure). A chip can also control a process on an assembly line. Some tags are for single use only, while others can be updated and reused. Tag types include active, passive, and semipassive:

An active tag is “a radio frequency identification tag that broadcasts information and contains its own power source” (Dictionary). Such tags can transmit data to a reader at long ranges and are the most expensive type of tag. They are often used to tag containers or pallets. A passive tag is “a RFID tag which does not send out data and is not self-powered” (Dictionary). The radio frequency energy from the reader temporarily powers the tag. Passive tags can transmit data at short range and are cheap if purchased in bulk. Readers must typically be installed at gateway entry and exit points, on equipment such as a forklift, or be handheld. A semipassive tag is “an RFID tag that sends out data, is selfpowered, and widens its range by harnessing power from the reader” (Dictionary). Companies will likely use a mix of active and passive tags, for example, placing active tags on high-value assets and whole containers and passive tags on boxes full of merchandise. The cost of tags is a limiter in the expansion of RFID, since, in comparison, the cost of a bar-code label is practically negligible. Printers burn an RFID tag and may simultaneously print a label with a bar code. Printer cost, reliability, and throughput may be the most

relevant issues. Interference (a distorted radio signal) can be a problem with RFID. A signal can be affected by variables such as antenna size, reader power level, frequency used, and other radio frequency emissions (e.g., machinery white noise). Some liquids absorb reader/tag signals, and some metals reflect signals. Reading multiple boxes on a pallet is not foolproof; reading singular cases on a conveyor system is very reliable. Common adjustments to improve read rates include Placing readers in locations with less interference Placing a buffer or shield between the tag and the interfering object Adjusting the position and angle of the RFID antennae on readers Changing reader or tag type/manufacturer to suit the facility or product. The absence of human intervention in the process makes data acquisition with RFID extremely cheap and fast. However, many RFID users indicate that some human intervention is still needed to verify that the tags have been read, raising the cost and error rate of the system and reducing efficiency. Reader maintenance and testing must be included to verify promised reliability. For example, a major airline tested RFID and found that it could increase the accuracy of

luggage read rates to more than 90 percent, but the airline would need to change how its operators loaded baggage into the metal luggage carts to get that accuracy level. Because RFID generates vast amounts of data, the data must be brought into a usable state prior to sending them to ERP or analytical systems. Before implementing RFID, companies should be at a high stage of supply chain maturity. Implementations at lower stages will lead to an inability to use the gathered information (i.e., all the costs and none of the benefits of RFID). RFID’s value comes in when process discipline cannot be advanced with other technologies and human interaction has reached the limit of its efficiency. For example, a refrigerated goods company saved 25 percent in energy costs by using RFID to make refrigerated doors at their warehouse open and close automatically at the arrival and departure of trucks. The costs associated with RFID can be difficult to estimate because they include not just individual RFID tag costs but also infrastructure changes and capacity increases for filtering, storage, processing, and analysis.

A full implementation may be hard to justify, so a limited project may be the best way to add RFID, such as a plant area where items need careful tracking. The business case should drive RFID selection. The organization should target a supply chain process that has sufficient room for improvement and will provide a strategic advantage, such as collaborative product life cycle management, continuous demand management, reduction of stockouts, asset management, fulfillment and distribution, aftermarket sales, or reducing counterfeiting or theft. Other Types of AIDC Devices Other types of AIDC devices include the following. Smart cards. A smart card has an embedded microchip with a unique identifier. Companies give employees smart cards to regulate physical and computer access and create an automatic time log. Smart cards are also used for vehicle identification at tollbooths or in warehousing for a picking tour. Magnetic stripes. Magnetic stripes are used for credit and ID cards to automate number entry. Data on the magnetic stripe can be changed. Because the stripe must be read by contact, it can’t be used for high-speed sorting.

Vision systems. Vision systems use cameras along with computers to interpret the images. These systems are relatively expensive and can distinguish changes at moderate speeds with great accuracy in a controlled environment. A vision system may be used to identify incoming items that have only text labels.

Point-of-Sale Systems The Dictionary defines POS as “the relief of inventory and computation of sales data at the time and place of sale, generally through the use of bar coding or magnetic media and equipment.” A related term in the Dictionary is point-of-sale information , “information about customers collected at the time of sale.” These two terms provide a great deal of information about the benefits of capturing data at the point of sale. Transferring information from the POS to the organization’s information systems in real time allows the organization to Capture data on product SKU, price, promotion, and inventory Replace a push system with a demand-pull system based on actual customer orders and improve sales forecasting Deduct inventory from the books immediately at the time of sale Immediately forward accounting information to finance Collect information about individual customer purchasing habits (either through a credit card or through a voluntary affinity card

program) Reduce the bullwhip effect if the data are shared immediately throughout the supply chain Reduce data errors by collecting data at the source rather than later entry Update POS systems at reduced cost, simplifying returns, coupons, special orders, layaways, etc. A retailer may, for example, send information from the point of sale to suppliers each time a customer purchases an item to trigger production or shipment of a replacement. Large retailers may summarize the POS results in a data warehouse and provide all vendors with access to it through a vendor web portal. Such portals may include an application programming interface (API) to enable automated retrieval of the data. In addition to linking cash registers to POS data collection systems, field systems such as wireless credit card readers, wireless POS scanners, tablets, and cell phones can be used to collect POS data. Self-service POS terminals such as at a grocery store or an ATM also exist. POS data can be collected through manual entry or as part of a bar-code or RFID system. Many types of buyer-supplier partnerships, such as vendor-managed inventory, require that the retailer provide POS data to the supplier.

Business portals allow individuals to see exception-based information and forecasts based on POS data. The data are presented on a dashboard that allows users to configure what items are tracked. For example, Walmart shares POS data by broadcasting to all suppliers on a security-restricted basis using their own portal network. Consider the following case study of a company that has realized the benefits of capturing and communicating point-of-sale data in a retail setting. A small company designs and creates high-quality running shoes and apparel. It distributes goods through three outlet stores. For several years they have had trouble managing their outlet store inventory because they have no way of viewing inventory levels. They have resorted to sending the same quantities of inventory to each outlet no matter what the current inventory is, resulting in large excess inventory at stores. They have also had great difficulty in changing prices. These changes have to be sent via messenger service. Their problem is that their data are static but need to be dynamic and real-time. They decide to solve their issues by implementing a retail management system with real-time POS data transfer. The system allows them to view inventory levels at the outlet stores so they can optimize products by local demand. The company can determine

what products are selling at what locations and customize shipments accordingly. Headquarters can also change prices dynamically at each location, saving the company several days worth of labor per month. The system reconciles sales reports with actual sales for better reporting at the store level. This reconciliation feature also saves the outlet stores time and money by allowing faster nightly shutdowns and price change reconciliations. The company is more profitable and efficient.

Analyzing Data Analysis turns data into business information, or information that is actionable, relevant, reliable, and placed in context. Analysis should reveal the best way to allocate scarce resources. A holistic analysis of the extended supply chain should reveal the optimal use of assets for each partner. Analysis occurs at the strategic, tactical, and operational levels, such as determining the location and number of distribution centers or calculating which centers to ship certain goods from during seasonal demand fluctuations. Analytical systems should be flexible enough to enable shifts in strategies, such as weighing the pros and cons of moving from distributed warehouses to a centralized warehouse. Collaboration with key supply chain partners is a primary goal of organizations wishing to reach more mature stages of supply chain

development, and sharing the results of data analytics or sharing data with supply chain partners so they can do their own analytics are key ways to promote this maturity. Sharing data can help globally optimize the supply network, enable sharing both risks and rewards with partners, and promote collaborative forecasting and active visibility. When analyzing data, both the data and the models used need to be validated. Some degree of data aggregation is usually also needed. After discussing these concepts, decision support systems, big data, and data analytics are addressed.

Model and Data Validation When analyzing results, both the predictive model and the data used must be validated, or tested against actual results. The first step in analytical model validation is to put historical data into the model and see if the results are as expected. If they are, the model is run again using current data, and the output is compared with expected results for reasonableness. When either of the above validation tests returns unexpected or wildly inaccurate results, both the model and the data are explored to find errors, bugs, outlier exceptions, or incorrect or unrealistic assumptions.

If the results differ by too much, the model and/or the data must be modified until the model accurately predicts actual results within an acceptable margin of error. Then the model and the data are put to use in actual business decisions. They are, however, periodically reviewed to ensure that they continue to reflect actual usage. Because models often use aggregated data, the amount of error related to the level of aggregation should be estimated. If the error is within limits, it is considered acceptable. Finally, if the model makes intuitive sense and the data are consistent with actual results or if any anomalies in the data can be fully explained, then the model is ready to be used.

Data Aggregation Due to the large amount of data collected—especially in retail, where large numbers of different products are sold—data are usually aggregated, or grouped into like categories. Aggregation is “the concept that pooling random variables reduces the relative variance of the resulting aggregated variable” (APICS Dictionary, 16th edition). In other words, the peaks and valleys in the data are smoothed out when they are combined, which allows averages and trends to be more obvious. In addition to reducing variance, aggregation is useful because massive amounts of data

can be difficult to interpret when viewed at a granular level. For example, sales by SKU by store will have a large amount of confusing variation. Looking at sales by SKU by region will reduce variation and provide better insights. Further aggregation could be done with meaningful groupings of SKUs per region (e.g., all sizes of the same shirt). The aggregated data are used in data modeling and analysis, such as by using a decision support system.

Decision Support Systems A decision support system (DSS) is “a computer system designed to assist managers in selecting and evaluating courses of action by providing a logical, usually quantitative, analysis of the relevant factors” (Dictionary). DSS is a broad term for any software application used to help management make better decisions. A DSS generates analytical models that are based on mathematical algorithms, simulations, or hybrids of the two. Analytical models are simplified versions of a real situation, event, or transaction. A good model will have just enough information to help guide a decision without including details that would confuse the issue. Models may not always be purely mathematical versions because a DSS may be needed to help management make tradeoffs between qualitative objectives.

As shown in Exhibit 2-24, basic DSS components include an input database, a set of data analysis tools, and a set of database and spreadsheet presentation tools to display results.

Exhibit 2-24: Decision Support Systems (DSS)

Analysis tools also include data mining, defined in the Dictionary as follows: The process of studying data to search for previously unknown relationships. This knowledge is then applied to achieving specific business goals. Data mining commonly uses a data warehouse (a batch-updated database kept separate from the transactional database for use in analytics) or a shared interorganizational database.

Presentation tools filter the massive data output of a DSS analysis into role-specific information using “dashboards” that allow users to customize the information to suit their needs. For example, a dashboard could show a marketing manager the simulated results of a sales campaign but omit manufacturing simulation results. Input data to a DSS for supply chain management might include, among many other specific data items, the following: Static and semistatic data such as customer order history; locations of suppliers, warehouses, and retailers; weight; volume (cube); holding cost; and shelf life (maximum and minimum) of products Dynamic data, such as point-of-sale data and sales forecasts; current capacity and transportation costs to distribution centers; retailer inventory levels; delivery status; and product sales forecasts DSS queries, such as sales by customer, segment, or SKU; purchasing by supplier, SKU, etc.; on-hand inventory and inventory forecasts; orders by value, lines, units, etc.; and demand variability Strategic-level DSS can afford to be detailed and relatively slow because the decisions are long-term and need to be performed only periodically. Such systems often use the most extensive historical

data available. Tactical decisions require a balance between speed and sophistication. Operational DSS must be able to provide fast decisions and so are generally simpler models that use current data for short-term planning.

Big Data and Data Analytics The Dictionary defines big data as “collecting, storing, and processing massive amounts of data for the purpose of converting it into useful information.” “Big data” is a buzzword term that describes the massive amount of both unstructured and multistructured data that is hard to process using traditional database and software techniques. Big data comes from different sources—web, sales, customer contact, social media, mobile data, and so on. Many companies process millions of manual/automated transactions per day. A vast amount of data that can be used for numerous purposes is produced. Many frame the discussion of big data using volume (the amount of data), velocity (the speed of information generated and the flow of it through the supply chain), and variety (the kind of data available). However, the term may also refer to the technology that an organization requires to handle the large amounts of data.

Data analytics tools and big data are two elements that can help businesses identify problem areas within a supply chain before those areas actually do damage. Companies need to think about how they will use big data to improve their supply chain: Data collection. Deciding how much data to collect and how they will be analyzed. Technology usage. Separating insights from useless data and presenting the insights in a way that is instantly understandable. Leverage results. Incorporating insights into the decision-making process. In a strategic example, in determining the optimal distribution network, data can be collected on customer, retail, distribution center, and manufacturing locations; product sales by weight and cube; special transportation requirements; and forecasted demand. In a tactical or operational example, two uses of big data are demand sensing and demand shaping. Demand sensing is used to detect changes in demand from consumers in near real time; demand shaping is then used to alter demand plans to reflect the best current information on demand. Data acquisition and communication tools are methods of collecting, storing, and sharing data among areas in the organization and with members of the extended supply chain. The primary goal of data

acquisition and use is to create a seamless link between all points of production, distribution, purchase, and service. This goal can be broken down into the following components. Collecting information. Information should be collected at each point at which a good is handled or a service is rendered. Since these points occur within and between many companies, from raw materials companies to manufacturers and assemblers to distribution centers and retailers (plus transportation between each point), there are naturally many individual databases. This information may or may not be shared between supply chain partners. Providing timely access to data. Data are considered timely if they are received by the relevant system or decision maker within the time needed to execute the relevant transaction or make the decision. Some data are needed instantaneously, while other data can be sent in batches or subjected to intermediate steps such as analytics and still be considered timely. Controlling access to relevant data. Access to relevant data, especially data regarding the status of material, products, and services, is the basis for making efficient supply chain decisions. The goal of data access is to allow each information user access to a uniform set of role-specific data from any point of contact. For

example, a sand supplier should get the same information about a customer’s sandpaper sales or rejection rates whether inquiring by phone, ERP, or internet exchange. Likewise, regardless of the means used, the sand supplier should not see the sandpaper manufacturer’s labor rates or profit margins. Reducing visibility gaps. Depending on organizational strategy or the stage of supply chain development a company has achieved, data may or may not be shared. At the earliest stage, even internal information between divisions may not be shared, or it may have to pass through bottlenecks, making it less relevant when shared. At higher stages of development, the company may share data among its internal and perhaps even external partners in real time using straight-through processing (no reentry needed). Visibility implies not only tracking materials, products, and services but also providing active alerts to each affected party of upcoming actions and exceptions to planned events so alternate actions or methods can be devised. Improving planning effectiveness. A forecast or model is only as good as the data used to create it. Since the sales forecast is the basis of almost all of the other budgets for a traditional manufacturing or service company, improving the data used in planning has a direct effect on a company’s planning effectiveness

and ultimately on profitability. Improving forecast accuracy is primarily a function of accurate, timely data, measuring and reducing estimate error, and product lead time. Ensuring and maintaining data accuracy. Ensuring and maintaining data accuracy are critical to the perceived and actual usefulness of any technology system.

Data Maintenance Ensuring and maintaining the accuracy of data is a major issue and an ongoing concern. Data collection must be as automated as possible; however, with or without humans in the process, data can become compromised or erroneous. In an extended supply chain there are many more potential sources of error. Data errors can come from sources such as the following: Each time data are manipulated (Software bugs can introduce errors.) Numeric transpositions, typos, and missing or incomplete data Older or not fully integrated databases with multiple versions of a record Redundant databases in the network or different tags for the same objects

In addition, delays in data collection can mean that the data arrive too late to be relevant. Ensuring data accuracy requires resources for validating the data and correcting errors. Companies should use multiple methods to reduce and prevent errors. Without accurate data, advanced analysis will be ineffective and transactional systems will be inefficient. Data accuracy is especially relevant for planning systems. For example, when a transportation management system calculates how to load trucks, if the cube and weight data are wrong or missing from even a small percentage of items to be shipped, the system could recommend overloading the trucks. If this occurs too frequently, workers and managers may stop trusting in the integrity of the system. In another example, a customer could submit an address change, and the customer master data file is updated. However, if there is a separate shipping and billing address in the system, if the billing address is not also updated or is updated incorrectly, the customer may not receive the bill and could end up being delinquent by accident, be sent to collections, and so on. Even if the problem is eventually discovered and fixed, the customer could be lost permanently.

Improving Data Accuracy

A primary method of ensuring data accuracy is to institute consistent collection and data entry polices: Sharing POS and other transaction-specific data across the supply chain Collecting and transferring data in real time where feasible Completing data entry at the time and place of the event Use of industry-specific data accuracy standards (For example, GS1 Standards are used in the retail grocery supply chain.) Acquiring new software without improving the quality of the data will lead to poor return on investment for the software, possibly leading to distrust and abandonment of an otherwise useful system. A way to prevent this is to combine system upgrades with data cleansing and normalization initiatives. Data cleansing is defined in the APICS Dictionary, 16th edition, as sifting through a database to find and fix mistakes such as misspelling, missing information, and false data. Data normalization is defined in the Dictionary as a database maintenance term used in the context of relational databases, which helps to minimize the duplication of information or safeguard the database against certain types of logical or structural data

anomalies. It is often used when merging data from one or more databases. Cleansing, normalizing, and otherwise enhancing data become especially important when two or more databases are combined. Mergers are one occasion for combining databases. The format of the information must also be considered. IT systems should present data in like terms as well as in terms that are relevant to users’ needs. For example, when an intermediate customer is creating sandpaper, a sand supplier should be able to see the customer’s demand for kilograms of sand and not sheets of sandpaper.

Maintaining Data Accuracy Once a firm’s database has been deemed acceptable after cleansing or other improvements, the firm must take steps to ensure that the data quality doesn’t degrade over time. Steps to ensure data integrity include Instituting role-based access policies, procedures, and software limits for adding, deleting, and modifying information Investing in data maintenance/continuous improvement process training for current and future users.

Section C: Supply Chain Metrics and Reports This section is designed to Describe supply chain metrics and the process for selecting them Understand how dashboards can keep people focused on customized metrics that promote addressing business objectives Describe the balanced scorecard and how it is used to track improvements in business performance Describe how organization-specific scorecards help keep people focused on organizational objectives Describe the SCOR® model and its use for improving supply chains Identify how to use the SCOR metrics Know how to calculate the Level 1 strategic SCOR metrics Understand which Level 1 metrics apply to each supply chain process and how these will differ based on different operating models Show how using the Digital Capabilities Model for Supply Networks can help supply chains achieve higher levels of supply chain maturity

Understand the basics of global and country-specific accounting systems and which countries use various systems Define key financial terms Explain key financial statements that are commonly used in supply chain management Review the types of financial metrics used to measure supply chains Explain the metrics used for measuring operations within the supply chain in the areas of quality, productivity, and asset management. In this section we look at the relationship between supply chain strategy and the choice of metrics. We also review different metrics for measuring the performance of supply chains, including financial and operational metrics.

Topic 1: Supply Chain Metrics, Reports, and SCOR Developing a useful set of supply chain metrics is key to achieving desired results. The place to start is to understand the objectives of any measurement system. Choosing the right way to present measurement results can strongly influence their effectiveness, so balanced scorecards, dashboards, and other tools are covered.

Since use of a formal measurement methodology can help ensure a complete measurement system, the Supply Chain Operations Reference (SCOR®) Digital Standard and the related Digital Capabilities Model for Supply Networks are also discussed here.

Supply Chain Metrics and Reports Road Map Here we start with the big picture of why measurement systems are useful and then introduce supply chain metrics. Supply chain metrics are useful when there are sound processes for gathering performance data, analyzing that performance, and then using the data to improve performance. Metric selection and a metric selection framework are also discussed.

Measurement System Basics You get what you measure. When designing metrics, it is important to understand that people are motivated to improve what the organization chooses to measure and to ignore or deprioritize what the organization fails to measure. The second part of this statement references the unintended consequences lurking behind the statement “you get what you measure.” To ensure that businesses are getting the results they want while minimizing unintended consequences, organizations often turn to well-established process-

oriented measurement models because they are thorough yet not overly complex or cumbersome. One of the more widely accepted and used process-oriented models is the Supply Chain Operations Reference (SCOR®) Digital Standard. The basic objectives of any measurement system are as follows: Monitoring. Track actual system performance by observing and gathering data that is relevant to business objectives. Controlling. Compare data to appropriate standards for performance to determine when the system needs modification or attention, identifying causes, and adjusting systems to get back on course or to continuously improve the course. Directing. Develop an understanding of actual human motivation and what incentives motivate people to work toward organizational goals while minimizing unintended consequences. In other words, measurement becomes a tool to enable effective leadership and management of the workforce. Performance measures as a whole should be objective, consistent, and quantified. They should measure at least two parameters, such as a quantity and a time (e.g., delivery by a particular day). They also require target values or standards so that the person or

organization being measured and the person(s) doing the monitoring and controlling can objectively gauge relative success. Data are turned into information by placing them in context and analyzing them. Once this occurs, the right people need to get the information that is relevant to them in the right format. The timing of when the information becomes available is also relevant to the decision. Some communication methods need to be near real-time, while others are designed for periodic appraisal.

Supply Chain Management Metrics Measurement and feedback is essential for any supply chain, not only to continuously improve systems for greater efficiency and effectiveness but also to allow the systems to adapt to change. It is important to select measurements that will give proper incentives to the parties being measured in the areas of customer-focused, financial, and operational metrics for the supply chain. Metrics should cut across functions and organizations in the supply chain to promote collaboration and interdependencies. For example, the finance function is concerned with the cost of various supply chain operations and determines the break-even point when an operation could become profitable. Finance is also involved in

monitoring suppliers and customers for financial distress to provide early warning of trouble. Measuring and communicating the performance of the supply chain can provide benefits such as the following: Control of processes and employees Management or influence over suppliers and customers Reporting to managers and external sources (e.g., financial reporting) Sharing demand information with suppliers and supply information with customers Communication of expectations and problems Learning and continuous improvement Each organization will devise its own set of performance measurements for customer, operational, and financial measures. Exhibit 2-25 shows an example of a set of performance metrics one organization uses, many of which are discussed elsewhere (possibly under slightly different names). Exhibit 2-25: One Organization’s Performance Metrics 1. % orders delivered on requested delivery date

2. % orders delivered on promised delivery date 3. Production schedule performance 4. Production schedule stability 5. Forecast accuracy a. Forecast bias—performance to plan b. Forecast bias—tracking signal c. Product mix d. MAPE—mean absolute percentage error e. MAD—mean absolute deviation 6. Order fulfillment lead time 7. Total supply chain cost 8. Cost of goods sold (COGS) 9. Cash-to-cash cycle time 10. Inventory days of supply 11. Days’ sales outstanding 12. Days’ payables outstanding

Processes for Measuring, Analyzing, and Improving Supply Chain All along the supply chain, managers are responsible for measuring results and ensuring that they’re on target to meet their functional

goals as well as support the organizational and strategic plans. These plans may involve some form of continuous improvement initiative. Getting these things to move from plans or project to reality is often a challenge, so change management is often needed. The key processes that supply chain managers need to be able to perform related to measuring, analyzing, and improving the supply chain are Gathering performance data Analyzing performance Improving performance. Prerequisites to these processes involve setting measurement system objectives and planning what to measure: Determining organizational objectives and how to measure and incentivize their success Selecting metrics that are meaningful and promote desired behavior, yet are feasible and cost-effective to measure Gathering Performance Data The process of gathering performance data involves the following steps: Determining the data to be collected as inputs to chosen metrics Finding source(s) for the necessary data—including allowed external sources (e.g., reporting agencies, suppliers)

Assessing data collection feasibility; for example, for customers/suppliers: Assessing availability, quality, and cooperation levels Planning and executing data collaboration projects when feasible Finding alternative data sources (i.e., proxies) as needed Assessing data accuracy impact (For example, distance-based freight rates might be used unless actual freight rates would significantly improve decisions.) Choosing the method of gathering each type of data (e.g., manual estimate, manual measurement, automated information system) Determining the method of reporting the data (e.g., who, how, what, and when for manual or what events trigger automatic submission) Setting up these processes and systems as needed (e.g., using projects) Gathering and submitting data during normal operations Entering manual data in information systems/tools in the proper format and using controls to minimize data entry errors Validating data for relevance, reliability, and accuracy (e.g., compare to historical data to see if wide discrepancies exist; if so, investigate)

Archiving the data in a role-restricted repository (database) for ease of access and reference by appropriate parties For example, performance data could be shipping and arrival dates, percent completion of a manufacturing process, number of defects, actual costs, and so on. In another example, financial data for suppliers might include information directly from suppliers and/or their publicly available financial statements as well as data from credit reports, bank references, or third-party ratings such as Moody’s, Fitch’s, S&P Global, or Dun & Bradstreet. Analyzing Performance The process of analyzing performance involves the following steps: Formulating questions that the performance information or model outputs should be able to answer Turning data (raw observations and measurements) into information: Placing it in context (e.g., comparing to baselines, goals, benchmarks, or past results) Using the data as inputs for ratio analysis, formulas, or models Using the data for comparisons across supply chain organizations to see if there is a net improvement for all

Validating information and tools for relevance, reliability, and accuracy (i.e., compare ratios to historical ratios or use historical data in models) Making interpretations (e.g., viable options, status, trends, or forecasts) Selecting formats and media appropriate to the information and audience Preparing reports at predetermined intervals and on request Presenting reports Performance information might include shipment status, fill rate, ontime delivery variance, forecasted number of quality rejects, and so on. Reports can take the form of dashboards, regular status reports, updates, recommendations, formal presentations, and so on. Improving Performance The process of improving performance involves the following steps: Accepting feedback from decision makers and supply chain participants Preparing recommendations for short-term or incremental improvement Enacting approved short-term or incremental changes Periodically auditing processes (including the measurement process itself) against strategic or long-term objectives

Preparing recommendations for changes to processes or metrics that better align with strategic or long-term objectives Preparing recommendations as needed for making continuous improvement become part of the organization’s philosophy (e.g., lean, six sigma) Using change management and/or project management to enact strategic or long-term improvements to processes or performance

Selecting Metrics Related to Supply Chain Strategy Since it’s not feasible to measure and monitor every supply chain goal or activity, managers have to choose a reasonable number of metrics that are related to supply chain strategy. Some of the strategic attributes of supply chains are velocity, visibility, variability, collaboration, trust, customer focus, and flexibility. Other attributes include security (risk management), compliance with all regulations, and environmental excellence (with a well-developed, profitable reverse supply chain). Any of these attributes could be woven into strategy, expanded into specific objectives, and subjected to measurement. For instance, if the supply chain’s strategy were to increase the velocity with which information flows from the end customer back through the chain, objectives would be developed to assess the

current state of the system and identify metrics to measure progress toward a specific goal. The key metric might be a measure of the actual velocity of communications. The goal could be to substitute reports from intermediate customers with the direct transfer of data from the point of sale via scanners, bar codes, and the internet. A number of enabling objectives might be put in place for buying equipment, training staff, and so on. This would be a true supply chain metric, because the process it measures crosses nodes. What is being measured creates incentives and perhaps unintended consequences. For example, a purchasing agent whose performance is being measured on purchase price variance will work to minimize that variance but could be motivated to do so in ways that harm other objectives, like buying in bulk to get discounts and always selecting the lowest bidder. The selected metrics would introduce a side effect of increasing inventory and reducing quality. Organizations that used these as the primary purchasing metrics are moving away from cost and toward value for the final customer. While this is a more difficult metric to measure because it requires information from supply chain participants, it produces results that better align with objectives. Often a selection of metrics that are tailored to a specific supply chain is what is needed. For example, inventory turnover and cash-

to-cash cycle time might be two of several metrics, and these would promote ordering in wise quantities. They would then be balanced with other metrics such as on-time delivery, purchase price, and total cost to produce a well-rounded incentive system. So how do you select these metrics? One can use trial and error over time, but this can be costly, so many organizations instead use a framework or methodology when designing metrics.

Metric Selection Framework A framework for helping organizations select the best metrics to use was developed by Griffis, Cooper, Goldsby, and Closs in an article titled “Aligning Logistics Performance Measures to the Information Needs of the Firm.” In this framework oriented toward logistics metrics, there are three areas to focus on when prioritizing metrics. Each is a continuum, or range between two opposite forces: Competitive basis: responsive versus efficient. Greater responsiveness tends to lower efficiency. Measurement focus: strategic versus operational. Priority can be more toward selecting the best overall strategy, such as total cost of ownership, or on efficient daily operations. Measurement frequency: diagnostic versus monitoring. Diagnostic measurements are used to decide between

alternatives, while monitoring measurements are used to assess daily performance. The idea is to assess where the organization falls as to its competitive basis and then to determine where each metric falls on each of the second two ranges. Organizations can then select metrics that match their competitive basis. They could also use such a framework to help decide which metrics should be used when they want a strategic focus and which are more appropriate for daily operations management. Once a company determines the metrics to use, these metrics need to be communicated throughout the extended enterprise along with the benefits of achieving them.

Scorecards, Dashboards, and Performance Metrics Supply chain scorecards, dashboards, and performance metrics are ways of giving internal decision makers as well as other supply chain partners clear goals. When these tools are shared with suppliers, for example, both the suppliers and the organization can view performance on a daily, weekly, monthly, or other periodic basis. The tools make clear what is being measured and what results are considered unacceptable, marginal, and acceptable. This information

may be presented in customizable dashboards, with role-specific display of performance information. Often when a supplier or other supply chain partner has access to the performance information, they can self-correct issues before they become more serious. After all, to a supplier, the organization is the customer. Suppliers are naturally interested in maintaining a good relationship to promote their own success. First we present dashboards as useful ways to display relevant performance data, and then we address the balanced scorecard. Since most organizations create their own scorecards, these are discussed as well, using an example from a real company that is involved in global sourcing. Following this, some additional performance metrics from the same company are provided.

Dashboards The APICS Dictionary, 16th edition, defines a dashboard as “an easy-to-read management tool similar to an automobile’s dashboard designed to address a wide range of business objectives by combining business intelligence and data integration infrastructure.” One type of dashboard is an executive dashboard. The Dictionary defines an executive dashboard as

a set of cross-functional metrics for measuring company performance that indicates the health of the company. It usually includes the company’s key performance indicators. The key advantages of using dashboards are timeliness and selfmanagement. Since dashboards provide automated near real-time information that is customized to the viewer’s needs, the right information gets to that person quickly. Because the information is provided directly to the person, he or she can then plan any necessary changes without needing to be directed. Managers can then be involved in advisory and approval roles rather than needing to direct and control except in the cases when appropriate action isn’t being taken.

Balanced Scorecard™ Metrics provide a way to keep score, so it was only natural that someone would create a business-related scorecard. If an organization’s objective is to improve order fill rate from 93 percent to 98 percent, a scorecard can provide a means to compare actual performance against target performance. However, if the things that are being measured do not address some key objectives, this measurement imbalance can result in those objectives being ignored. To ensure that both the short- and long-term objectives are

addressed, in 1992 Robert S. Kaplan and David Norton introduced the balanced scorecard ™ (BSC), which the Dictionary defines as a list of financial and operational measurements used to evaluate organizational or supply chain performance. The dimensions of the balanced scorecard might include customer perspective, business process perspective, financial perspective, and innovation and learning perspectives. It formally connects overall objectives, strategies, and measurements. Each dimension has goals and measurements. The balanced scorecard (BSC) is a four-part system developed to evaluate organizational performance on more perspectives than just financial results. The BSC was initially designed to give managers a comprehensive view of overall business performance; however, it has since been adapted to many purposes, including the design and measurement of supply chain performance, both internally and to measure suppliers. Why is the scorecard “balanced”? Because unlike traditional measures, which focus only on financial results, it includes four different types of measurements that aim to provide a broader, more balanced perspective on business performance: Customer perspective Business process perspective

Innovation and learning perspective Financial perspective Exhibit 2-26 shows a balanced scorecard for a particular supplier for a period of time (such as a month), including some sample goals and metrics. Note that the second innovation and learning goal is a subgoal of the goal above it. Subgoals should contribute to meeting the overall goal. (In this case, it is a Level 2 SCOR metric that contributes to the Level 1 metric above it.) Exhibit 2-26: Balanced Scorecard (BSC) for Supplier XYZ Customer Perspective

Innovation and Learning Perspective

Goal

Measure

Target Actual Goal

Meet customer delivery promises.

Supplier XYZ 99% delivery performance

98%

Meet customer quality expectations.

Number of floor failure events related to XYZ materials

1

0

Target

Actual

Supplier XYZ can withstand economic downturns.

Downside 20% supply fewer chain orders adaptability

15% fewer orders

Reduce production with no layoffs.

Downside 20% adaptability fewer (make) orders

18% fewer orders

Business Process Perspective Goal

Measure

Improve supplier sustainability conformance.

XYZ’s 100% sustainability conformance rate

Measure

Financial Perspective

Target Actual Goal 100%

Promote supplier cost reductions.

Measure

Target

% cost –10% relative to incentive cost target

Actual +5%

Business Process Perspective Reduce WIP material refinishing time.

Number of conditionally accepted XYZ materials

0

2

Financial Perspective Work with financially stable suppliers.

XYZ’s 0.35 debt-tototal assets ratio

0.40

Note the four categories of information for each metric: goal, measure, target, and actual. All four items are necessary. The goal shows the result that should be achieved. All goals included in a scorecard must be measurable. Targets are performance standards that set a value that the measurement should achieve to be considered successful. Some organizations expand this into three categories of targets such as good, better, and best or failing, acceptable, and excelling. The “Actual” column is where actual performance is recorded for a given period. As will be seen in the custom scorecard example to follow, there may be individual columns for multiple periods. Consider what each perspective adds to a manager’s knowledge of his or her area’s role in the supply chain: Customer perspective. The customer’s view of the business clearly has value for assessing the current performance and future prospects of the business. Measures such as on-time delivery or subjective measures such as satisfaction with customer service or impression of reliability are important to track.

Business process perspective. In a functionally oriented business, this area might focus on number of prospecting calls or productivity. It can also encompass flexible response, waste reduction, or other supply chain management goals. Innovation and learning perspective. This area can include formal training for staff, or it can refer to innovations in products or processes (such as adopting a balanced scorecard approach to supply chain management). Financial perspective. The traditional way of judging business performance relied on such measures as cash-to-cash cycle time, return on investment, and debt-to-equity ratio. But financial measures are retrospective, and they don’t always provide a true indication of the current state of affairs, much less of future performance. Kaplan and Norton wanted to give managers a tool that would encourage a broader, more future-oriented view. Nevertheless, a balanced scorecard approach must always include the financial perspective; bottom-line results are still the final measure of success. Also, the measurements used in all four perspectives must ultimately be linked to their financial contribution to the bottom line. Key Elements in Balanced Scorecard Initiative

Developing a balanced scorecard approach to managing the supply chain requires careful preparation, leadership, and follow-through. Here are some key elements that should be present in a balanced scorecard initiative: Communicate the strategic purpose of the scorecard to partners. Organizational strategy, let alone supply chain strategy, too often remains in the minds of top executives without being communicated to other levels of management. If managers are to help make change happen, they have to understand why it’s good for the business, the customer, their own area, and themselves. Develop goals and measures consistent with internal and supply chain strategies. There’s a temptation to use the balanced scorecard as a brainstorming tool without understanding that the four areas need to be mutually reinforcing and aligned with strategy. They aren’t catch-all containers for random suggestions. If the supply strategy is to penetrate a new, high-end market with innovative electronics, then the business process perspective might be to develop a more rapid product innovation cycle linked to measures of process innovation and design workshops in the innovation and learning area, reduced delivery cycles in the customer perspective area, and a profitability measure in the financial area.

Create schedules and assign responsibilities. The BSC requires establishing ownership of results. When an initiative crosses functional areas in one company it is likely to encounter resistance if not coordinated and promoted from above. But in a supply chain comprising different companies, there is no unified “above”; agreement has to be established first at the executive level across the supply chain. Then a reporting structure has to be established across company boundaries. Moreover, there may be obstacles to overcome, such as incompatible systems. Setting up a balanced scorecard initiative is not a job for novices. The first time around it can be worthwhile to bring in outside expertise. Still, even a highly sophisticated consultant cannot substitute for support at the executive level; outsiders are not always immediately accepted if employees aren’t convinced that management is behind the initiative.

Custom Scorecards Balanced scorecards are designed to be customizable because organizations can specify their own goals and the measures used to achieve each goal. If the four perspectives are not considered useful categories for an organization, organizations often design their own custom scorecards. The benefits are that both the categories used and the individual metrics can be tailored to the needs of the

organization and its culture and organizational structure. The drawback is that a custom scorecard may not be as well balanced. When an organization has key, indispensable suppliers or alliances, it may be best to develop the scorecard in consultation with these organizations rather than handing the results down from above. Suppliers who are involved are more likely to accept the measurements and may be able to provide suggestions or innovations. Exhibit 2-27 shows a custom scorecard that reflects the unique priorities and measurements that a particular organization uses for one of its 3PL sites. Note the following points about this scorecard: It includes metrics for two suppliers to the 3PL. An organization will likely have multiple scorecards, but suppliers of the same good or service could be shown on the same scorecard for direct comparison. Measurements are in numbers and percentages for easy reference. The title of the scorecard is “Monthly Quality of Service (QOS) Report.” The categories do not have any direct financial measures,

which are likely the subject of a different report. There are seven categories: active suppliers and parts, advanced shipment notification (ASN) compliance, receipts, receipt discrepancies, inventory count, deliveries, and corrective actions. These categories are more of a blend of business process, learning and growth (discrepancies and corrective actions), and customer perspective (the customer being the organization producing the scorecard). Exhibit 2-27: Custom Scorecard

Source: Laura Gram

Visual Tools for Scorecards The custom scorecard in also contains some visual tools to augment the seven categories of measurements in the previous scorecard. Visual tools such as those shown in can make some trends obvious.

Exhibit 2-28: Visual Tools for Scorecards

Source: Laura Gram

Performance Metrics This discussion continues the case study for the organization that designed the previous custom scorecard. Performance metrics for its raw material suppliers and its freight forwarders are also in the form

of visual graphs and charts that are easy to interpret and easy to discuss with the suppliers. These tools help the organization exercise the proper level of control over its suppliers because problem areas become obvious. Exhibit 2-29 and Exhibit 2-30 are KPIs (key performance indicators) for raw material suppliers; Exhibit 2-31 and Exhibit 2-32 are KPIs for freight forwarders.

Exhibit 2-29: KPIs for Raw Material Suppliers

Source: Laura Gram

Exhibit 2-30: KPIs for Raw Material Suppliers

Source: Laura Gram

Exhibit 2-31: KPIs for Freight Forwarders

Source: Laura Gram

Exhibit 2-32: KPIs for Freight Forwarders

Source: Laura Gram

Exhibit 2-29 shows months in which there were occurrences of incorrect weight, packaging problems, or damage to raw materials. The categories stack to highlight months when multiple problems occurred. This chart cannot show the magnitude of the problems, only that they exist. Exhibit 2-30 shows that relative to the target shipment booking of 14 days prior to sail date, many suppliers booked shipment with little or no notice. Exhibit 2-31 shows that only in February, November, and December did the freight forwarder meet the target goal of no containers bumped and that April through July may require more serious monitoring in the next year. Exhibit 232 shows that the average number of shipments that were not precleared was around 50 percent even though the target was five

percent. This may be an area where the measurement and target must be reviewed to see if they are accurate and feasible, which could result in either mandating a supplier process correction or setting a more realistic target. The key points about supplier scorecards and performance metrics that can be gained from these examples is that rather than just having a few universal ways to measure performance, organizations have many ways. However, organizations should select only measurements that can be objectively gathered, that provide useful information for decision making, and that can be enforced. The standard or target selected should be challenging but realistic. Finally, there is no point in measuring something unless you intend to do something about it if it is significantly or consistently off target (and celebrating it if it exceeds expectations).

Sustainability Scorecards Many organizations are now presenting their sustainability reports in the form of a sustainability scorecard. Using a scorecard format allows a quick view to compare year-over-year results on key performance metrics. These scorecards enable organizations to target and track the best opportunities for improvements in energy, water, pollution, and waste

reduction targets across their supply chain. They also demonstrate continuous progress toward implementing sustainability plans. While formats vary across organizations, some examples exist in open format for review and usage. Proctor & Gamble (P&G) has a sustainability scorecard and rating process to measure the environmental performance of its key suppliers. Their scorecard is “open code” for use by any organization to help determine common supply chain evaluation processes across all industries. P&G relied on input from a supplier sustainability board and used protocols set by the World Resources Institute, the World Business Council for Sustainable Development, and the Carbon Disclosure Project. It focuses on year-on-year improvement regardless of the current stage of a supplier’s sustainability program. The P&G scorecard was developed by referencing another example, Walmart’s The Sustainability Insight System (THESIS) Index, in which the retailer asks questions about the sustainable practices of its suppliers. This allows them to understand the sustainability hotspots within product categories and rank the suppliers based on information they provide around those hotspots. In 2017, Walmart reached its goal of buying 70 percent of its U.S. goods from suppliers that participate in the index (and can use the index), or 1,300 suppliers. By 2020, this had increased to 1,600 suppliers.

SCOR Performance Measures One of the more widely accepted and used process-oriented models is the Supply Chain Operations Reference (SCOR®) Digital Standard. It is “a process reference model developed and endorsed by the [APICS] Supply Chain Council (APICS SCC) as the crossindustry, standard diagnostic tool for supply chain management” (APICS Dictionary, 16th edition). It reflects the collective wisdom of years of field-based practices and provides a unique framework that links business processes, metrics, best practices, skills, and technology features in a unified structure. The SCOR Digital Standard provides methodology and tools to diagnose and benchmark organizations. Individuals can enhance their understanding of supply chains and associated processes using this model, and they can improve their own supply chain management systems and practices by using these tools. The model has been developed and refined by dozens of major companies and applied in initiatives available as case studies. The SCOR Digital Standard has several major categories: A Processes category, which is organized around the SCOR process model explored below. A Performance category, which is the specific metrics in the model. Each part of the process model references selected

performance indicators. A People category, which is standards for managing supply chain talent in terms of baseline skills, critical skills, related performance measures, and skill credentialing. A Practices category, which is related emerging practices and technologies, best practices, and standard practices. Note that the SCOR Digital Standard (this version supersedes SCOR 12.0) is designed to enable the supply chain digital transformation. The SCOR Digital Standard has added a number of new emerging practices, including augmented reality, robotic process automation, artificial intelligence, big data analytics, shouldcost modeling, predictive analytics, digital twin, smart contracts, advanced data visualization and visibility, real-time location systems, autonomous delivery, stock taking via drones, dynamic inventory management, quick-response codes, mobile distribution centers, machine learning, dynamic routing, virtual reality, and multienterprise business networks. This has augmented the prior version’s emerging technology practices, which included things like blockchain and the Internet of Things. These emerging practices, plus the best practices and standard practices, are linked to specific supply chain processes. For example, for planning the deliver process, there are standard practices such as cross-docking, best practices such as vendor-managed inventory, and emerging

practices such as machine learning. These practices help show where to leverage each technology. Another way that the SCOR Digital Standard helps create an intelligent supply chain is by linking to a new model called the Digital Capabilities Model for Supply Networks. This model is discussed in its own area. The SCOR process model and its metrics are the primary subject of the rest of this discussion of SCOR. The boundaries within which the SCOR process model applies are carefully defined. Specifically, it does not apply to all business processes, only to those involved in the supply chain as the chain extends two tiers in both directions from the company at the core. This is shown in Exhibit 2-33. At the center is “Your Organization.” To the immediate right is the first tier of customers, which can be either internal or external. To the left is the first tier of suppliers, which, again, can be either internal or external. The model goes out two tiers in both directions; the second-tier suppliers and customers are assumed to be external.

Exhibit 2-33: Supply Chain Operations Reference (SCOR) Model

Source: Adapted from APICS Supply Chain Council

The model focuses on six areas: Plan—creating strategies to meet goals and developing best practices to guide decisions Source—obtaining goods and services in a way that meets market demand and quality expectations Make—assembling finished products to meet customer demand Deliver—managing ordering, transportation, and distribution processes Return—accommodating returned goods from suppliers, distributors, or customers Enable—supporting performance in the other areas through, for example, effective hiring and performance management, information sharing, and business expertise (e.g., compliance, quality, risk management, information technology)

These processes—which are not traditional functional areas or departments—exist within the entities of the supply chain. All the processes are carried out by the central triad of chain members. The entities at each end of the supply chain (a raw material supplier and a retail outlet, for example) perform only two processes (the supplier’s supplier handles only delivery and returns, while the customer’s customer manages only sourcing and returns). This model can also be applied to supply chains containing many more linked organizations. SCOR does apply to the following activities: All customer interactions from order entry through paid invoice All product transactions (defined as physical materials and services), including equipment, spare parts, bulk product, and software, among others All market interactions from understanding aggregate demand through order fulfillment SCOR does not apply to the following processes: Sales and marketing (defined as demand generation) Research and technology development Product development Some elements of post-delivery customer support (But it does include returns as a fundamental process.)

The SCOR model assumes that the product has already been designed and tested for production. However, the design of a product may significantly influence the functioning of the chain, so supply chain representatives should play a role in the design process. The SCOR model was developed specifically to measure crossfunctional, cross-company supply chain processes at four levels. It includes metrics that allow it to be used to compare performance against industry-best or best-in-class performance as well as against a company’s own previous performance and future goals. Once the supply chain has a percentage score for a particular metric, it can then conduct research to determine its ranking among relevant organizations and decide whether to undertake an improvement initiative.

SCOR Levels The levels of SCOR metrics are as follows: Level 1 SCOR: These are the strategic-level metrics. This level defines the scope and content of a given supply chain. Here is where the competitive basis of the organization is translated into high-level performance targets. Level 2 SCOR: These are the operational strategy metrics. Examples of operational strategies include make-to-stock and

make-to-order. Level 3 SCOR: This level is used to configure the individual processes and enable execution of the strategy. It involves defining processes, inputs and outputs, process performance (including more detailed performance metrics), practices, technology capabilities, and staff skills. Level 4 (not in scope for SCOR): These are the industry-, company-, or location-specific processes and practices needed to achieve required performance. Metrics at this level will be defined by the organization. The selection of metrics depends upon the supply chain strategy; there is no requirement, for example, that all the metrics for a particular SCOR level have to be applied simultaneously. In fact, the opposite is more likely to be true. Achieving greater overall velocity might require that one link in the chain actually underperform in the interest of boosting performance elsewhere. Shipping might have to rely on more expensive transportation, for example. These tradeoffs have to be carefully negotiated with those involved, and rewards may have to be shared in such a way that the interest of each stakeholder is brought into alignment with that of the overall enterprise. Strong leadership from above is paramount. A pilot project is helpful if it starts at the most manageable level and has a

good chance of quick success. Applying one metric across two or three supply chain partners is not too modest a project. Level 1 SCOR SCOR Digital Standard Level 1 includes six management processes. As seen in , each process is made up of subprocesses, specific tasks, and activities. Exhibit 2-34: Level 1 SCOR Management Processes Process

Activities

Plan

The plan processes describe the planning activities associated with operating a supply chain. They include gathering customer requirements, collecting information on available resources, and balancing requirements and resources to determine planned capabilities and resource gaps. This is followed by identifying the actions required to correct any gaps.

Source

The source processes describe the ordering (or scheduling) and receipt of incoming goods and services. They include issuing purchase orders, scheduling incoming deliveries, receiving, shipment validation and storage, and accepting supplier invoices.

Make

The make processes describe the activities associated with the conversion of materials or creation of the content for services. They focus on conversion of materials rather than production or manufacturing because they represent all types of material conversions: assembly, chemical processing, maintenance, repair, overhaul, recycling, refurbishment, remanufacturing, etc. As a general guideline, these processes are recognized by the fact that one or more item numbers go in and one or more different item numbers come out.

Process

Activities

Deliver

The deliver processes describe the activities associated with the creation, maintenance, and fulfillment of customer orders. They include the receipt, validation, and creation of customer orders; scheduling order delivery; pick, pack, and shipment; and invoicing the customer.

Return

The return processes describe the activities associated with the reverse flow of goods back from the customer. They include the identification of the need for a return, the disposition decision making, the scheduling of the return, and the shipment and return of the returned goods. (Repair, recycling, refurbishment, and remanufacturing processes are not described using the Return process elements. See “Make” above in this exhibit.)

Enable

The enable processes describe the activities associated with establishing, maintaining and monitoring information, relationships, resources, assets, business rules, compliance and contracts required to operate the supply chain. Enable processes support the realization and governance of the planning and execution processes of supply chains.

In Level 1, there are also five core supply chain attributes: reliability, responsiveness, agility, cost, and asset management. These are addressed elsewhere. Level 2 SCOR Level 2 can be broken down into two processes, planning and execution, as illustrated in . Exhibit 2-35: Level 2 Process Types

Process Type Planning

Description A process that aligns expected resources to meet expected demand requirements Planning processes:

Balance aggregated demand and supply Generally occur at regular, periodic intervals Consider consistent planning horizon Can contribute to supply chain response time Execution

A process triggered by planned or actual demand that changes the state of material goods Execution processes:

Generally involve: 1. Scheduling/sequencing 2. Transforming product, and/or 3. Moving product to next process Can contribute to order fulfillment cycle time The execution process, for example, has three different possible capabilities of representing and responding to customer orders, as seen in : Make-to-stock (production in anticipation of a customer demand)

Make-to-order (production due to an incoming customer order) Engineer-to-order (customer order requiring specific engineering involvement) Exhibit 2-36: Possible Capabilities in Execution Process Make-to-Stock

Make-to-Order

Engineer-to-Order

Driven by inventory (plan) Standard material orders High fill rate, short turnaround

Driven by customer orders Configurable materials Longer turnaround times

Driven by customer requirements Sourcing new materials Longest long lead times, low fill rates

Different supply chain strategies support corresponding product or service types. These categories also affect the plan and return processes. Level 3 SCOR In Level 3, the processes describe the steps performed to implement the Level 2 processes. illustrates how the SCOR metrics for perfect order fulfillment cascade from one level to the next.

Exhibit 2-37: SCOR Level Metrics for Perfect Order Fulfillment

Industry Level 4 Processes The SCOR model does not detail Level 4, so organizations and industries create their own Level 4 processes. The processes detail the industry- or company-specific activities that are needed to perform Level 3 processes.

Level 1, 2, 3 Metrics Understanding the three levels of SCOR process details will help you understand how each level cascades down to the next, which

contains more details and more specific measures. Exhibit 2-38 shows the SCOR levels, the application for each, and some examples. Exhibit 2-38: Levels of Process Detail in SCOR Level

Application

Examples

1

Level 1 processes describe the scope and high-level configuration of a supply chain. SCOR has six Level 1 processes.

Plan, source, make, deliver, return, enable

2

Level 2 processes differentiate strategies of the Level 1 processes. Both the Level 2 processes themselves as well as their positioning in the supply chain determine the supply chain strategy.

“Make” Level 2 processes: Make-to-stock Make-to-order Engineer-to-order

3

Level 3 processes describe the steps performed to execute the Level 2 processes. The sequence in which these processes are executed influences the performance of the Level 2 processes and the overall supply chain.

“Make-to-order” Level 3 processes: Schedule production activities Issue sourced/inprocess product Produce and test Package Stage finished product Dispose waste Release finished product

Level 4

Application SCOR does not detail Level 4 processes because they are industryspecific. Organizations and industries develop their own Level 4 processes (standard process descriptions of activities within Level 3 processes).

Examples

“Issue product” Level 4 processes for the electronics industry might include: Print pick list Pick items (bin) Deliver bin to production cell Return empty bins to pick area Close pick order.

Source: Adapted from Supply Chain Operations Reference (SCOR®) Model, Overview

If you would like more information on the SCOR Digital Standard or its levels, links to a quick reference pamphlet and to an inexpensive SCOR application are available online in the Resource Center.

Level 1 SCOR Metrics Level 1 strategic metrics help an organization measure its success in achieving its market positioning goals relative to the competition. Here are the Level 1 metrics grouped by performance attribute: Supply chain reliability Perfect order fulfillment

Supply chain responsiveness Order fulfillment cycle time Supply chain agility Upside supply chain adaptability Downside supply chain adaptability Overall value at risk Supply chain cost (financial metric) Total supply chain management cost Cost of goods sold (COGS) Supply chain asset management Cash-to-cash cycle time Return on fixed assets Return on working capital All supply chain processes (plan, source, make, deliver, return, and enable) are directly or indirectly tied to Level 1 metrics. However, the Level 1 metrics that are needed may differ depending on the operating environment. For example, for the source metrics, under reliability, perfect order fulfillment is a metric for make-to-order and engineer-to-order but not for make-to-stock. We will go through the metrics for each performance attribute next.

Supply Chain Reliability The only Level 1 measure of supply chain reliability is perfect order fulfillment. The APICS Dictionary, 16th edition, defines perfect order fulfillment as “a measure of an organization's ability to deliver a perfect order.” The Dictionary defines a perfect order as follows: 1) An order in which the “seven R’s” are satisfied: the right product, the right quantity, the right condition, the right place, the right time, the right customer, the right cost. 2) A fulfillment metric used measure order proficiency, which meets the following criteria: on time, complete, accurate and undamaged. In short, it is the percentage of orders meeting delivery performance with complete and accurate documentation and no delivery damage or defects. Components of a perfect order include all items and quantities, so any late items or any items delivered in the wrong amount would violate the requirements of a perfect order. The definition of “on time” has to come from the customer. Documentation includes all packing slips, bills of lading, invoices, etc. A perfect order must satisfy all of the following conditions: A product is considered perfect if the product ordered is the product provided.

A quantity is considered perfect if the product ordered is provided in the ordered quantity. A delivery is considered perfect if the location and delivery time ordered are met upon receipt. A customer order is considered perfect if the product is delivered to the specified entity. Documentation supporting the order is considered perfect if it is all accurate, complete, and on time. The product condition is considered perfect if the product is delivered and faultlessly installed (as applicable) according to specifications with no damage, is customer-ready, and is accepted by the customer. The calculation for perfect order fulfillment is as follows:

Supply Chain Responsiveness The order fulfillment cycle time metric is the only Level 1 measure of supply chain responsiveness. The Dictionary defines order fulfillment cycle time (order fulfillment lead time or customer order cycle time) as follows: The average amount of time between the customer’s order until the customer receives delivery; this includes every

manufacturing or processing step in between. Since it is an average, cycle time for individual orders may vary. For each individual order, this cycle time starts with the order receipt and ends with customer acceptance of the order. The order fulfillment cycle time is calculated as follows:

Order fulfillment process time approximates order fulfillment lead time (the minimum amount of time to fulfill a customer order in the absence of inventory). Dwell time is the amount of time an order spends waiting to move from one stage of processing to another stage. The formula for calculating average actual cycle time for a group of orders is the following:

Supply Chain Agility Agility in the supply chain is its ability to respond to market changes and remain competitive. Agility is measured using three Level 1 metrics: upside supply chain adaptability, downside supply chain adaptability, and overall value at risk.

Upside Supply Chain Adaptability The Dictionary defines upside supply chain adaptability as “a discrete measurement of the quantity of increased production a supply chain can achieve and sustain in 30 days-time.” In other words, if unexpected orders come in with the requirement that they be filled within 30 days, what total amount of new product can the organization produce in that time? The calculation of upside supply chain adaptability determines the largest sustainable quantity increase that can be achieved when considering source, make, and deliver components. Downside Supply Chain Adaptability The Dictionary defines downside supply chain adaptability as “a discrete measurement of the reduction in quantities ordered sustainable at 30 days prior to delivery with no inventory or cost penalties.” In other words, how much of a reduction in quantities can the company sustain given 30 days? The calculation for downside supply chain adaptability determines the least reduction sustainable when considering source, make, deliver, and return components. Overall Value at Risk (VaR)

Another Level 1 metric that measures supply chain agility is based on value at risk (VaR), which can be used in the supply chain to evaluate the different aspects of risk. Suppliers can be evaluated based upon the VaR of performance measures. Customers can be measured based upon performance measures (profitability, volume growth, returns, and complaints) as well as products (warranty claims, etc.). VaR can also be applied to internal supply chain entities such as manufacturing, distribution, or sales locations. Each VaR calculation uses historical data for a specific event, such as on-time delivery, to calculate the number of times the event performed below target expectations times the amount below the target. The Dictionary defines overall value at risk (VaR) as “the sum of the probability of risk events times the monetary impact of the events which can impact any core supply chain functions (e.g. Plan, Source, Make, Deliver and Return) or key dependencies.” The overall value at risk calculation is simply the sum of the supply chain’s VaRs (Plan + Source + Make + Deliver + Return).

Supply Chain Cost (Financial Metrics) The financial metrics for a supply chain can be complex. The financial measures that the CFO of a large company focuses on may

be different than those that are pivotal to supply chain managers. There are two metrics at Level 1 for measuring the costs of operating the supply chain: total supply chain management cost (TSCMC) and cost of goods sold (COGS). Total Supply Chain Management Cost The total supply chain management cost is calculated as the sum of the costs associated with the SCOR Level 2 processes to plan, source, deliver, and return. The official calculation for total supply chain management cost is to combine the Level 2 costs including mitigation.

As you can see in this formula, the SCOR framework also includes cost calculations for the cost to plan, the cost to source, the cost to make, the cost to deliver and/or install, the cost to return, and mitigation cost. However, since these calculations are Level 2 calculations, a summary calculation that can be used for Level 1 TSCMC is:

Note that the cost to serve is the more difficult part of this second calculation, as a number of different expenses can be included. Though collecting these data is commonplace, assigning these

expenses to the core processes of the organization and transforming them into calculated costs is a challenging task. Cost of raw material and make costs are generally accounted for in cost of goods sold. It is recognized that there is likely to be overlap or redundancy between supply chain management costs and COGS. A similar concept, total cost to serve, includes the costs of the SCOR make process and is defined in the Dictionary as the sum of the supply chain cost to deliver products and services to customers. Includes the cost to plan the supply chain; source materials, products, goods, merchandize and services; produce, manufacture, remanufacture, refurbish, repair and maintain goods and services; manage orders, customer inquiries and returns; and deliver products and services at the agreed location (point of revenue). Comprises both direct cost and indirect cost. Other costs to consider are direct material cost, direct labor cost, and indirect cost related to production. Cost of Goods Sold (COGS) The Dictionary defines cost of goods sold (COGS) as “an accounting classification useful for determining the amount of direct materials, direct labor, and allocated overhead associated with the products sold during a given period of time.” COGS is a financial

accounting measurement of the cost associated with buying raw materials and producing finished goods. The cost of raw materials and the cost to make in the SCOR model are generally included in this calculation. The formula includes direct costs (labor, materials) and indirect costs (overhead). The calculation for COGS is

SCOR states that direct material costs include the purchased materials cost at their purchase price net of any discounts. (Purchased materials cost may equal the landed cost if the price includes the cost to deliver, such as if a freight-and-duties-paid method of billing is used.) SCOR includes the following costs in direct labor: wages, income taxes at all levels, and employer contributions to health insurance, social security, and retirement plans. Overhead is not well defined globally, but SCOR's definition includes product automation costs (software and hardware acquisition, depreciation, and disposition, licensing fees, cost of maintenance contracts, and cost of internal maintenance and support); property, plant, and equipment cost (leases, rents, acquisition, depreciation, maintenance labor and parts, and disposal); and governance, risk management, compliance, inventory, and other overhead costs (e.g., human resources, legal, quality, office supplies, and process improvements).

Supply Chain Asset Management Metrics related to the supply chain’s effective use of resources, including fixed and working capital, are the cash-to-cash cycle time, return on fixed assets, and return on working capital. Cash-to-Cash Cycle Time Cash-to-cash cycle time is defined as the time it takes for an investment to flow back into a company after it has been spent for raw materials. It is a continuous measure of how many days the organization’s working capital is invested in managing the supply chain. The data needed to calculate cash-to-cash cycle time (average inventory, accounts receivable, and accounts payable) can be found on the balance sheet (statement of financial position). Cash-to-cash cycle time is calculated as follows:

Each of the items used in this calculation can be determined as follows:

The Dictionary has some relevant definitions: Days’ outstanding . A term used to imply the amount of an asset or liability measured in days of sales. For example, accounts payable days are the typical number of days that a firm delays payments of invoices to its suppliers. Days’ sales outstanding .A measure of the average number of days that a company takes to collect revenue after a sale has been made calculated by the total accounts receivable/average daily sales rate. [Also called accounts receivable days.] Days of supply . 1) Inventory-on-hand metric converted from units to how long the units will last. For example, if there are 2,000 units on hand and the company is using 200 per day, then there are 10 days of supply. 2) A financial measure of the value of all inventory in the supply chain/the average daily cost of goods sold rate. Cash is tied up in the system by the difference between amounts owed to the organization and amounts still owed to others plus inventory. Reducing inventory will directly reduce the cash-to-cash cycle time, thus increasing cash flow.

For example, if a supply chain has 60 inventory days of supply, 40 days of sales outstanding, and 45 days of payables, its cash-to-cash cycle time is 55 days.

The three elements of the cash-to-cash cycle reflect the impact of supply chain management on the company’s cash position. Negative indicators include high levels of inventory, high days of sales (receivables) outstanding (it’s taking a long time to get paid), or low levels of payables (the company is not benefiting from keeping money invested as long as possible before making payments). If unnecessarily high inventory levels are the problem, the company can reduce the cycle time by improved forecasting and Just-in-Time (JIT) initiatives to reduce inventory (consistent with avoiding stockouts). Cash-to-cash cycle time is considered to be an important indicator of a company’s health. The faster the cycle, the healthier the company. A fast cycle indicates effective management of cash flow to maximize the use of the cash and to reduce working capital requirements.

However, what is considered a normal duration for the cash-to-cash cycle time will differ by supply chain, industry, and organizational strategy. Even within a given industry, one organization may have owned less of its inventory than another due to heavier use of strategies such as vendor-managed inventory (VMI) or consignment. VMI helps to lower the inventory in the pipeline by sharing information between the links in the supply chain. Consignment stock postpones the handoff of ownership. Similarly, an organization that is vertically integrated will own its inventory for much longer than one in a horizontal supply chain. Therefore, it is not necessarily possible to compare cycle times without understanding the relevant strategies for each business. An organization’s cycle time can always be a benchmark for its own continuous improvement. One advantage of using this metric is that it can be easily benchmarked to information found in public financial statements such as those of a competitor. Note that while cash-to-cash cycle time can be calculated using historical data, a preferred method for supply chain management is to base the inventory portion of the calculation on more current data such as dividing the current inventory level by average daily demand. Return on Supply Chain Fixed Assets

The APICS Dictionary, 16th edition, defines return on supply chain fixed assets as “the return an organization receives on its invested capital in supply chain fixed assets. This includes the fixed assets used to Plan, Source, Make, Deliver and Return.” Fixed assets include property, plant, and equipment. Return on supply chain fixed assets is calculated as follows:

For example, if supply chain revenue is US$1,000,000, cost of goods sold is US$700,000, supply chain management costs are US$150,000, and supply chain fixed assets cost US$600,000, then the return on fixed assets is 25 percent.

Return on Working Capital Another metric used to measure supply chain asset management is return on working capital. The Dictionary defines return on working capital as “a measure of profit on the amount of cash consumed calculated as after-tax operating income/net working capital.” Return on working capital assesses the magnitude of an investment relative to a company’s working capital position versus the revenue

generated from a supply chain. Components include accounts receivable (A/R), accounts payable (A/P), inventory, supply chain revenue, cost of goods sold, and supply chain management costs. The calculation for return on working capital is as follows:

Digital Capabilities Model for Supply Networks The Digital Capabilities Model for Supply Networks is a joint development of ASCM and Deloitte. It is designed to work with the SCOR Digital Standard to help organizations increase their supply chain maturity level to that of an orchestrated supply chain. This includes breaking down organizational silos more, reducing buffer inventories and safety stocks by providing end-to-end visibility, and better management of the bullwhip effect. The model defines capabilities as “the synergistic combination of people, processes, and technologies that creates sustained business value.” Here is a brief overview of each of the capabilities: Connected customer. This is about creating a seamless customer experience throughout the customer life cycle, which

ranges from inspiration at the beginning of the model to service at the end of the model. Product development. This is about optimizing product life cycle management using proactive planning and emerging technologies. Synchronized planning. This is about making planning significantly more efficient by leveraging human and process capabilities like information sharing. Intelligent supply. This is about leveraging emerging technologies to reduce costs. Smart operations. This is about bringing operations into the digital transformation by increasing connectivity, agility, and proactivity. Dynamic fulfillment. This is about providing speed and agility to order fulfillment to increase customer service. This model integrates well with the SCOR Digital Standard. SCOR’s enable process links to all of these capabilities (and it is the only SCOR process that maps to connected customer and product development). Plan maps to synchronized planning, source maps to intelligent supply, make maps to smart operations, and both deliver and return map to dynamic fulfillment.

Rather than focusing on the linear relationships of a traditional supply chain, the capabilities in this model are presented as a network. This shows how the capabilities are interrelated and how a digitized supply chain no longer needs to be linear in every case but could use various enabling processes (including emerging technologies) to skip some processes or do them in a different order. For example, 3D printing can skip the source process or sensordriven replenishment can directly feed data into the plan process. Organizations should prioritize various capabilities as needed to fit their strategy or to address gaps. Like the SCOR Digital Standard, the Digital Capabilities Model contains more than one level. At the top level are the capabilities. At the second level, there are subsets of these capabilities that help clarify the top level capability and how to use the capability to differentiate the organization from less mature traditional supply chains. For example, connected customer has seven supporting capabilities: product as a service (PAAS), connected field services, self-service, customized experience, customer issue management, intelligent product tracking, and monitoring and insights.

Topic 2: Financial and Operational Metrics and Reports

Financial and operational metrics and reports are prepared by specialists in these areas, but supply chain managers need to have an understanding of them. Here we address cost accounting and financial statements as well as financial and operational metrics. Cost accounting addresses core production costs; financial statement analysis covers these and other organizational costs. Being able to interpret organizational accounting and financial reporting information can help supply chain managers develop an understanding of the current state of the organization’s finances. It is also vital to sell the financial impact of improvements. Operational metrics address quality, productivity, and asset management.

Cost Accounting According to the APICS Dictionary, 16th edition, cost accounting is the branch of accounting that is concerned with recording and reporting business operating costs. It includes the reporting of costs by departments, activities, and products. A term related to cost accounting is management accounting. Cost accounting is used to calculate the costs that will be reported on the organization’s external financial statements and to tax authorities; management accounting is used for internal management decision making and doesn’t need to conform to external reporting or tax

accounting rules. While cost accounting is backward- or historicallooking, management accounting is forward-looking (budgets and forecasts). A basic understanding of how costs are managed internally by the organization can help supply chain managers determine a complementary cost structure for the supply chain. One common method of cost accounting is standard costing.

Standard Costing According to the Dictionary, standard costs are the target costs of an operation, process, or product including direct material, direct labor, and overhead charges. The Dictionary defines a standard cost accounting system , or standard costing, as a cost accounting system that uses cost units determined before production for estimating the cost of an order or product. For management control purposes, the standards are compared to actual costs, and variances are computed. Standards are targets that the organization sets to show the expected or desired outcome of an activity. These are periodically

reviewed and changed as needed. To understand standard costing, some additional terms from the Dictionary should also be reviewed or introduced. Cost of goods sold (COGS) : An accounting classification useful for determining the amount of direct materials, direct labor, and allocated overhead associated with the products sold during a given period of time. Current price : The price currently being paid as opposed to standard cost. (A related term is market price, which is the going price for an item on the open market.) Usage variance : Deviation of the actual consumption of materials as compared to the standard. Cost variance : In cost accounting, the difference between what has been budgeted for an activity and what it actually costs. Standards are set for each of the elements of the cost of goods sold. Each cost has two components that are set as standards: volume and rate.

Volume is how many units of a resource are purchased or used, and rate is the cost per unit of that resource. When volume has variances from the standard, it is a usage variance; when the rate has variances, it is a cost variance. Both variances are tracked separately, and their sum should equal the total variance. Variances can be positive or negative. Negative variances occur when costs are greater than expected; positive variances occur when costs are less than expected. Note that the quantity of materials for an operation has standards both for what should be purchased and what should be used, since these quantities may differ due to factors such as scrap in an operation or quantities for bulk discounts. Note also that overhead costs are allocated based on a cost driver. A cost driver is simply a measurable aspect of an operation that is used to approximate how much of the overhead should be associated with the units produced. The rate is the total expected overhead for the period divided by the total of the expected cost

driver for all operations at that site for the period. A frequently used cost driver is direct labor hours. For example, during a given period An operation to make 30,000 units is expected to use 1,500 direct labor hours. All operations in the plant are expected to use 15,000 direct labor hours. Total overhead costs for the plant are expected to be US$300,000. The overhead rate is US$300,000/15,000 hours = US$20/direct labor hour. The standard overhead cost for the 30,000-unit operation is 1,500 hours x US$20/hour = US$30,000 (one-tenth of the total overhead cost). The following shows the variance calculation for actual results: Actual overhead cost for 30,000-unit order: 1,300 hours x US$21/hour (a rate determined only at the end of the period) = US$27,300. Variance: US$30,000 − US$27,300 = US$2,700 positive overall variance (less cost than expected), made up of a large positive variance from lower labor hours than expected and a smaller negative variance (higher cost than expected) from the higher actual overhead rate.

Standard costs and variances for direct materials and direct labor would be similarly calculated and accounted for, except that the actual costs may be known during or before production. Standard costing is used to estimate the cost of goods sold before all costs are known with certainty. It also provides benchmark targets for use during production. Thus it is a method of controlling a process during production rather than only being applied by accounting after production is complete. When variances are detected as they occur, process controls can sometimes keep negative variances from continuing to expand or can prevent the problems from recurring in a later operation. Management and accounting should exercise a high level of control over variances, because this is the key to avoiding period-end surprises that impact financial results. Note, however, that variances can occur simply because standard costs need to be revised. Depending on how quickly material, labor, and overhead prices are changing, organizations may need to revise their standard costs annually, quarterly, or even monthly. Many of the concepts discussed in these modules make use of standard costing. Inventory can be valued using standard costing. (Although other methods also exist.)

If standard costing is used at an organization, efficiency can be calculated using a formula:

For example, a work center that produces 110 standard hours of work while operating for only 100 hours has an efficiency rate of 110 percent. This is where supply chain management comes into play. It is used to bring a synergy for all the entities in the supply chain and to enable them to operate and produce more efficiently, whether this means optimizing production, storage, or movement capacity. The effectiveness and efficiency of supply chain management are partly measured by its contribution to the bottom line, and financial statement analysis can provide this information.

Analysis of Financial Statements Financial statements help managers and investors track the financial results of an organization’s activities. Whenever you are discussing supply chain financials, remember that each department in an organization has its own particular priorities based on its activities, and those priorities may compete with each other. For instance, the primary objective of marketing is to maintain and boost revenue, and it strives toward that by providing great

customer service. Although the finance function is also interested in increasing revenues, its primary focus is on keeping costs and investment expenses low. Production wants the lowest operating costs it can achieve. Those conflicting viewpoints may spill over into how each function views financial documents and metrics.

Accounting Standards Accounting standards are an important factor in creating financial statements. While supply chain managers do not need to know the details of these standards, a brief overview will help in understanding how doing business in multiple areas with conflicting accounting standards will increase costs due to multiple reporting requirements. The majority of the world uses one set of financial accounting standards, the International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board (IASB). A few countries permit rather than require use of these standards, and a few others, including the U.S., use country-specific standards. International Financial Reporting Standards The Dictionary defines the International Financial Reporting Standards (IFRS) as follows: A common global language for business affairs so that company accounts are understandable and comparable

across international boundaries. As a result of growing international shareholding and trade, they are rules to be followed by accountants to maintain books of accounts which [are] comparable, understandable, reliable, and relevant as per the users internal or external. As of 2018, 144 of the 166 jurisdictions in the world (i.e., these are countries for the most part) had fully adopted IFRS for all or most of their domestic publicly accountable organizations, and others were in the process of doing so. Some countries require IFRS for financial institutions but not listed companies, and others (12 jurisdictions) permit rather than require it. IFRS is a principles-based accounting system, meaning that it presents simple accounting and disclosure requirements and expects organizations to live up to the principle being set down rather than presenting more detailed rules. The argument in favor of principles-based accounting is that promulgating rules provides an incentive to find loopholes and exceptions and workarounds, while principles do not provide this incentive. The organization and regulators can assess whether the entity is operating within the spirit of the principle or not. However, ethics violations have occurred under IFRS. IFRS and the U.S. system—U.S. GAAP—both allow businesses to organize as proprietorships, partnerships, and corporations, but the

most advantageous business form may differ by country, not only due to differences in the country’s required accounting rules but also to other country-specific legal and tax differences. The IFRS financial statements include the following. Since IFRS financial statements are very similar to U.S. GAAP financial statements, naming differences are called out in parentheses. A statement of financial position at the end of the period. (This is similar to the balance sheet presented in Exhibit 2-39.) A statement of comprehensive income for the period. (This is similar to the income statement presented in Exhibit 2-40.) A statement of changes in equity for the period. (This is similar to a U.S. GAAP statement of retained earnings, which is not presented in these materials.) This statement breaks down changes in equity, including shares purchased, held, or sold. A statement of cash flows for the period. (This is similar to the statement of cash flows shown in Exhibit 2-41.) Notes and explanations of significant accounting policies and so on. (U.S. GAAP also requires notes such as these.) A revised statement of financial position as soon as possible if there have been significant changes in accounting policy. (U.S. GAAP has this same revision policy.)

IFRS statements report on assets and liabilities, equity, income (called revenue in U.S. GAAP), and expenses using simple principlebased definitions. (By contrast, U.S. GAAP uses rules-based definitions that are slightly more complex and legalistic.) Here are the IFRS definitions of the major financial statement components: Assets. A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liabilities. A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Equity. A residual interest in the assets of the entity after deducting all its liabilities. Income. Increases in economic benefits that result in increases in equity (other than those related to contributions from shareholders). Income includes both revenues (resulting from ordinary activities) and gains. Expenses. Decreases in economic benefits that result in decreases in equity (other than those related to distributions to shareholders). Expenses include losses that are not the result of ordinary activities. Country-Specific Accounting Regulations

A number of countries, including the U.S., use country-specific accounting regulations. As noted above, the U.S. generally accepted accounting principles (U.S. GAAP) use rules-based accounting, meaning that the standards for accounting are detailed and specific. The intent is to ensure that all of the details are addressed. However, a drawback to this system is that organizations can operate within the rules while still finding loopholes to exploit, which can mean that organizations might be less transparent than the rules intend. Like the IFRS system, rules-based accounting has had its share of accounting scandals. While the broad strokes of IFRS and U.S. GAAP are very similar, there are numerous small differences in what is allowed and what is not allowed in accounting. For example, under U.S. GAAP a disaster at a plant that is not expected to recur may be classified as an extraordinary item, which means that gains or losses from the event are not classified as part of normal operating revenue or expenses. Under IFRS all income and expense is considered ordinary; there is no such thing as an extraordinary item. The effect of significant unusual events would be handled as part of disclosures in the notes. The U.S. GAAP financial statements (primarily the balance sheet, the income statement, and the statement of cash flows) are very

similar to the IFRS financial statements. The statements have different but complementary functions. Supply chain managers need to understand that doing business in multiple areas with conflicting global and country-specific accounting standards will increase administrative costs due to the need to use multiple reporting methods and comply with any related transparency and disclosure rules and regulations. However, these costs are decreasing. Most of the countries that do not use IFRS or only partially adopt it are working toward convergence of their standards with the international standards. In addition, the need to reconcile international standards with country-specific standards (i.e., produce two sets of statements) is lessening. For example, the U.S. no longer requires foreign companies that trade shares in the U.S. to reconcile their accounting with U.S. GAAP. Next, we’ll take a closer look at each of the U.S. GAAP financial statements, define some key terms, and discuss some key relationships among the elements of the statements.

Balance Sheet The APICS Dictionary, 16th edition, defines the balance sheet , or statement of financial position, as “a financial statement showing the resources owned, the debts owed, and the owners’ share of a

company at a given point in time.” The balance sheet is often called a “snapshot” of the company’s financial position, because it is a static view of financial value or net worth at a point in time, usually the last day of the fiscal or calendar year, though it could also be for the end of any reporting period, such as a month or quarter. It gets its name from the fact that it has two major sections that have to be in balance—assets on the one hand and liabilities and owners’ equity on the other. The accounting equation defines this balance; it states that

The balance sheet sections are always in balance because owners’ equity is simply the difference between assets and liabilities. An organization uses investments from owners (e.g., shareholders) and amounts owed to others (e.g., bank debt) to acquire assets that are expected to generate a return greater than the amount invested. Owners’ equity can increase or decrease if the organization generates a positive or negative return. The balance sheet shows the increases or decreases in assets, liabilities, and owners’ equity from year to year. Exhibit 2-39 shows a sample balance sheet for a publicly traded company.

Exhibit 2-39: Sample Balance Sheet Showing Two Years of Results

One purpose of the balance sheet is to show whether the organization has increased or decreased its owners’ equity during the year. This is done by comparing the current year’s amounts to the amounts in prior years. Note that in Exhibit 2-39, the size of the owners’ equity has increased in Year 2 from Year 1, based primarily on profits that were reinvested (retained earnings) and to a lesser degree on new owner investments (common stock and additional paid-in capital).

The value of inventory as presented on the balance sheet may not match the value of inventory used by supply chain managers for internal control purposes. This is because there are a number of ways accounting rules may allow for inventory to be presented for purposes of external financial reporting. The Dictionary defines inventory valuation as the value of the inventory at either its cost or its market value. Because inventory value can change with time, some recognition is taken of the age distribution of inventory. Therefore, the cost value of inventory is usually computed on a FIFO basis, LIFO basis, or a standard cost basis to establish the cost of goods sold FIFO stands for first in, first out, while LIFO stands for last in, first out, and each refer to whether the oldest inventory purchased is considered to be sold first when a sale is made or whether the newest inventory is sold first. Another method for inventory valuation is average costing, where the costs for all items are summed and averaged. Once an inventory valuation method is chosen, the organization should keep it the same for a number of years so that stakeholders can compare the results of different time periods. The accounting method chosen may have nothing to do with actual inventory movement policy.

Note that IFRS bans the use of LIFO. Inventory on the balance sheet and property on the income statement can be impacted by obsolescence. According to the Dictionary, obsolescence is 1) The condition of being out of date. A loss of value occasioned by new developments that place the older property at a competitive disadvantage. A factor in depreciation. 2) A decrease in the value of an asset brought about by the development of new and more economical methods, processes, or machinery. 3) The loss of usefulness or worth of a product or facility as a result of the appearance of better or more economical products, methods, or facilities. When inventory is obsolete, it must be sold at a discount or written off and removed from the financial statements. As plants and equipment become obsolete over time, they are depreciated, as will be discussed below. The balance sheet can also be used as a source for a number of financial measurements used in part to measure the success of supply chain activities. For example, the balance sheet lists accounts receivable and accounts payable. According to the Dictionary, accounts receivable are

the value of goods shipped or services rendered to a customer on which payment has not yet been received. Usually includes an allowance for bad debts. Accounts payable are “the value of goods and services acquired for which payment has not yet been made.” These two balance sheet amounts are used to calculate the cash-tocash cycle time, which measures how many days the organization’s working capital is invested in managing the supply chain. Net working capital is “the current assets of a firm minus its current liabilities.” Working capital is important to the supply chain because these are the funds the organization has readily available to invest in normal operations.

Income Statement The APICS Dictionary, 16th edition, defines the income statement , or statement of comprehensive income under IFRS terminology, as “a financial statement showing the net income for a business over a given period of time.” In contrast to the balance sheet, the income statement is cumulative and dynamic, meaning that the statement covers business results over a period of time, such as a quarter or a year, rather than being a static snapshot. The income statement shows managers, investors,

and creditors whether the company has made or lost money during the given period of time. The basic equation for the income statement is:

Here are key terms to be familiar with, all of which can be impacted by the effectiveness and efficiency of a supply chain: Profit is money remaining from revenues after deduction of certain expenses. The profit margin , which measures the degree of financial success for a business, is “the difference between the sales and cost of goods sold…sometimes expressed as a percentage of sales” (Dictionary). The gross margin measures “the difference between total revenue and the cost of goods sold” (Dictionary). It is also called the gross profit margin. Net profit is figured by deducting all expenses, not only the cost of goods sold, from revenues. Exhibit 2-40 shows a sample income statement, with some explanations in the margin.

Exhibit 2-40: Sample Income Statement Showing Two Years of Results

Supply chain managers can use an income statement to determine the effect of supply chain expenses on net income. For example, for a manufacturing organization, the direct materials expenses listed in the statement would consist primarily of raw material expenses, so reducing this type of inventory would reduce overall expenses, directly increase profits, and likely increase owners’ equity on the balance sheet. Note that operating expenses such as sales bonuses or general and administrative expenses (all costs that cannot be linked to specific

units sold) are called period costs because they must be expensed in the period in which they are incurred. COGS are called product costs. Product costs are accounted for in the period in which the units are sold even though many of these costs may be incurred in earlier periods. A final concept of importance to the income statement is matching. Matching refers to reporting related revenues and expenses together in the period in which they were incurred. For example, sales expenses incurred to make a sale should fall in the period in which the sale was made. When they do not, accountants use adjustments called accruals to account for the period differences. Note the text “The ‘bottom line’ ” near the bottom in the exhibit. This refers to the line at the bottom of the income statement that shows a net profit or loss. Note also that the economic perspective of the triple bottom line is a reference to this financial bottom line.

Statement of Cash Flows The APICS Dictionary, 16th edition, defines the statement of cash flows (funds flow statement) as “a financial statement showing the flow of cash and its timing into and out of an organization or project.” The statement of cash flows shows the sources of a company’s cash flows and how these cash flows are used over a given period of time.

Within a cash flow statement, there are three sections of cash flows: operating, investing, and financing. According to the Dictionary, cash flow is The net flow of dollars into or out of the proposed project [organization]. [It is] the algebraic sum, in any time period, of all cash receipts, expenses, and investments. There are three factors that determine cash flows: sales, after-tax operating profit margins, and capital requirements. Some organizations consider cash flow to be a better long-term indicator of financial health than net income. The purpose of a statement of cash flows is to show lenders, investors, and creditors whether the organization has sufficient cash to pay debts, bills, and dividends to owners, because cash, not net income, is needed to make these payments. The after-tax net income on the income statement is not the same as cash flow, but it is the starting point for the statement of cash flows (under the most popular method for preparation, the indirect method). The statement adjusts this amount by increases or decreases in certain accounts to show whether the cash balance has increased or decreased in the period.

Being able to read and understand a cash flow statement is important: In order to keep the cash flow turning over, the supply chain professional must efficiently manage the company’s inventory level and cost while maintaining and improving customer satisfaction. The cash flow statement shows if the company is generating enough cash to fulfill its minimum obligations to lenders, investors, and governments (taxes). Generating extra cash can be used to repay debt, purchase additional assets for growth, or invest in new products. This information is particularly helpful for financial managers, who use it along with a cash budget when forecasting their organization’s cash positions. Exhibit 2-41 shows a sample statement of cash flows using the indirect method.

Exhibit 2-41: Sample Statement of Cash Flows Showing Two Years of Results

Note the depreciation amount that is added back on the statement of cash flows. Depreciation is a predetermined incremental reduction in the value of fixed assets, such as property, plant, and equipment, on the income statement to account for their deterioration over time. This provides organizations with a tax benefit to offset the investment in fixed assets. However, while depreciation is calculated and expensed on the income statement as the cost of using an asset over its life, this cost is a noncash charge (i.e., no one is paid). Since depreciation reduces net income on the income statement but

doesn’t reduce actual cash levels, depreciation is added back on the statement of cash flows to determine the actual cash flow.

Financial Metrics Financial metrics are often assembled by finance professionals, but supply chain managers need to know how to interpret these metrics. Financial metrics for the supply chain include profit, cost, supply chain cost, the speed of converting orders to into cash, supplier bankruptcy risk, and customer credit.

Profit Metrics Supply chain management cost reduction and efficiency efforts are a powerful lever that can improve organizational profitability with more impact even than increasing sales. (Sales also increase the cost of goods sold and other variable costs, while cost reductions directly increase profits.) Therefore many supply chain functions measure and report on their contributions to profitability. This can be broken down into segments for further analysis, such as customer segment profitability or direct product profitability. Furthermore, individual product families or products can be assessed for their profitability using contribution margin analysis (sales minus variable costs) to show how well the product contributes to profit.

Cost Metrics There are a number of ways to measure the cost of an organization’s supply chain function. Cost areas include order processing, inventory, transportation, warehousing and materials handling, and facility network integration. Here are some ways of breaking down the organization’s costs: Total landed cost (or total cost) Cost per major supply chain function (e.g., order processing) Cost per detailed supply chain function (e.g., order picking, loading) Cost per unit Cost as a percentage of net sales Inbound freight cost Warehouse order processing cost Inventory carrying cost Administrative costs Direct labor costs Outbound freight cost Damage cost Return cost Service failure cost Backorder cost

In addition to cost breakdowns, supply chain managers can analyze cost trends and variances from budget. Trends analyze changes in cost over time and can be graphed to make a trend easier to project forward. Variances require some form of baseline or budget against which operational data can be compared. Variances can be in a favorable or unfavorable direction, so the direction and magnitude of the variances are tracked. Often organizations set a threshold for variances to indicate what level of minor variances are acceptable but beyond which a variance will require exception handling. Total costs for all of an organization’s supply chain functions may be challenging to collect, as this may involve multiple subsidiaries and business units as well as multiple information systems. Nevertheless, it is important to put the work in to achieve this level of data gathering so that analysis captures the big picture. In some cases cost metrics may be best served by also measuring number of orders, volume, or weight in addition to cost. This will help explain why certain activities consume more expense than others so that management control can be fine-tuned. Multiple-Organization Metrics Multi-organization metrics include supply chain total cost, which is an aggregation of the costs of all organizations that participate in a given supply chain. Supply chain total cost is illustrated in .

Exhibit 2-42: Supply Chain Total Cost

The purpose of developing methods of assessing the costs from end to end is to combat suboptimization. The APICS Dictionary, 16th edition, defines suboptimization in part as “a solution to a problem that is best from a narrow point of view but not from a higher or overall company point of view,” or in this case, not from an entire supply chain point of view. When one company attempts to shift costs to another supply chain participant, it is only a good move when the total supply chain cost is lower. If the total supply chain cost is higher, it ultimately means a higher price to the final end user, which reduces demand and provides more room for competitors to offer lower prices. The idea is to share the benefits of cost reductions fairly so that everyone benefits. Many of the metrics discussed in these materials can be used with data collected and aggregated from multiple supply chain partners. However, it is difficult enough to collect data for some of these metrics from just within one’s own organization. It is considerably more difficult to gather data from multiple organizations. In many cases the data will not be made available. For example, data on

costs may be considered secret. One way to improve data collection for the entire supply chain is to use a third party to collect all of the data. This third party can collect the data that are available, extrapolate other data, and then provide objective reports on the performance of the supply chain. Some additional ways to measure the entire supply chain follow: Measure total supply chain cost and total supply chain quality together to get a sense of value being delivered. Measure inventory days of supply. This is the total amount of inventory anywhere in the supply chain. It is used to show how shifting inventory to other parts of the supply chain just becomes a hidden cost. This can be extended to include raw material supplies. Measure dwell time. This is a measure of all inventory idle time in all parts of the supply chain. Idle inventory is nonproductive inventory for the most part, and shifting dwell time elsewhere is still a cost to all. Use fill rate and order-to-receipt response time (both are defined elsewhere) to measure overall delivery effectiveness. Measure on-shelf-in-stock percentage in addition to fill rates. Fill rates measure replenishment at warehouses and retail locations but do not provide assurance that goods are on the shelves at retail stores when the customer wants to buy them. Therefore,

also measuring the percentage of time goods are on the shelves is important for determining overall customer satisfaction. In addition, it is a good idea to assess how much formal collaboration and information sharing is going on in your supply chain versus how much work remains to be done.

Assessing Supplier Health Using Financial Statement Ratios The financial statements of publicly owned suppliers will be available for review. (Privately owned organizations are not required to publish financial statements, so the following techniques cannot be used unless such organizations voluntarily make the information available.) Information from financial statements can be used to develop financial ratios, which are basically one value divided by another to provide a one-number assessment of some part of the organization’s relative financial status. Your organization’s financial professionals can create a set of ratios for each publicly owned supplier in your supply chain (or private supplier who voluntarily publishes this data). You may need to interpret these ratios, at least in so far as to see when these ratios are improving or getting worse. There are four major groups of ratios that can be of use in determining an organization’s financial health:

Liquidity ratios. Liquidity ratios measure how quickly certain assets can be converted into cash or how easily the organization can meet its short-term financial obligations. These ratios should be increasing or remaining steady if already high enough. Example: Quick Ratio = (Current Assets − Inventories)/Current Liabilities

Activity ratios. Activity ratios measure effective use of assets. This can be total assets, current assets (excludes long-term assets), or inventory. These are called turnover ratios when they use sales divided by the type of asset. Turnover ratios should in general be increasing. Example: Inventory Turnover = Sales/Average Inventory If there was $100 in sales and $50 in inventory, then the ratio would be 2.0, and this would mean that inventory turned over twice in a year. Inventory days’ outstanding is another example. Example: Inventory Days’ Outstanding = 365/Inventory Turnover

This ratio counts how many days it takes to sell off all the inventory (e.g., 365/2 = 182.5 days,) and this type of ratio ideally should be decreasing. Leverage ratios. Leverage ratios measure how much debt is being used to finance the business and thus help to project whether it is likely to meet its debt payments. Various types of debt divided by equity are better when they are lower, from a supplier solvency point of view. Example: Current Debt to Equity = Current Liabilities/Equity However, the interest coverage ratio should be higher. (This is how well the organization’s earnings can cover its interest payments.) Profitability ratios. Profitability ratios measure various types of return on investment. All of these ratios are better when they are higher. Example: Net Profit Margin = Net Profit/Net Sales A 10 percent margin would mean that for every dollar earned, you get ten cents of profit. Financial analysts can also look at the supplier’s financial market values or growth over time to see if they are getting more valuable or

growing or the opposite. Obtaining financial statements in many parts of the world is very easy and straightforward. (They are typically available online.) Financial statements in some parts of the world may not be sufficiently regulated to be considered completely reliable. Another complication for suppliers that are owned by large holding companies is that splitting off the financial information for just one subsidiary may require significant effort. Alternate or supplemental sources of financial information may be needed. Bankruptcy Risk Metric: Altman Z-Score The Altman Z-score, or Z-score for short, is a combination of four or five weighted ratios developed by Dr. Edward Altman to measure bankruptcy risk. The resulting one-number score has a 90 percent accuracy in predicting bankruptcy one year into the future and 75 percent accuracy for two years out. Tracking this score on a quarterly basis can provide relatively current information on each supplier’s bankruptcy risk or financial stability. Organizations are rated using a red/yellow/green system. Suppliers with a score below the red threshold might not be selected or could be candidates for replacement. Suppliers in the yellow zone might be watched closely or given assistance. Suppliers above the green threshold are stable.

There are different Z-score formulas for public and private organizations. Public organizations use the following five-ratio formula:

Private organizations use the following four-ratio formula:

While you will not likely need to calculate this ratio yourself, take a look at what makes it up and note that the first four ratios are the same for both variants. Note also how the weightings (the hard numbers to multiply against each ratio) differ depending on whether it is a public or private organization. The higher the weighting, the more importance it has as a bankruptcy predictor. shows the relevant information for the supply chain manager: the cutoff scores for the red, yellow, and green categories. Note that these cutoff scores come from Schlegel and Trent in Supply Chain Risk Management: An Emerging Discipline and that other resources may use slightly different cutoff scores. Exhibit 2-43: Z-Score Cutoff Points

Public Organization

Private Organization

Red (supplier is at bankruptcy risk)

Less than 1.8

Less than 1.1

Yellow (monitor supplier carefully)

1.8 – 3.0

1.1 – 2.6

Green (supplier is fiscally sound)

Greater than 3.0 Greater than 2.6

Customer Creditworthiness The basic goal of monitoring customer creditworthiness is to ensure that invoices are paid on time (or at all). Customers who do not have a sufficiently high credit score might be denied trade credit (e.g., payment within 30 days or some other terms) and be asked to submit a wire transfer or other form of cash in advance. In addition to maintaining internal records, an organization’s credit department might use third-party credit ratings for organizational customers. For example, Dun & Bradstreet produces ratings of organizational creditworthiness, including recommended credit limits. Another example is the Coface Group’s Debtor Risk Assessment (DRA) score, which is a score from one to ten that is based on organizational history, ability to pay, and market factors.

Strategic Profit Model (Return on Assets Breakdown) One way to measure return on investment is to measure return on assets (ROA). ROA equals net profit margin multiplied by asset turnover. This is a ratio that shows how much in profits the organization’s assets generate. It is a good measure of profitability for supply chain managers, because they are responsible for managing a number of the assets that are counted in this metric as well as the expenses that make up the cost of goods sold. One way to break return on assets down into its components is the strategic profit model, which is shown in Exhibit 2-44 along with some sample data.

Exhibit 2-44: Strategic Profit Model with Sample Data

Moving from top to bottom, the exhibit shows first how to calculate ROA (0.143 or 14.3 percent in the example), then how to calculate these two base ratios, and then how to calculate some of the inputs. (Others are simply entered into the spreadsheet as input data.) Net profit margin is net profit divided by net sales, while asset turnover is net sales divided by total assets. Of these, net profit and total assets are broken down further. Net profit is gross profit less total expenses, while total assets is current assets plus fixed assets. Gross profit,

total expenses, and current assets are also calculated using the inputs shown. The benefit of looking at ROA in this way is that it shows there are multiple ways to increase ROA. Supply chain managers can see the areas where they can have influence. They can reduce inventory but will also see how ROA could drop if lack of inventory starts to hurt net sales. They might also reduce the cost of goods sold but again only to the point where net sales don’t cause ROA to fall (e.g., due to quality issues). Supply chain managers can also use this model to work with managers in other areas, such as helping sales managers expand from a view of just increasing sales volume to a holistic view of maximizing ROA. When the model is put into a spreadsheet, as in the exhibit, the additions and subtractions and divisions can be automated so that various scenarios can be explored. This might include reducing inventory, increasing sales, or reducing the cost of goods sold. However, these values usually affect one another. For example, reducing inventory would also reduce the inventory carrying cost, so this would reduce variable expenses by a certain amount. As stated before, it could also reduce net sales. These complexities could also be included in the model or calculated in a different way. Using the sample data in the prior exhibit, Exhibit 2-45 assumes that inventory

is reduced by US$40 and that, since there is an inventory carrying cost of 25 percent, there is also a reduction in variable costs of US$10 (0.25 × US$40 = US$10). However, there is a reduction in sales of 1 percent (or US$10).

Exhibit 2-45: Strategic Profit Model with Reduction in Inventory, Carrying Cost, and Net Sales

In this scenario, the ROA increases from 14.3 to 15.8 percent, even with the reduction in net sales. However, without that reduction, the ROA would have jumped to 18.4 percent. Conversely, a reduction in sales of about 1.59 percent or more (given this data) would result in

a net reduction in ROA. In such a case, the inventory reduction would have destroyed more value than it created. Analyses such as these can play out hypothetical scenarios or be used to study the impact of actual decisions after the results have come in.

Operational Metrics and Reports Operational metrics measure how well day-to-day operations are functioning. These metrics are important for management monitoring and control. Categories of operational metrics include quality, productivity, and asset management.

Quality Metrics Quality is an operational metric because it relates to accuracy, manufacturing goods to quality standards, avoidance of damage to goods at various stages, and so on. Some examples of quality metrics for the supply chain follow: Order entry accuracy Information availability (e.g., manufacturing status, customer order tracking) Information accuracy Number of manufacturing defects found by quality control (in total, per million units)

Number of manufacturing defects found by customers (in total, per million units) Picking and shipping accuracy Damage frequency in total or by functional area (e.g., warehouse, loading, transportation) Document and invoicing accuracy Number of returns and warranty issues Number of credit claims Accuracy metrics are reported as the number of times the activity was done correctly in relation to the total number of times it was done. Damage frequency by functional area can be hard to tabulate since the damage is often not reported until it reaches the customer. Supplier Quality Costs: Supplier Performance Index When a supplier has quality issues, these costs can be added to the cost of the materials purchased from the supplier to find the true cost of doing business with them. The supplier performance index is one metric that adds these costs together so that suppliers can be compared on a basis other than price. The formula for the supplier performance index is

Nonconformance includes rejected materials as well as delays and failures to provide accurate or complete information. Therefore, the organization could assign their costs of tracking down missing paperwork, the costs of late deliveries, and so on. An index value of 1.05 would mean that prices were actually 5 percent higher than stated when all of the problems are factored in. The way to compare suppliers using this index is to multiply the index value times the price per unit to find an adjusted price per unit for each supplier. However, it is best to compare like amounts of the same items when comparing suppliers so as to focus just on price and quality. Note that suppliers providing very different total material costs will have different index values. (Lower total costs increase the index value.)

Productivity Metrics The APICS Dictionary, 16th edition, defines productivity in part as an overall measure of the ability to produce a good or a service. It is the actual output of production compared to the actual input of resources. When measuring productivity, the key is to see whether resource inputs are being used as efficiently and effectively as possible by looking at the outputs. When inputs and outputs are measured precisely and routinely, these metrics can be automatically

generated. Some examples of productivity metrics for the supply chain are Labor productivity in total and by area (e.g., order entry, manufacturing, warehousing, transportation) Units shipped per employee Units shipped per labor dollar Orders per salesperson Equipment downtime. Productivity can measure variances from schedule and budget as well as variances from goals and stretch goals. Productivity can also be compared against historical or competitor benchmarks. Since labor expenses take up a major portion of an organization’s expenses, labor productivity metrics are critical to track by total expense, expense by area, by labor hours used, and by number of employees. Analysis by multiple factors can help show where productivity issues exist and where improvements goals can be set.

Asset Management Metrics Asset management metrics measure how well the organization is employing its substantial investment in operational assets. Inventory is an operational asset of primary concern to supply chain managers, and most asset management metrics have something to do with

inventory, but equipment and facility capacity are also of concern. Here are some common asset management metrics: Inventory turnover Inventory days of supply Absolute inventory levels Obsolete inventory Inventory by ABC analysis or other type of inventory classification Equipment capacity utilization (e.g., downtime for manufacturing equipment, materials-handling equipment, or vehicles) Manufacturing capacity utilization Warehouse capacity utilization In addition, some financial measurements can be used in asset management, such as return on equity. Inventory turnover is discussed more next, followed by a discussion of cash-to-cash cycle time, which is a financial metric but is discussed here to compare it to inventory turnover. Supplier capacity metrics are also addressed. Inventory Turnover The Dictionary defines inventory turnover (also called inventory turns) as follows: The number of times that an inventory cycles, or “turns over,” during the year. A frequently used method to compute inventory turnover is to divide the annual cost of

sales by the average inventory level. For example, an annual cost of sales of $21 million divided by an average inventory of $3 million means that inventory turned over seven times. Higher inventory turnover ratios are preferred and can result from increasing sales and/or decreasing average inventory. Increasing this ratio means that there is lower investment in inventory relative to sales volume, lower risk of obsolescence, and greater liquidity. A related term is inventory velocity , which is “the speed with which inventory passes through an organization or supply chain at a given point in time as measured by inventory turnover” (Dictionary). Inventory turnover is important because of the profit margin built into each product. Sales of manufactured products convert inventory and its associated costs into revenue. The profit margins directly add to cash (an asset) and increase owners’ equity on the balance sheet. Therefore, a major objective of supply chain management is to increase the speed at which inventory can be converted to cash. The appropriate level of this ratio depends on the organization’s industry. For example, in a French bakery, the turnover of baguettes is close to 365 times per year. Organizations in the slow-moving spare parts service industry average turnover of less than one to four times per year. Most manufacturing plants experience turnover of

between six and 26 times per year. It may be a useful question to ask yourself, “What is the turnover at my organization, and why?” Benchmarking inventory turnover against competitors or even internal targets can help establish the best target values for a given organization or supply chain. A generic inventory turnover ratio is:

Inventory turnover can be calculated using average inventory , which the Dictionary defines as one-half the average lot size plus the safety stock, when demand and lot sizes are expected to be relatively uniform over time. The average can be calculated as an average of several inventory observations taken over several historical time periods; for example, 12-month ending inventories may be averaged. When demand and lot sizes are not uniform, the stock level versus time can be graphed to determine the average. Average inventory can be calculated from the balance sheet if two or more years are shown, since the inventory at the beginning of the year is the same as that at the end of the prior year. Here is one way to calculate average inventory (listed in thousands):

Using more than two points in a year or other time period for an average inventory calculation may be even better, because it can remove the effects of seasonality. Different types of organizations may use variants on inventory turnover. A retail organization might use the following ratio:

Retailers favor measuring inventory value at selling price because it is the most accurate valuation for them. Manufacturers often use the following formula for inventory turnover:

Manufacturers use the cost of goods sold (COGS) because they produce the inventory using the materials and labor that make up COGS. They value inventory at cost for the same reasons. Annual cost of goods sold is listed on the income statement. Note that the definition of inventory turnover calls this cost of sales, but this is a synonym for COGS. The calculation for inventory turnover follows (using information from the financial statements).

This organization invests cash into inventory and gets it back 2.75 times per year. Sellers of commodities that might shift in value quickly often use units of product in both the numerator and denominator rather than relying on volatile sales prices:

Cash-to-Cash Cycle Time Cash-to-cash cycle time is a financial metric that is presented here to compare it to inventory turnover. Cash-to-cash cycle time is far more useful than the most basic form of inventory turnover that uses average inventory levels on two years of balance sheets to measure how well an organization is managing its saleable assets. Average inventory levels on balance sheets can be deceiving, because they are measured at two specific points in time, when some orders might be delivered yet still awaiting payment (e.g., trade credit) and suppliers may also be awaiting payment. Since cash tied up in inventory cannot be used for other purposes, the real question is how effectively is an organization using its cash?

Cash-to-cash cycle time answers this question because it accounts not only for days of supply of inventory but also the cash benefit of accounts payable and the cash delay of accounts receivable. Since cash-to-cash cycle time is also a SCOR metric, the formula is presented where SCOR is discussed. Supplier Capacity A rough estimate of supplier capacity can be calculated if the total sales of the given product are known for a recent period along with their capacity utilization percentage and their price per unit. This rough estimate calculation is as follows. (An example is also provided of sales of US$1 million for product X, a 97 percent capacity utilization, and US$5 per unit.)

This formula can be used when selecting a supplier by comparing the units available of various suppliers. Suppliers with more units available will be less at risk of being unable to fill an order promptly. Keep in mind that other buyers could still use up this available capacity or contracts could end, freeing up capacity, so it is just a

high-level assessment. Note also that too much available capacity could be a red flag of supplier distress.

Index A Accounting Cost accounting [1] Accounting standards [1] Accounts payable [1] See also: Accounts receivable Accounts receivable [1] See also: Accounts payable Active tags [1] Active visibility [1] Activity ratios Inventory turnover [1] Agility Downside supply chain adaptability [1] Overall value at risk (VaR) [1] Upside supply chain adaptability [1] AIDC [1] AIS [1] Altman Z-score [1] Asset management Cash-to-cash cycle time [1] , [2]

Return on working capital [1] Asset management metrics [1] ATP [1] Automatic identification and data capture [1] Automatic identification systems Bar codes [1] Bar-code scanners [1] Magnetic stripes [1] Smart cards [1] Vision systems [1] Warehouse automation systems [1] Automatic identification technologies [1] Available-to-promise (ATP) [1] See also: Capable-to-promise (CTP) Average inventory [1]

B B2B marketplaces [1] B2C [1] , [2] Balanced scorecard (BSC) [1] Balance sheet [1] Bankruptcy risk metric [1] Bar codes 2D bar codes [1]

Universal Product Code (UPC) [1] Bar-code scanners [1] See also: Bar codes Batch processing [1] Benefit-cost analysis [1] Best-of-breed systems [1] See also: Enterprise resources planning (ERP) Big data [1] BPM [1] BSC [1] Business process management [1] Business-to-consumer (B2C) sales Buy-side e-commerce [1] Content management e-commerce [1] Sell-side e-commerce [1] Buy-side e-commerce [1]

C Capable-to-promise (CTP) [1] See also: Available-to-promise (ATP) Carrier selection [1] Cash flows [1] See also: Statement of cash flows Cash-to-cash cycle time [1] , [2]

Channel master [1] Cloud computing [1] COGS [1] , [2] Collaboration [1] , [5] See also: Collaborative design, Collaborative planning, forecasting, and replenishment (CPFR), Quick-response programs (QRPs) Consignment [1] Content-level middleware [1] Content management applications [1] Content management e-commerce [1] Continuous replenishment [1] Cost accounting [1] Costing Standard cost accounting [1] Cost metrics Supply chain total cost [1] Cost of goods sold (COGS) [1] , [2] Costs Standard costs [1] Sunk costs [1] Cost variance [1] Cross-functional teams [1] CTP [1]

Current price [1] Customer creditworthiness [1] Customer metrics Customer creditworthiness [1] Customer order cycle time [1] Cybersecurity [1]

D Dashboards Executive dashboards [1] Data accuracy [1] Data aggregation [1] Data analysis [1] , [2] Data analytics [1] Databases [1] See also: Database management systems (DBMS) Data capture [1] , [2] Data cleansing [1] Data communications [1] Data dictionaries [1] Data management Master data management (MDM) [1] Data manipulation language [1] Data mining [1]

Data normalization [1] Data-oriented middleware [1] Data privacy [1] Days of supply [1] Decision support systems (DSS) [1] Depreciation [1] DI [1] Distribution center location [1] Distribution channels Business-to-consumer (B2C) sales [1] , [2] Electronic commerce (e-commerce) [1] , [2] Distributor integration (DI) [1] Downside supply chain adaptability [1] DSS [1]

E E-business [1] E-commerce [1] , [2] EDT [1] Efficiency [1] , [3] See also: Effectiveness Electronic business [1] Electronic commerce (e-commerce) [1] , [2] Electronic data transfer (EDT) [1]

See also: Electronic data interchange (EDI) Electronic documents [1] Electronic product codes (EPCs) [1] EPCs [1] Executive dashboards [1] Extended enterprise stage [1] Extranet [1]

F Facility locations [1] Financial metrics Altman Z-score [1] Cash-to-cash cycle time [1] , [2] Financial ratios Activity ratios [1] Leverage ratios [1] Liquidity ratios [1] Profitability ratios [1] Financial reporting [1] See also: Generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS) Financial statements Balance sheet [1] Income statement [1]

Statement of cash flows [1] Fleet management [1] Freight rate [1] Freight settlement [1] Funds flow statements [1]

G Global track and trace [1] Gross margin [1] Gross profit margin [1]

I Income [1] Income statement [1] Information sharing [1] , [2] Information system architecture [1] , [2] Information system configuration [1] , [2] , [3] Information system customization [1] Information systems [1] Information technology (IT) [1] , [2] Infrastructure [1] Insurance [1] Integrated enterprise stage [1] Intermittent manufacturing processes

Batch processing [1] Intranet [1] Inventory Average inventory [1] Inventory metrics Inventory turnover [1] Inventory turnover [1] Inventory turns [1] Inventory valuation [1] Inventory velocity [1] IS [1] IT [1] , [2]

K Key performance indicators (KPIs) [1] KPIs [1]

L LANs [1] Lead time Order fulfillment lead time [1] Legacy systems [1] Level 1 SCOR [1] , [2] Level 2 SCOR [1]

Level 3 SCOR [1] Level 4 industry processes [1] Levels of service [1] Leverage ratios [1] Liquidity ratios [1] Load matching [1] Load tendering [1] Local area networks (LANs) [1]

M Magnetic stripes [1] Manifesting [1] Master data [1] , [2] Master data life cycle [1] Master data management (MDM) [1] MDM [1] Measures Performance measures [1] Metrics Asset management metrics [1] Cost metrics [1] Financial metrics [1] , [2] Multi-organization metrics [1] Performance metrics [1]

Productivity metrics [1] Profit metrics [1] Quality metrics [1] Supplier metrics [1] Microservices [1] Middleware Data-oriented middleware [1] Process-oriented middleware [1] Multi-organization metrics [1] Multiple dysfunction stage [1]

N Net profits [1] Network design [1] Net working capital [1] Network optimization [1] , [2] Networks Local area networks (LANs) [1] Virtual private networks (VPNs) [1] Wide area networks (WANs) [1] NIST Cybersecurity Framework [1] Nucleus firm [1]

O

O/S [1] Obsolescence [1] Operating systems (O/S) [1] Orchestrated supply chain [1] Order fulfillment cycle time [1] Order fulfillment lead time [1] Orders Perfect orders [1] Overall value at risk (VaR) [1]

P Passive tags [1] Perfect order fulfillment [1] Perfect orders [1] Performance measures [1] Performance metrics [1] Point-of-sale (POS) systems [1] POS [1] Post-shipment analysis [1] Process-oriented middleware [1] Productivity [1] Productivity metrics [1] Profitability ratios Profit margin [1]

Profitable-to-promise (PTP) [1] Profit margin Gross profit margin [1] Profit metrics Strategic profit model [1] Profits [1] PTP [1]

Q QRPs [1] Quality metrics [1] Quick-response programs (QRPs) [1] See also: Collaboration

R Radio frequency identification tags Active tags [1] Passive tags [1] Semipassive tags [1] Reliability Perfect order fulfillment [1] Replenishment Continuous replenishment [1] Responsiveness

Order fulfillment cycle time [1] Return on assets (ROA) [1] Return on investment (ROI) [1] , [2] Return on working capital [1] ROA [1] ROI [1] , [2] Routing [1]

S SaaS [1] Sell-side e-commerce [1] Semifunctional enterprise stage [1] Semipassive tags [1] Servers [1] Service levels [1] Shipment planning [1] Shipment visibility [1] Smart cards [1] Software Operating systems (O/S) [1] Software as a service (Saas) [1] Sourcing [1] Standard cost accounting [1] Standard costing [1]

Standard costs [1] Standards Accounting standards [1] Statement of cash flows [1] See also: Cash flows Strategic profit model [1] Strategy alignment [1] Suboptimization [1] Sunk costs [1] Supplier capacity [1] Supplier metrics Supplier capacity [1] Supplier performance index [1] Supplier performance index [1] Supply chain configuration [1] Supply chain cost Cost of goods sold (COGS) [1] , [2] Supply chain design [1] , [2] , [3] Supply chain development Extended enterprise stage [1] Integrated enterprise stage [1] Multiple dysfunction stage [1] Orchestrated supply chain [1] Semifunctional enterprise stage [1]

Supply Chain Operations Reference (SCOR) level 1 metrics Agility [1] Asset management [1] Reliability [1] Responsiveness [1] , [2] Supply chain cost [1] Supply Chain Operations Reference (SCOR) levels Level 1 SCOR [1] , [2] Level 2 SCOR [1] Level 3 SCOR [1] Level 4 industry processes [1] Supply Chain Operations Reference Digital Standard [1] , [2] Supply chain performance [1] , [2] Supply chain resilience [1] Supply chain total cost [1] Supply chain visibility [1] Sustainability scorecards [1]

T Teams Cross-functional teams [1] Technology design [1] , [2] Three Vs Visibility [1]

Total cost to serve [1] Tracking [1] Trading exchanges [1] See also: Horizontal marketplaces, Vertical marketplaces Transportation optimization [1]

U Universal Product Code (UPC) [1] Universal product codes [1] Upside supply chain adaptability [1] Usage variance [1]

V Valuation Inventory valuation [1] Value-added networks [1] VANs [1] VaR [1] Variance Cost variance [1] Usage variance [1] Vendor-managed inventory (VMI) [1] Virtual private networks (VPNs) [1] Visibility

Active visibility [1] Shipment visibility [1] Supply chain visibility [1] Vision systems [1] VMI [1] VPNs [1]

W WANs [1] Warehouse automation systems [1] Warehouse functions [1] Warehouse location [1] See also: Warehouse number Warehouse number [1] See also: Warehouse location Web directories [1] Web services [1] Wide area networks (WANs) [1]

Z Z-score [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Module 3: Sourcing Products and Services This module addresses the sourcing and procurement processes. Sourcing involves strategic decisions, such as whether to make or to buy and, if buying, to determine sourcing requirements and timing. When considering suppliers, many large organizations now use a category management strategy to enable different categories of suppliers to get different amounts of sourcing attention. Such a strategy also enables conducting a supply base analysis to ensure that the number of suppliers in a given category is correct. This module also addresses various ways to influence product designs, such as for manufacturability, sustainability, transportation, or warehousing. The procurement process is a subset of the sourcing process, but it is more detailed and involves individual supplier decisions. Much of this process is operational in nature. Discussions include developing supplier selection criteria, negotiations, and contracting. The process of managing purchase orders and following up on exceptions is also covered.

Section A: Aligning Sourcing to Demand This section is designed to Define a make-versus-buy analysis Describe the uses and factors involved in a make-versus-buy analysis Understand what constitutes a core competency and how it is relative to the competition Describe the reasons behind decisions to contract out portions of supply (e.g., outsource, offshore, and/or nearshore) Define sourcing requirements and timing Define the total cost of ownership Indicate how the total cost of ownership can be used to justify investments in the supply chain. Starting with a goal of aligning the supply plan to the business strategy, supply chain managers determine the total cost of ownership of the supply network. Supply plans may lead to contracting out activities (e.g., outsourcing, offshoring). Part of this decision is determining whether to make or buy the necessary

capabilities, components, or products. The results of these and other strategic supply choices are summarized in the supply plan.

Topic 1: Make-Versus-Buy, Outsourcing, and Offshoring Sourcing involves strategic processes such as deciding whether to make or buy goods or services and setting category strategies to allow the vital few procured items to receive more attention than the trivial many. In addition, the procurement process involves selecting and working with suppliers. After providing this overview of sourcing, here we delve into a strategic-level sourcing decision tool, a make-versus-buy analysis, and we also address contracting, including outsourcing and offshoring. Some organizations distinguish between make-versusbuy and outsourcing decisions to show that the process has evolved to become more strategic. This text treats the make-versus-buy analysis as a strategic decision that includes contracting for any activity, including products, subassemblies, business processes, or services. Offshoring is outsourcing to a different country.

Sourcing Road Map

The advent of things like supplier relationship management (SRM) and strategic sourcing has had a strong effect on how organizations assess their sourcing alternatives, choose supply partners, and interact with their suppliers. Interactions are more collaborative, involving two-way discussions with suppliers on product design, material choices, and supply chain options and timing rather than just handing down specifications and deadlines. Technology has enabled this shift by streamlining many of the repetitive or timeconsuming portions of sourcing processes. The overall sourcing process is discussed next, followed by a discussion of the procurement process, which has strategic elements but is primarily tactical and operational. After that, there is a discussion of how to develop sourcing competency.

Sourcing Process Exhibit 3-1 shows common steps in the sourcing process. Some of these steps might be taken in a different order, and some sourcing processes may have different steps.

Exhibit 3-1: Sourcing Process

The first step, develop and/or validate the supply plan, is a major strategic process in itself. Since most organizations already have supply plans, usually this is a process of revisiting the plans to address new product introductions, product retirements, new lines of business, and continuous improvement feedback. To stay focused, this step is often run using project management. A project team is determined, and a project charter is used to limit the scope of work to the organization’s priorities in this area. Tools used can include make-versus-buy analysis, contracting or offshoring strategies, and consideration of existing systems (e.g., regional supply and manufacturing facilities, customer locations). Supply plans are iteratively developed, so the results of some of the later steps in the sourcing process are used to refine the plans to be more specific. The second step, research the supply market, can include determining sourcing requirements and timing, performing total cost

of ownership analyses, and performing supply market research. The third step, create/refine categories and category strategy, involves classifying the organization’s purchasing spend in relevant ways and developing an overall strategy for effectively managing purchasing categories. The fourth step, do spend and portfolio analyses, builds off of these organization-specific categories. A spend analysis can use tools such as a Pareto analysis to identify which categories have the most procurement spend and which suppliers get relatively more spend. This is useful for rationalizing or right-sizing the supply base. A portfolio analysis is an assessment of how much you need the suppliers in a given category. It places categories into groups related to their strategic importance versus supply chain difficulty (bottleneck, core competency, leverage, and commodity). The fifth step, segment suppliers, also complements the category strategy by determining the proper level of relationship for specific suppliers, and this is based on the portfolio analysis and on how much the supplier needs the organization. The sixth step, conduct procurement processes, is addressed more next. The seventh step, continuously improve, is a feedback step that involves determining how to improve the supply planning process or specifying areas of the supply plan or categories that need to be prioritized in the next version of the supply plan.

Procurement Process Exhibit 3-2 shows various purchasing functions. Often a senior, experienced individual is responsible for the strategic tasks, and others will oversee the tactical tasks. As purchasing has become more strategic and global, purchasing roles have been stratified according to strategic and tactical expertise.

Exhibit 3-2: Functions of Purchasing

The individual with the strategic role may be charged with tasks such as Identifying and researching strategic partners Assembling and managing the sourcing risk portfolio Developing certification standards and supplier improvement programs Conducting make-versus-buy analyses

For buy decisions, determining whether to outsource or offshore and what types of contracts to use Negotiating long-term contracts Adding value to products by managing supplier and strategic sourcing relationships Serving on cross-functional teams to integrate workflows and share data Enforcing compliance with sourcing contracts and related supplier policies Analyzing purchasing data to report impact on corporate goals and to identify areas for improvement. The more tactical tasks, managed by one or more persons, may include Managing supply (planning and procuring supplies based on the master production schedule, auditing present needs on the manufacturing floor, releasing work orders, creating purchasing planning schedules) Issuing purchase orders Tracking orders Resolving discrepancies or exceptions in orders or accounts Monitoring the performance of suppliers and issuing reports on timeliness, completion, policy compliance, and quality of work.

Developing Sourcing Competency Various sourcing technologies or services put in-depth information about the supply channel in the hands of purchasing managers, planners, and purchasing agents/buyers in real time. The requirements for purchasing jobs have changed accordingly. A survey of job postings shows that managers must have a greater understanding of the corporation’s business goals (rather than merely the departmental goals) and how purchasing can affect the achievement of those goals. They must have substantial analytical abilities and people skills, including awareness of cultures with which they may come into contact. Global expertise (market research, knowledge of taxes and local laws) is necessary. And purchasers must be customer-centric. Planners, purchasing agents, and buyers must be familiar with a host of sourcing and supplier relationship management technologies, but they must also be creative in translating corporate purchasing strategies into specific tactics and in finding opportunities to improve tactical processes. They must be detail-oriented and able to track global logistics and contract performance. As the world’s economy becomes increasingly integrated, it is imperative for purchasing management to master the best practices for operating successfully in a global market. Organizations need

skilled operations management and supply chain management professionals to keep their business favorably positioned throughout their markets. The ideal manager for international suppliers will need a special set of soft skills. The individual should be someone who can moderate a discussion of expectations and who is sensitive to the values and needs of the other party’s culture.

Make-Versus-Buy Analysis The APICS Dictionary, 16th edition, defines make-or-buy cost analysis as follows: A comparison of all of the costs associated with making an item versus the cost of buying the item. An associated definition from the Dictionary is for make-or-buy decision : The act of deciding whether to produce an item internally or buy it from an outside supplier. Factors to consider in the decision include costs, capacity availability, proprietary and/or specialized knowledge, quality considerations, skill requirements, volume, and timing. Make-versus-buy is strategic, because global sourcing of processes or products is a complex and challenging decision that impacts organizational profits and reputation. Make-versus-buy is also

tactical; when procuring and delivering goods and services, individual decisions can be made on an ongoing basis to address current prices, current capacity, and so on. Before selecting a partner to provide materials or services, a supply chain company needs to ask and answer a set of questions about the possible consequences of giving the activity in question to another company, including Is the activity a core competency? What are the consequences of losing related skills or knowledge? What is the landed cost (or total cost of ownership)?

Is the Activity a Core Competency? There is seldom a good reason for outsourcing a core competency; there are very good reasons to contract out tasks an enterprise does only adequately or poorly. A logistics specialist can make its clients look very good by providing customers with same-day or next-day service (plus other options). But if an enterprise has its own fleet and is known around the region for the color of the trucks, the skill of the drivers, and flawless delivery, it should carefully consider the effect on its image before letting a third-party provider take over its delivery functions—even if logistics isn’t a core activity.

When considering contracting out components of a product or service, the core competency question revolves around whether the component is integral to the device or if it is modular. An integral component is typically unique to a product, and if it fails the whole product fails. A modular component is interchangeable with other variants on the market, such as a computer component. Integral components are much more risky to outsource. A detailed process for considering core competencies in the makeor-buy decision is described in Customer-Centered Supply Chain Management (Kuglin, 1998). As an example, assume that an enterprise is considering contracting with a supply chain partner, yet to be identified, to provide its customers with overnight order-todelivery service. Kuglin’s process might be adapted as follows. Step 1: Determine whether the enterprise already has overnight order-to-delivery as a core competency. In making this determination, the enterprise consults both internal and external experts among its clients and providers. If there is a difference of opinion, the enterprise does further research to decide which opinion is correct. It is possible that the enterprise believes overnight delivery is a core competency while clients say otherwise. It is also possible that clients believe the enterprise has

overnight delivery as a core competency but the enterprise itself is not fully aware that it has that capability. (Kuglin uses the process as part of a complete transformation to a customer-centered supply chain leader. In that effort, the enterprise develops a complete list of all core and non-core competencies as part of a decision of what activities to contract out and which to keep or develop as core competencies.) Step 2: Determine whether there is a need in the marketplace for overnight order-to-delivery service. While interviewing customers and suppliers about the core competency of the enterprise, the interviewers also question respondents about the need for the capability in the marketplace. Step 3: Determine the relationship between the enterprise’s capability to deliver the service and the need for the service in the marketplace. The preceding steps can produce several outcomes: The marketplace needs overnight delivery and the enterprise already can meet that need as a core competency. In this case, the enterprise might choose to market its capability to raise awareness in the marketplace. (It will “make” rather than “buy” overnight delivery.)

The marketplace does not need overnight delivery, in which case the enterprise may not need to maintain, develop, or buy that capability. The marketplace needs overnight delivery, but the enterprise is not able to provide it as a core competency. This situation triggers the final step, which is the make-or-buy decision either to develop the capability or to find a supply chain partner who can do so as a core competency. Step 4: If a need for overnight order-to-delivery service exists in the marketplace and that capability is not a core competency of the enterprise, determine whether to develop the capability as a core competency or to contract with a supply chain partner. Develop the core competency to perform the activity. The company may decide to develop a core competency in providing overnight order-to-delivery service. This may be advisable if doing so is consistent with the company’s mission and vision— and if the company has the resources to develop the core competency within a time frame acceptable to the market. Contract out the activity. Having decided to outsource overnight order-to-delivery service, the enterprise makes a short list of available third-party logistics providers and selects one to

develop into a supply chain partner. The selection process may be accomplished by soliciting proposals. However, Kuglin suggests instead developing a business problem and asking potential providers to work with the enterprise to find a solution. This method tests the unique abilities of each company.

What Are the Consequences of Lost Skills or Knowledge? When an enterprise contracts out functions to another company, domestic or foreign, it may be divesting itself of valuable expertise. When all the components of a complex electronic system are made offshore, for example, the enterprise no longer maintains the knowledge of those systems in-house. The skill, knowledge, and perhaps the creativity of its former workers in that area are gone and cannot be easily recovered. The costs of those losses may be difficult to measure and balance against the gains, but they are real. The result of a nuanced analysis may be that an activity is only partially outsourced. For example, Toyota Allows the electronic systems in its vehicles to be both designed and produced by external suppliers Retains the design portion of its vehicle transmissions but outsources much of transmission production

Both designs and manufactures all of its engines because this is a core competency.

What Is the Landed Cost (or Total Cost of Ownership)? Once an enterprise has decided to contract out a particular component or service, attention turns to comparisons of quality, cost, and availability. The traditional cost measurement in this case is landed cost, which is the cost of the item including all costs to deliver it to the organization (transportation, tariffs, etc.). If the goods from domestic and foreign sources are of equal quality and cost becomes a main consideration, landed cost provides a better basis for a meaningful comparison than just price. In other cases, such as when quality differences require broader analysis, total cost of ownership may be used to compare costs in a make-or-buy decision. Total cost of ownership starts with landed cost but considers many more factors, such as quality costs and life cycle costs. Components or services delivered by a foreign supplier are often priced far lower than those produced domestically. Even assuming that the components or services are of the same quality, however, there are other considerations. Will foreign suppliers be able to provide the components in sufficient quantities to meet production needs? Will the (likely) longer lead times and larger delivery sizes

(higher average inventory) be acceptable? Are there infrastructure constraints that may stall shipments unexpectedly? Will labor, economic, or political problems suddenly cut off supplies? Will shipments be secure against pilferage, damage in transit or handling, tampering, and terrorism? Finally, what other costs are incurred by bringing the components to the manufacturing site from a foreign rather than domestic producer, such as higher monitoring and control costs?

Making the Decision Organizations justify their make-or-buy decision by comparing the advantages to the risks and costs of each alternative. As was implied in the previous discussion of Kuglin’s step-by-step process, a primary aspect of this decision is whether an outsourcing partner can provide the organization with new capabilities because they have complementary core competencies. The organization weighs these potential advantages against the drawbacks of contracting such as potential loss of skills and knowledge and higher-than-expected landed costs. Sometimes the result is that the organization settles on a hybrid approach, retaining some processes and outsourcing others.

Contracting and Outsourcing

Contracting out activities to third parties can take many forms, including outsourcing and offshoring or the use of service providers such as third- and fourth-party logistics providers. Outsourcing is a popular term, but it isn’t always the correct one. For example, if the organization never did an activity in the first place and then finds a third party to provide that capability, it isn’t really outsourcing it but is instead contracting for those services. However, “outsourcing” is commonly used interchangeably with “contracting out,” so this topic treats it as a synonym. The APICS Dictionary, 16th edition, defines outsourcing as the process of having suppliers provide goods and services that were previously provided internally. Outsourcing involves substitution—the replacement of internal capacity and production by that of the supplier. Outsourcing can be contrasted with insourcing , which the Dictionary defines as “using the firm’s internal resources to provide goods and services.” A synonym for outsourcing is subcontracting, which involves “sending production work outside to another manufacturer.”

Trends in Contracting

Anything that can be digitized can be contracted out globally. As a consequence, many corporations have sought out the cheapest labor sources in a wide variety of occupations. This outsourcing takes place in many directions—not only from developed countries to emerging economies. Developed countries now outsource to one another. Japanese car companies once made inroads into U.S. and European markets with low-priced automobiles. When the competition responded and transportation costs increased, the Japanese car companies began moving production closer to customers in countries such as the U.S. and Canada. Similarly, American car companies are now successfully manufacturing American cars in China for sale to Chinese consumers. Another trend in contracting is the use of smart contracts. Smart contracts use blockchain technology (a distributed ledger that forms a chain of permanent records one secure “chain link” at a time) to make contracts more legally defensible because the record, once agreed to by all parties, is almost impossible to surreptitiously alter. The contracting process can also be conducted remotely and quickly. However, a smart contract can be amended fairly easily by adding another link in the chain to the blockchain ledger, following agreement by all parties.

Examples of Supply Chain Contracting

Many of the Fortune 1000 companies contract out multiple business processes, from payroll to manufacturing. The following are some outsourcing examples related to supply chain management. Supplier relationship management (SRM). SRM organizations with experience in a particular region could assume responsibility for transactional purchasing or supplier sourcing, contract negotiation, two-way communications of expectations, and compliance management. Outsourced SRM can also provide strategic support for alliances such as spend analysis or facilitating design collaboration. Manufacturing. Manufacturing can be contracted out to organizations that have advantages in labor costs, are located closer to raw materials, or have special expertise in producing products or subassemblies efficiently at expected quality levels. Logistics and logistics management. Third- and fourth-party logistics providers are ways of contracting out logistics operations or its management. Customer relationship management (CRM). CRM suppliers may provide call centers or advanced telephony services (like universal queue or voice recognition), database collection and management, and online service agents. The best CRM suppliers

train their service representatives in their clients’ products and processes to make performance seamless. Information systems. Offshore development of custom technology applications can reduce labor costs significantly. Software as a service (SaaS) can be seen as a way to limit investment in software, hardware, and support staff for systems that otherwise become obsolete quickly.

Benefits of Contracting Potential benefits of contracting out activities include the following: Economies of scale. A third-party provider with a core competency in the activity may have numerous customers for the given activity and therefore can spread its fixed costs over more units of the good or service. Risk reduction. Contracting transfers risks, such as demand uncertainty, to the third-party provider. The provider may be better equipped to manage demand uncertainty by spreading forecasts over a larger number of customers. (It may handle many more orders than those brought in by any one of its clients, which reduces risks through risk pooling.) The outsourcing provider may also be able to react more rapidly to changes in customer demand.

Increased capital available for investment. Since some of the capital required to engage in the outsourced activity is supplied by the third-party provider, the enterprise has more capital available for research, payment of dividends, debt reduction, etc. Clearer focus. An organization contracts out an activity only if it is not a core competency (in most cases). This increases the organization’s ability to focus on core competencies. Access to new technologies. The third-party provider, because it focuses on the outsourced activity as a core competency, is more likely to have the latest and most effective resources for carrying out that activity. Indeed, if it is to maintain its market share, it must keep up with advances in strategy and technology. Access to regional benefits or avoidance of regional issues. A third party may operate in a market that is currently underserved and so can provide better market access. The third party also may be able to help the organization avoid certain regional issues, such as requirements for majority local ownership. Faster development cycle times. The third-party supplier’s technical expertise may enable the enterprise to accelerate development time for new products or services.

Complexities of Contracting Contracting reduces some complexities, since the organization will no longer need to perform or directly administer certain tasks. At the same time, it increases the complexity of other forms of business administration, especially for monitoring and controlling and risk management. Risks include poor quality, intellectual property theft, supplier corruption/fraud, or failure to maintain organizational policy such as for worker protection or environmental sustainability. These all relate to a higher risk of reputation damage, so organizations need well-developed contract clauses, legal review, audit functions to verify compliance, and enforcement mechanisms.

Offshoring Outsourcing partners may be located near at hand or offshore. Offshoring is defined as “outsourcing a business function to another company in a different country than the original company’s country” (APICS Dictionary, 16th edition). An organization could also offshore without outsourcing by opening a branch in a different country and hiring employees there to staff a business function. Thus, offshoring usually implies locating a business unit or facility in a different country, which could be directly owned or owned by a supply chain partner. Note that in many smaller countries that have numerous neighbors, offshoring could still involve relatively short distances. A

related term, nearshoring, refers to this type of offshoring to a nearby country, often as a shift of business away from a more distant country.

Reasons for Offshoring With offshoring, the first consideration should be organizational needs, not a search for “today’s global sourcing hot spots.” Only when an organization has thoroughly assessed its needs for offshoring is there a sound basis for evaluating and selecting specific countries and suppliers. An organization is then ready to consider how potential global suppliers can support the organizational value proposition. Although cost cutting may be the primary driver for offshoring, it should not be the sole criterion. Another reason for global sourcing is market growth. Sourcing from a particular country may open up new market possibilities. Sourcing relationships allow an organization to learn about conducting business in a potential market. Offshoring may also provide additional sourcing options. Sourcing or procuring products or services from more than one country develops alternate sources and can provide backup for emergencies or other supply chain disruptions.

Offshoring Complexity

Offshoring increases the complexity of assessing potential suppliers. Once a supplier is selected, offshoring increases the complexity of developing suppliers to continually improve products and processes. Dealing with foreign-based organizations requires understanding and overcoming complexities such as language differences, culture differences, country-specific processes, and legal, tax, and regulatory differences. Many suppliers located in countries with lower labor costs also have less mature organizational levels, less emphasis on total quality initiatives, or less developed information visibility and technology. Investing in improving these factors adds to the total cost of ownership and may not provide a payback if the relationship must be terminated prematurely. In addition, some countries with lower labor costs have onerous government regulations and bureaucracy that slow cycle times or permitting unless local expertise in navigating these impediments is obtained. Even with local expertise, organizations could be prohibited by their home country and/or organizational governance policy from engaging in certain locally expected activities (e.g., bribery).

Risk Management in Offshoring

Although many benefits may be achieved by offshoring, organizations must be careful about the risks they assume. Risks include failure to perform or deliver on time, failure of technology systems or electrical grids for unacceptable periods, or theft of intellectual property. Either the supplier or any transportation intermediary could be at fault, or the cause could be from “force majeure,” such as a natural disaster. Organizations need to exercise great caution in whom they work with and how much to trust these organizations, and they may need contingency plans such as backup suppliers to enable supply chain resilience. One method of mitigating risks when embarking on offshoring is to build sufficient inventory prior to a move to prevent supply interruptions. For example, in the medical device industry, when a product line is offshored, it is not unusual for the organization to build one year of stock to mitigate the risks in the offshore transfer of the production line as well as regulatory risks. However, this is not an option if inventory faces fast obsolescence/perishability. Note also that there is a cost associated with such a build-up and this cost would need to be factored into the original analysis. Another issue is how the organization will enforce compliance with its business goals and values. For example, many countries have relatively few government regulations related to environmental

protection or sustainability. While avoiding onerous regulations could be among the reasons to choose an offshore site, global organizations risk damage to their reputations if problems occur. Take, for example, the lead found in many children’s toys and the contaminated foods that have harmed some organizations’ reputations and bottom line. Compliance and control costs can increase significantly when using outsourcing or offshoring. The key point related to risk in any outsourcing arrangement is that the organization remains the responsible party in the eyes of the customer, so it must seek ways to manage its exposure—perhaps through pilot programs, close monitoring for compliance, maintaining backup suppliers, or redundant capacity.

Comparing Manufacturing and/or Assembly Sites Sometimes organizations contract out manufacturing but continue to perform assembly of the final components, while other organizations choose to outsource both of these activities. Final assembly in the country of sale may lessen tariffs, reduce transport costs for bulky items, and enhance the organization’s reputation by providing local jobs. Determining the relative costs of manufacturing and/or assembly in different markets is as complex as comparing landed costs for goods.

Exhibit 3-3 summarizes some of the advantages and risks of product manufacturing and/or assembly in another country. Exhibit 3-3: Advantages and Risks of Overseas Manufacturing and/or Assembly Advantages

Risks

Advantages

Risks

Low labor rates (depending on country) Lower material costs Lower benefits costs in countries with national health care Favorable duty rates (especially if materials are domestic) Lower taxes Smaller capital investment (if assets are transferred to foreign country) Ability to be agile as customer requirements change Foreign country experience and market opportunity

Possible costs and disruptions caused by time zone differences (as much as 15 hours between United States and Asia) Higher transport costs and longer lead times Higher relationship management costs for communications, travel, monitoring, etc. Possible political risks in unstable, unfriendly countries Costs of hedging currency exchange risks Costs of maintaining environmentally responsible forward and reverse logistics chains Environmental costs for mitigating air, water, and noise pollution and preventing spread of invasive species Higher costs of increased safety stock Costs of holding inventory in warehouses or in the pipeline Shrinking inventory due to theft, damage, spoilage, etc. Increased costs of insurance against damage, theft, spoilage

Source: APICS, Advanced Supply Chain Management

Topic 2: Sourcing Requirements and Total Costs Sourcing requirements, including delivery timing requirements, can differ widely among different types of products and services, so it is important to arrive at these decisions as soon as the decision has been made to contract out the good or service. A more detailed total cost analysis may also be needed once potential sources are being considered and more costs can be known.

Sourcing Requirements and Timing Once the organization has recognized the need for selecting one or more new suppliers through processes such as a make-versus-buy analysis, the next step is to determine sourcing requirements, including the necessary timing. Sourcing and timing requirements are not homogeneous. Determining sourcing and timing requirements and priorities often requires a detailed analysis. Evaluations should result in decisions for each category of requirement. Categories may include Cost to organization and target price to consumer Quality culture and product/service quality Delivery performance (due date promises and scheduling, delivery window size, acceptability of early or late deliveries, how to

measure, and penalties for failures) Lead time (slow and cheap to fast and expensive) Available capacity (and ability to change capacity) Design expertise or ability to collaborate Time to market (in weeks or months, plus ability to improve this duration) Sustainability. For example, a clothing staple item may have requirements for quality that ensure that the item is durable enough but also low enough in cost to enable low prices. Delivery performance may need to be average. Lead times can be long. The supplier may need to provide high capacity for large bulk orders but may not need to collaborate much except for providing cost-cutting suggestions. Time to market may be a low priority unless there are pending shortages. Sustainability depends on the organization’s values. The top priority is low enough cost to maintain an acceptable profit margin. Once a set of sourcing requirements is determined, a sourcing search can begin. The intensity of this search depends on the strategic importance or technical complexity of these sourcing requirements plus the relative capabilities of existing suppliers, according to Monczka, et al., in Purchasing and Supply Chain Management. Exhibit 3-4 shows this relationship.

Exhibit 3-4: Research Relates to Requirements and Existing Supplier Capabilities

Total Cost of Ownership (TCO) According to the APICS Dictionary, 16th edition, the total cost of ownership (TCO) is defined as follows: In supply chain management,...the sum of all the costs associated with every activity of the supply stream. Two other inventory-related cost category terms are purchase price/production cost and landed cost. Exhibit 3-5 shows how these terms relate to one another.

Exhibit 3-5: Relationship between Cost Terminology

The purchase price or acquisition cost is the price per unit of materials acquired from suppliers. Production cost is the cost per unit of direct materials, direct labor, and factory overhead (cost of goods sold) that is applied to products produced by the organization. According to the Dictionary, landed cost “includes the product cost plus the costs of logistics, such as warehousing, transportation, and handling fees.” The total cost of ownership includes all of the above costs, plus it considers all other lifetime ownership costs such as durability, ongoing maintenance costs, and responsible disposal.

Use of TCO The intent of TCO is to get decision makers in the supply chain to see supply chain activities as an investment in capabilities rather

than just an expense to be minimized. TCO is primarily a strategic rather than tactical measurement tool, meaning that it is used to select between supply chain strategy options. Once a strategy has been selected, TCO can be used for performance measurement to assess how well the strategy is contributing to organizational strategy and as a high-level control over the end-to-end supply chain process. TCO may change over time and should be periodically reassessed. For example, labor costs in developing countries may increase over time relative to other countries and the lowest cost solution may change accordingly. TCO compares the differences between incremental (or marginal) costs of alternative supply chain solutions. An incremental cost is the cost associated with producing one additional unit of a product or service. Some costs remain relatively stable until they go above or below a certain level of capacity, at which point they step up or down in incremental cost. Measuring incremental costs considers the effects of system constraints on proposed solutions.

Determining What Costs to Include in Analysis A supply chain is a complex system with multiple costs. Effective analysis requires selecting only those costs that help differentiate between alternative strategies. Costs that are the same for each option are omitted from consideration. Being consistent in the choice

of costs to include allows comparison of multiperiod measurements or competing alternatives. TCO considers both tangible and intangible costs. Tangible costs can be given a value using objective measures such as market value; intangible costs are difficult to measure in financial terms yet may have a real impact, especially in the long term. Examples of intangible costs include customer satisfaction, employee morale, quality, risks (e.g., outsourcing partner failure to meet obligations), or loss of intellectual capital. Such costs may be estimated and included in TCO, but the estimates should be conservative or based on a formula so they are less likely to be rejected by decision makers. Dividing costs into landed costs, process change costs, and ongoing costs can help determine what costs to include in an analysis and what costs to omit because they are not relevant or would only complicate the analysis. Landed Costs Landed costs are often the most important costs considered for a TCO study of the supply chain. Some important landed costs that frequently differ between alternatives are Purchase price/production cost

Transportation cost (at each stage), including special packaging costs Customs and related costs (tariffs, duties, taxes, fees for various intermediary services) Inventory costs (carrying, ordering, and backorder costs) Outsourcing cost Monitoring and control costs, which are generally higher when outsourcing is used (e.g., sending employees abroad to manage the relationships). Some landed costs may or may not differ between the alternatives or may be omitted from consideration to simplify analysis. Such costs could include Financing and opportunity costs Sales and marketing Administrative (executive, clerical, including billing/payment, and information system) Reverse supply chain (returns) Insurance and risk management Taxes and foreign exchange (relevant for global sourcing decisions). Process Change Costs

Process change costs include the costs of evaluating choices and implementing the changes to the supply chain. These costs are sometimes called pre-transaction costs because they are administrative costs often incurred before landed (transaction) costs are incurred. Such costs may include Requirements identification and research Product development Contract sourcing (search, selection, qualification, and legal review) Process change and training of supplier and organization in each other’s operations Plant openings/closings, hiring/layoffs Supplier education and integration (including software systems integration). Ongoing Costs Ongoing costs (or post-transaction costs) are the costs of ownership that occur throughout the life of the product or equipment. A durable product will have lower ongoing costs than one that costs less but has lower quality. Examples include Life cycle costs (quality, durability, and maintainability versus price) Maintenance, repair, and operations and other ongoing service and repair part costs

Costs of quality (line fallout, defects, in-house or field repairs, rework, returns, warranties) Sustainability costs (recycling, recovery of materials, etc.) Reputation costs (customer loyalty versus lost customers). Net Costs TCO measures the net effect of all cost increases and cost reductions. Research by Kalakota and Robinson on TCO related to offshore outsourcing reported a reduction in total labor costs of 70 percent, an increase in total transportation costs of 20 percent, and an increase in the organization’s monitoring and control costs of 20 percent, for a net reduction in costs of 30 percent. TCO analysis can thus sometimes help make the case for closer sourcing. Research by Lewis, Culliton, and Steele compared two alternatives for sending electronic parts directly to customers. The first option was to centralize inventory in a single warehouse and make all shipments using rapid air transport services. The second option was to have regional warehouses combined with cheaper transportation options. The first option was found to have the lowest total cost because the higher cost of transportation was offset by the lower total costs for inventory and warehousing. Part of the reason for this

is that electrical parts are small and inexpensive to ship via air. Other items and supply chains will have different relative costs. shows how a TCO economic tradeoff study can show that the lowest total cost for a supply chain is often at a different point than the lowest total cost for any given system component. The exhibit compares the number of distribution points to total costs. Note that a single distribution point would produce the lowest inventory cost, while seven or eight distribution points would minimize total transportation cost. Four distribution points result in the lowest TCO. Note also that this is just the TCO for distribution. A separate analysis would be needed for supply-side and manufacturing costs.

Exhibit 3-6: Determining Economic Tradeoffs in Total Cost of Ownership for Distribution

TCO Challenges A key observation to make from is that total cost analyses grow more and more complex as more costs are considered. The above analysis takes no consideration of transportation lot sizes, the global distances involved, or the amount of safety stock to maintain in the system, to name only a few factors in the total cost of a supply network. Therefore, TCO analysis may require sophisticated analytical tools such as a network model for scenario or simulation use or a decision support system. Either tool can optimize multiple factors such as actual locations of facilities and actual transportation options to generate a globally optimized supply plan. One way TCO integration can be accomplished is if TCO is incorporated into control and continuous improvement tools such as a scorecard or dashboard. These tools can also ensure that customer service or other objectives are given weight in the analysis. When properly implemented, TCO can help organizations and supply chain partners make and justify wise, cost-effective choices for the long term. TCO can be difficult to implement at an organization, much less across a supply chain. Organizations have long-standing department-specific cost reduction policies, management incentives, and accounting practices in place that may penalize individuals for

failing to minimize costs in their departments. A TCO strategy therefore requires extensive process changes starting at the executive level, realignment of management incentives toward total cost, and a method of measuring and rewarding success based on achieving least total cost. These change issues are magnified in an extended supply chain.

Should-Cost Estimate When estimating the total cost of ownership in an extended supply chain, one complication is that actual or potential suppliers may not share their cost information. One way to compensate for this is to use a should-cost estimate. A should-cost estimate is an estimate of the cost drivers for a given product or service that leads to an estimate of how much it should cost to produce a good or service in a given region and get it to a desired location. This estimate is sometimes used along with a target pricing process, which determines the price the market will bear. A cost driver is an element that strongly contributes to how much something costs. Cost driver categories may include materials, labor, overhead, transportation, materials management, quality, inventory carrying costs, and administrative costs. Each of these categories can have several cost drivers. For example, materials cost drivers

could include market prices for commodities, engineering tolerances, design limitations, manufacturing lead times, and manufacturing process choices. Labor may include degree of skill, safety issues, scrap levels, learning curves, and so on. Overhead could include the complexity and expense of machining and tools, maintenance costs, and production space requirements. Supply market scanning in a specific country or region can provide information on typical cost driver rates and quantities. Government data or data from industry standards may also be used. The analysis team should include a set of experts with local area knowledge and knowledge of the production processes involved. The results of a should-cost analysis can then be compared to supplier responses to requests for quotations or to internal costs. This can provide the organization with negotiating leverage or a best alternative to a negotiated agreement with a supplier (such as to make it oneself if that cost should be lower than what the supplier is indicating).

Section B: Category Strategy for Sourcing This section is designed to Align and optimize supply plans Determine supply categories and a category strategy in part by assessing the strategic importance or complexity of the materials as well as their availability Perform a portfolio analysis to group categories into commodity, bottleneck, leverage, and core competency materials Use a segmented sourcing strategy by determining how much you need each supplier and how much each supplier needs you, and then classify each supplier as transactional, preferred, strategic, or owned Identify the range of buyer-supplier relationships Discuss how each type of buyer-supplier relationship has its uses in a supply chain Describe how a supply base analysis can help in determining, validating, and winning approval for the supply plan Use spend analysis to identify which suppliers got more spend than others and which categories could benefit from a right-sizing of the number of suppliers.

Supply plans need to align with the organization’s overall strategy, but different types of materials need different types of management to ensure both effective use of the materials and efficient use of operations and management resources. A common way to add nuance to supply plans is to create categories of things that need to be purchased, determine the relative importance of the category to the organization, and then decide upon the appropriate type of relationship to have with each supplier. Using a segmented sourcing strategy helps determine this relationship type.

Topic 1: Supply Plans, Categories, and Segmentation Supply plans need to be developed related to sourcing strategy. Category strategies help provide nuance to these plans. Supplier segmentation differentiates the level of integration with suppliers.

Supply Planning Developing a supply plan is the strategic design of a supply network based on total cost of ownership, make-versus-buy decisions, sourcing requirements, and desired or necessary levels of buyer-supplier relationships. Supply plans set the organization’s design for how it will identify and manage suppliers.

Supply plans answer questions such as Are we going to have centralized global sourcing, will each location source independently, or will there be a combination of these methods? Will we seek local sources over cheapest sources? What are our contingency plans for supply risks? Will we need to rely on sole-source suppliers or decide to use single-source suppliers? What are the differences in our supply plans for strategic versus nonstrategic material sourcing? The last two items in the supply plans are often addressed using a category strategy.

Plan Validation and Refinement The results of the prior analyses may need to be validated and refined at a high level to take into account additional considerations such as the following: Corporate strategy alignment. The supply planning process starts with corporate strategy as an input, so the proposed supply plan should be built from the perspective of meeting corporate goals for customer service, production capacity, and product quality. Any differences must be resolved at this point, either by providing decision makers with several supply plan options if all of these

factors cannot be simultaneously met or by making a case to change corporate strategy if analysis shows that the desired service, capacity, and quality are not feasible or profitable. Corporate mission and culture alignment. Developing supply plans takes the results of the analyses discussed in these materials and determines if the results suggested by computer optimization integrate well with the organization’s mission and culture. For example, a corporate social responsibility policy regarding supporting local communities may override a global sourcing decision if the cost difference is considered acceptable given the social and reputation benefits received. Risk assessment. The risks of a supply plan must be spelled out for decision makers at a high level, including an assessment of the likelihood of each identified risk, its impact if it occurs, and possible means and costs involved in mitigating risks. Process change risks should be called out. Contingency plans should be included. Centralized versus autonomous sourcing. Centralized control over sourcing decisions to generate the systemic savings may need to be balanced against some amount of autonomy for local sourcing. While centralized sourcing provides the benefit of control, autonomous sourcing provides local expertise and the ability to personalize supplier relationships. However, local management can

have a local bias. Centralized control for strategic sourcing with some autonomy for nonstrategic sourcing may generate a good balance if the local areas are guided by central policy and controls. Additional optimization. Given high-level tentative approval of the supply plan, some additional strategic refinements can be made to increase customer service, capacity, or quality or reduce costs further without significantly changing the plan. For example, when distribution locations have overlapping territories, the supply plan can specify which of these locations will provide the fastest or least costly delivery to a given area, and that distribution point can be designated as the primary distributor. Planning for future growth. A supply plan is a long-term plan, so it must incorporate the flexibility to grow to meet continuous improvement goals, additional demand, and/or new products and services. A benefit-cost analysis for each alternative supply plan should consider the plan over a base period plus the costs involved in growing these capabilities over an extended forecast horizon. One way to measure a plan’s flexibility is to measure the baseline level of customer service, output capacity, and quality in the optimized supply chain and then calculate the incremental costs of increasing each factor. A mathematical analysis called a sensitivity analysis can help make this determination. For example, if the supply plan is

capable of fulfilling 96 percent of customer orders within 72 hours but long-term strategy calls for increasing these amounts to 98 percent of customer orders or filling them within 48 hours, the costs to make these changes can be quantified by their incremental increase. These tests could result in plan changes or in contingency plans. For example, a supply plan could include different contingency plans for increasing customer service without significantly changing the supply plan strategy: Increase customer service by increasing planned safety stock levels. This strategy increases inventory costs but is a flexible solution. Increase customer service by adding more warehouses, which has a high fixed cost and reduces system flexibility.

Plan Finalization Plan finalization involves executives (and possibly a broader range of stakeholders) weighing all factors—such as plan flexibility and ability to accommodate growth, the tradeoff between service levels and total system costs, and alignment with corporate mission and culture—and then selecting a final plan from among the competing options. Supply chain managers should develop and present a small number of supply plan options. The plans should be limited to those that can be sufficiently differentiated based on how their priorities are set. The supply chain manager can present the rationale for each option and then make a recommendation. The key is to make the argument in

terms that the audience will understand, avoiding excessive details in favor of graphs or other visual tools to make the key points clear. Once the supply plan is approved by all decision makers, it is just the beginning of plan refinement. After that, the organization researches the supply market as needed. Then, the organization may need to create or refine sourcing categories as well as the category strategy.

Category Strategy and Portfolio Analysis Part of the sourcing process involves determining procurement categories and setting a category strategy. A spend analysis per category may also be conducted at this point.

Categories and Category Strategy A category in terms of sourcing is a grouping of purchased goods or services and the suppliers that provide them. Categories are organization-specific. Categories should be made that the organization finds relevant to the management of suppliers and overall purchasing spend. A category is like a product family used for grouping the organization’s saleable goods and services in that managing purchasing as a category helps add customer value. In this case, it is groupings of goods and services that need to be procured for use in operations, the supply chain, or business administration. Category

strategies add nuance to supply planning by both helping to differentiate the types of things the organization needs and helping to segment types of suppliers into their optimum relationship levels. Specific category managers may be responsible and accountable for specific categories and their subcategories. For example, an organization that makes college textbooks may have the following categories of outsourced activities or purchases: advertising; contract labor (research, writing, graphics design, and editing subcategories); printing; bookbinding; paper/cardboard; ink/toner; maintenance, repair, and operating supplies; logistics; IT; and so on. The categories themselves are also classified in several ways, including by total spend or number of suppliers. A portfolio analysis can also be used, which results in four general item categories: bottleneck, core competency, leverage, and commodity. In addition, supplier segmentation is applied within a given category to see how much each given supplier needs the organization’s business. The type of category plus this information on relative leverage with the supplier are inputs to determining whether suppliers should be segmented as transactional, preferred, strategic, or owned.

Determining Strategic Importance and Related Factors

Determining the strategic importance and other product or service factors is a prerequisite to conducting a portfolio analysis. Strategic importance depends on cost, quality, delivery reliability, precision, and flexibility. Cost speaks for itself, but cost and quality often are inversely proportional. Quality and delivery reliability are usually measured by number of defects allowed or late orders and are often collectively rated by members of an exchange using supplier history. Precision is measured as degree of variance from specifications. (Small variances in components from different vendors may actually prevent assembly.) Flexibility is the ability of the supplier or manufacturer to deliver in varying quantities when given a specific number of days’ notice. These criteria are strongly influenced by several factors related to the product or service: product factors of strategic importance and complexity and availability factors of the number of suppliers and supply uncertainty. Strategic importance. The primary sourcing consideration is the strategic importance of the product or service. If the company cannot afford to make mistakes, it should produce the item in-house, even if this is more expensive. If the company lacks internal capability, it should form an alliance with one or more companies that can make the item or perform the service. Multiple sources provide a backup. Commodity products, by contrast, are widely available, have little strategic importance, and can be purchased at the lowest available price. This includes modular products and overhead items such as electricity.

Complexity. The next factor is the complexity of the item and of the process steps required to produce it. Strategic alliances may be needed for very complex items simply because of the level of collaborative planning needed to get the item right in the necessary time frame. Examples include military technologies such as missiles. Many contractors may need to form strategic alliances to get all of the components to work together and to provide the appropriate level of security. Airplanes also require alliances for many major systems, although minor systems can be sourced through lowerlevel relationships. Number of suppliers. The number of suppliers available for a product or service can determine how much the company should escalate the relationship. When one or very few suppliers are available to produce a required component, the company may need to form a strategic relationship in order to guarantee continued availability of the item. For example, Canon is one of the only producers of high-quality engines suitable for use in laser printers, so Hewlett Packard has a strategic alliance with them for this part even though the two compete on printer sales directly. Focusing only on price or time to market with such a supplier would be a mistake. Uncertainty. Finally, supply uncertainty is the risk that the good or service may not be available or may have strong fluctuations in price or quality. Even if there are hundreds of suppliers of finished lumber

on the market, there may be great variability in quality and in precision of milling. If a manufacturer that uses this lumber advertises its superior quality of lumber as a selling point, then it shouldn’t simply buy from the lowest-price supplier but should develop a partnership with one or more suppliers who can meet these stipulated levels of quality.

Portfolio Analysis A portfolio analysis is a tool that can be used to segment sourcing into four categories so that the appropriate level of management attention and resources can be applied to the sourcing and procurement processes. If a partnership requires more than one of the intense collaboration levels noted above—for example, when a material is critical to the product’s quality or there is uncertainty about an item’s availability— then the need for higher collaborative intensity can be termed as “high strategic importance.” Strategic importance can be considered one half of the overall equation. Difficulty, which includes the supply chain challenges of complexity, number of suppliers, and uncertainty, is the other portion of the equation. Exhibit 3-7 shows how a portfolio analysis creates four basic categories of goods.

Exhibit 3-7: Portfolio Analysis

Source: Adapted from Designing and Managing the Supply Chain, third edition, Simchi-Levi et al.

This model can be used to determine which suppliers are most appropriate for each of the four types of goods or services: Commodity materials and services are of low strategic importance and low supply chain difficulty. They require suppliers whose priority is cost reduction. These items are best purchased at arm’s length with little negotiation. Which of your suppliers can provide the best cost reduction on the commodity items you need? A key strategy here is to simplify and automate the procurement process for these categories. Rationalizing or rightsizing the supply base is also important.

Bottleneck materials and services are of low strategic importance but are of high supply chain difficulty. A key strategy is to ensure that the need for these items is fulfilled. Therefore some level of ongoing relationship with a particular supplier may be vital. Another goal can be to eliminate the bottleneck by finding or developing more potential suppliers. Leveragable materials and services have high strategic importance but low difficulty. The key strategy for these highpurchase-volume materials is to determine a set of preferred suppliers one can work with over time to get high and increasing levels of quality, service, objectives compliance, and cost improvement. To achieve these goals, collaboration will be needed to optimize both cost savings and reliability. While consolidation is desirable, one should maintain a healthy amount of competition. Other options include exploiting market cycles or bulk purchasing by multiple members of the supply chain. Direct/core competency materials and services are of high strategic importance and high difficulty. The key strategy for these goods and services is to form strategic partnerships for longer periods of time to ensure availability and quality. Great suppliers get an increased role in design and more business volume. This area requires detailed negotiations for contracts and contingency plans.

Sometimes companies do not heed these factors and end up buying at arm’s length to get the lowest price for items that are critical in one or more of these ways. Sometimes the cost of the process of checking goods for defects or repairing them or for resolving problems with customers after resale is quite a bit higher than the cost savings found by switching from supplier to supplier. Some damage to reputation may be irrevocable but hard to measure. Companies must add these costs to the cost of the product when determining how much they are actually spending.

Segmented Sourcing Strategy Treating some sourcing relationships as strategic priorities and sourcing all over the globe have increased the complexity of purchasing. From the purchasing organization’s perspective, what were once routinely one-time transactions may now be recurring relationships that must be planned, monitored, and measured for their impact on business goals. The best supplier may not be the one that offers the lowest price but rather the one that can collaborate with the purchaser to achieve multiple, interrelated business goals while still offering a desirable total cost of ownership. A segmented sourcing strategy creates a set of segments for suppliers. A supplier in a given category can be in a transactional, preferred, strategic, or ownership segment. In addition, strategic

relationships can have subtypes. Before we explore these types in more detail, we discuss an additional analysis that needs to occur related to how much the supplier needs you as a customer.

How Much Does the Supplier Need You? In addition to determining how much you need a particular type of supplier based on product portfolio classifications of commodity, leveragable, bottleneck, and core competency, it is also important to determine how much each specific supplier in a given category needs the organization as a customer. This is determined by two factors: Alignment of your purchases with their strategy. If your purchases are the core thing the supplier sells and wants to sell in the future, you are more important. Other clues include suppliers offering new products or technologies or being responsive to your changing requirements. Percentage of the supplier’s business. According to Monczka, et al., in Purchasing and Supply Chain Management, a customer is considered more important if they represent at least five to ten percent of the supplier’s business. Related factors include the profit margins that sales to the customer provide, if multiple supplier locations work with the organization, if they provide goods in multiple sourcing categories, or if they are small and need to highlight the customer’s business in their marketing materials.

As shown in Exhibit 3-8, these criteria can be compared on a customer desirability matrix to create four quadrants of customers: core, nuisance, development, and exploit.

Exhibit 3-8: Customer Desirability Matrix

Source: Adapted from Monczka, et al., Purchasing and Supply Chain Management, 7th ed., which cites Aberdeen Group.

If you are aligned well with a supplier’s strategy and are a large share of their business, then you are a core customer. The supplier will make investments to keep you. If the opposite is true for both of these perspectives, you are a nuisance customer. The supplier will not make investments, and you may be ignored. When your account is attractive to the supplier but you do little business with them, you are a development customer. The supplier will work to increase their business with you. Finally, if you are not attractive to the supplier but

do a lot of business with them, you are an exploit customer. This type of supplier may raise prices or cut services since you are not part of their long-term plans. The combination of the analysis of how much you need them plus how much they need you then results in the choice of the appropriate supplier segment.

Supplier Segments Supplier segments range across a spectrum of buyer-supplier relationships. At one end of the spectrum (shown in Exhibit 3-9) is the traditional transactional supplier segment, or “buy on the market.” The next segment is preferred suppliers. These suppliers receive significant spend, which creates some business continuity risk. Preferred suppliers need to be committed to continuous improvement. The strategic relationships segment is next. This segment needs to be a core supplier in terms of how much they need you. Also, what is sourced is a core competency material. Detailed contracts are needed due to the significant risks. At the far end is the ownership supplier segment, or the translation of external supplier relationships into purely internal processes via ownership through mergers and/or acquisitions —a relationship with others essentially becomes a relationship with oneself.

Exhibit 3-9: Spectrum of Possible Business Relationships

Any of these relationships can be global in nature. In developing supply plans, organizations must decide on the optimal type of relationship for each product or component for which a “buy” decision (or “make” in a merger/acquisition) is made. Note how each of these segments corresponds to one or more relationship types.

Relationship Types Exhibit 3-10 compares supplier relationship types according to five variables: Proximity (How long is the relationship? How narrowly defined is it?) Visibility (How much information sharing is occurring? What type of information is being shared?) Suppliers’ interaction with competitors (Do they work with many competitors as their clients or have some level of exclusivity with you?)

Communication (At how many points do our organizations touch and communicate with each other? How much trust exists?) Culture (Is there any attempt to share cultures or influence the other culture?) Exhibit 3-10: Characteristics of Different Types of Supplier Relationships Relationship

Characteristics

Proximity

Visibility

Interaction with Competitors Communication

Culture

Transactional: buy on Arm’s the market length

Technical Significant requirements of purchase

Computerized interaction

Preferred: ongoing relationship

Some sharing of goals and tactics

Some

Through Awareness designated of culture contact points such as account managers

Full sharing of goals, strategies, and tactics

Limited

Increased interaction between related departments; some degree of trust

Mediumterm contracts

Strategic: partnership Longerterm contracts

Strategic: Long-term Full sharing Limited or collaboration/strategic relationship of goals, none alliance strategies, and tactics and attempt to reflect partners’ plans in their own

Not an issue

Awareness and adaptation to each other’s cultures

Extensive Merging of communication; cultures high levels of trust; enforced via contracts and licensing

Relationship Ownership: mergers and acquisitions

Characteristics Ownership Full sharing of goals, strategies, and tactics as internal, commonly held information

None

Varies

One culture

Buy on the Market In the “buy on the market” approach to purchasing, organizations buy in response to immediate needs, choosing freely from among all the vendors that can meet those needs. There is sharing of technical purchasing requirements (e.g., specifications and proposal components) rather than strategies or plans. The relationship is transactional and not ongoing. It is also not exclusive. The purchaser may be buying from competing vendors either simultaneously or sequentially. There may some communication of information electronically (e.g., billing, change orders). These are lower-value relationships, with smaller levels of involvement by both parties. Ongoing Relationship An ongoing arm’s-length relationship with traditional suppliers involves repeated transactions, perhaps regulated through medium-term contracts and designation as a preferred supplier. The supplier may

learn enough about the purchasing organization to suggest opportunities. Communication is funneled through an account manager who adjusts to the customer’s culture and way of doing business in all interactions. The company may also define a set of criteria to certify some suppliers. Partnerships Partnerships use longer-term contracts. A supplier partnership is “the establishment of a working relationship with a supplier organization whereby two organizations act as one” (APICS Dictionary, 16th edition). The length of the relationship creates opportunities for increased understanding of each other’s organizations and increased efficiencies through greater communication and more value-added services. Business with the competition is minimal. Collaboration/Strategic Alliance According to the Dictionary, a strategic alliance is a relationship formed by two or more organizations that share information (proprietary), participate in joint investments, and develop linked and common processes to increase the performance of both companies. Many organizations form strategic alliances to increase the performance of their common supply chain.

This alliance is a long-term arrangement that sometimes operates under blanket agreements or blanket purchase orders rather than by individual purchase orders. Blanket purchase orders are discussed more elsewhere. The suppliers are fully aware of the purchaser’s goals and strategies and work with the purchaser to develop and implement complementary tactics. Contact points exist throughout the organizations, and information flows in an unrestricted manner between the two business entities. The trust level is high, and there is a greater level of involvement by both parties. Either to enhance the collaboration or because the two organizations share similar values, the culture of the supplier may evolve toward that of the purchaser. Mergers and Acquisitions In this type of relationship, suppliers are folded into the purchasing entity. Business goals are shared; business areas participate in setting strategy and planning integration of capabilities, processes, and information. Competition has been eliminated. The level of trust, communication, and shared values will vary, depending on the effectiveness of the merger. Some divisions in merged companies retain separate processes and a separate culture that detract from full communication and trust.

Topic 2: Supply Base Analysis and Right-Sizing Supply base analysis helps determine which categories of purchasing would provide the greatest cost savings because there is significant room for improvement. This information helps with supply base rightsizing, such as consolidating to fewer suppliers.

Supply Base Analysis A supply base analysis involves using a spend analysis to determine what categories would provide the greatest room for optimization and then conducting supply base market research to better understand the nuances of the given categories being analyzed.

Spend Analysis A spend analysis is a review of all purchases that the organization makes during a period. It is typically a retroactive review of the prior year. The process can include assessing whether the amounts paid resulted in the right amount of goods and services (i.e., records are accurate, which is important for financial compliance), which suppliers got more of the spend than others, whether classifications such as preferred suppliers were honored, whether departments adhered to their budgets, and whether some different way of consolidating spending with various suppliers would reduce total marketing spend.

Data preparation is key to a spend analysis. This includes consolidating supplier databases (perhaps across different business units or acquired organizations), reviewing the database for duplicates or other issues to be corrected, and ensuring that category and subcategory descriptors for suppliers are correctly assigned. The supplier list is sorted by category, and from there the list is sorted from highest to lowest amount of spend to find the total spend by category. Note that this is often done in a spreadsheet, and tools such as a pivot table function can enable sorting both by category and category spend. These data can be used to create a Pareto chart, which ranks the top spending categories from highest to lowest, as shown in Exhibit 3-11. This process helps sort out the vital few categories (such as the top 10 spending categories) from the trivial many. (Some of the lower categories might be grouped together in an “other” category.) Even a small improvement in how one of the top categories is managed can result in significant savings. Improvements in lower spending areas will not generate the same bottom-line impact.

Exhibit 3-11: Pareto Analysis of Spend by Category (in Thousands)

Another useful Pareto analysis is to sort the data so that the analysis ranks categories from the most suppliers per category to the least. This analysis can reveal areas where the most benefit can be had from a supplier right-sizing review. Focusing on reducing suppliers in categories with the most suppliers can reduce administrative costs and enable getting price discounts for giving other suppliers more business. A third Pareto analysis is to sort the data so it shows the average spend per supplier by category, but this time the ranking should be from lowest to highest average spend. This is because the vital few to manage are the categories that have low average spend per supplier. This will complement the prior analysis by showing categories that could benefit from increasing the volume of business per supplier and/or consolidation of suppliers.

The results of a spend analysis can be used for supply plan refinement, such as by determining which categories need a prioritized review. Focusing improvements on areas that can return the most savings while maintaining acceptable levels in other criteria such as quality and risk will provide the most value for the investment.

Supply Base Market Research Supply base market research starts by gathering internal information on projected demand for the categories being analyzed. This starts with demand forecasts for the products or services that use the given categories. Be sure to consult with internal stakeholders regarding new product introductions or other new sources of demand for the category. The data on demand for end units then needs to be translated into demand for the given supply category. Next, existing suppliers in the category are reviewed. This includes data from the spend analysis such as total annual purchase volume from a supplier, what percentage of the category spend this is, and other details, such as the percentage of business unit spending this represents. Other data on the supplier may be located in the supplier relationship management database. Once the researchers understand historical demand from the prior year, forecast demand for the upcoming year, and how well a given supplier has performed, it is time to start interviewing key supplier representatives, who are often the best sources of market research.

This should include salespersons, line managers, and even their purchasing staff. Determine the degree of capacity they could commit in the next year, and also ask them about the state of their market. Supply base market research also requires looking at the external market to determine what other suppliers are out there, to validate information on existing suppliers, and to better understand market conditions such as commodity price trends, technology trends, or upcoming regulatory changes. Sources of external information could come from an expert supplier or consultant who knows the category well. Networking can also reveal additional experts to consult. Published research can be purchased or could be publicly available if from a government source. Trade journals, supplier annual reports, textbooks, trade conferences, and internet research are also useful. It is important to determine whether such sources of information are too dated to be useful. Finding great sources of market intelligence can convey a competitive advantage and so could be worth a significant investment, such as by commissioning a new study from a trusted market research firm. The key is to get corroboration on any market predictions from multiple sources. Decisions on sourcing can require significant investment, so it is important to get ample justification to support a given set of assumptions.

It is also important to determine what information is the most important to present to decision makers and present just that information in an easily digestible format such as a slideshow or a dashboard.

Supply Base Right-Sizing Supply base right-sizing or rationalization involves a review of the suppliers in a category to determine the ideal number. Using a different number of suppliers or a higher quality set of suppliers could provide cost savings or other benefits. Usually this involves finding categories with too many suppliers and reducing that number by awarding the business to fewer, more preferred suppliers, especially those who are willing to provide volume discounts or to commit to ongoing cost improvements or deeper relationships or who can provide a full-service range of products or services. Note that in addition to improving the quality of remaining suppliers (and having fewer costs of quality) or getting quantity discounts, another key cost-saving opportunity is in administrative costs. Ordering costs and supplier relationship management costs (including problem remediation) will be much lower when fewer suppliers are used. More time can be spent on each supplier when fewer suppliers exist, and this can enable more collaborative relationships. Different approaches can be used to determine which suppliers to omit and which to retain. A Pareto analysis can be done, and the top 20

percent of suppliers by category spend could be those retained. A set of more rigid supplier requirements could be rolled out to all suppliers with an ultimatum to meet the requirements or be dropped. A triage approach could be used to evaluate suppliers and place them into categories such as unacceptable, minimum qualifying, and world-class performance. A competency staircase approach could be used, which involves setting a series of more and more difficult hurdles for suppliers over time. A key benefit of some of these methods is that the initiative can be used to end contracts with suppliers who have poor performance records or who cannot achieve best-in-class performance. When suppliers who currently a have low volume of business are among the first to be eliminated, this has the benefit of being fast and easy to do, but it is a risk because some of these suppliers may be well worth a greater investment. Research is needed to mitigate this risk. A SMART (specific, measurable, attainable, relevant, and time-bound) goal should be set, such as reducing the number of suppliers used in the given category by 25 percent over six months, saving $X dollars of purchasing spend. The amount of the reduction should not be arbitrary but instead be based on an assessment of what is the ideal number. Specifying an appropriate time frame is important because in addition to being a measurable goal, ending supplier contracts may require allowing some contracts to expire if other contractually allowed exit criteria have not been met.

While cost reduction is typically the top priority in these endeavors, other organizational goals might also be accommodated, such as prioritizing use of local suppliers or retaining suppliers who meet sustainability objectives. However, one organizational goal that may be difficult to accommodate using this strategy is risk reduction. The number of remaining suppliers in a category needs to be enough to enable continuity of supply, maintain competition in sourcing, avoid becoming too dependent on one or a few suppliers, or risking lack of available capacity. This is why the ideal number of suppliers is not always a lower number. A supplier right-sizing initiative can work well with outsourcing or offshoring initiatives. After all, the lowest cost or best-in-class suppliers for a given category could be located anywhere. While contracting out will increase total sourcing spend, right-sizing initiatives are more concerned with the efficiency of individual categories. Right-sizing may be more or less difficult at different points of a product’s life cycle. During growth or maturity, there will often be many suppliers, and so this is a key area of focus. However, right-sizing from the start can help avoid many problems in the first place. For example, if a supplier is involved in product design or prototyping, the supplier will be “locked in” to some extent, even if a final contract has not yet been signed for supply of the final material. Involving supply management earlier in new product development can help ensure that

the right set of suppliers is selected in the first place, before the supplier has too much negotiating leverage. Supply base right-sizing could also occur by redesigning products or services to require fewer or different materials. Efforts to reduce product complexity could result in an entire category of purchasing no longer being needed. Supply base right-sizing is a continuous endeavor. In addition to there being new categories upon which to focus improvement attention, the needs of the organization are continually changing, so new categories can be formed at any time. Finally, any system that is not continually monitored can go back into its old ways. Supply bases grow too large one new supplier at a time. Better enforcement of procurement policies such as use of preferred suppliers can help slow this type of efficiency degradation.

Section C: Product Design Influence This section is designed to Describe the design process and identify the contribution of design to product and delivery costs Describe the levels of supplier involvement in product design and explain the trend toward supplier integration Contrast traditional over-the-wall design with collaborative design for the supply chain Explain the features, benefits, and tradeoffs of various approaches to design, including design for logistics and design approaches that focus on standardization, modularization, simplification, customization, quality, and sustainability. Influencing product design is a supply chain manager’s chance to get things right from the start. An efficient supply chain needs products that are planned, sourced, made, delivered, returned, and enabled with the needs of each of these stages in mind. They may also need to satisfy other goals such as for sustainability. Supply chain managers can help decision makers see that the most

effective and least costly time to do this is when the product is being designed.

Topic 1: Product Design The big picture related to product design is all about how the design process should be collaborative, involving all the functions and partners that are impacted by the product’s design. However, in reality, sometimes the design of a product or service is carried out in isolation by one or two departments and without involving supply chain partners. Traditional design takes this over-the-wall approach. After this discussion, a number of important product design methods are addressed here, including broad-based methods and those that focus on standardization, modularization, and simplification.

Product Design Road Map Product design is a “process [that] consists of translating a set of functional requirements into an operational product, process, or service” (APICS Dictionary, 16th edition). Design spans all the work between marketing and production. Depending on the industry, the business, and the product, design may involve models and prototypes as well as sketches and plans.

Automobiles are sketched, rendered as models, and constructed in prototype for test driving and are subject to design revision at each step in the process. Each component of the finished vehicle must be designed with more than looks and function in mind but also raw materials, sourcing, manufacturing, labor costs, and regulations regarding safety and environmental impact. Services, too, go through a design phase. Investment portfolios, for example, were once custom-designed for wealthy clients. Today, prepackaged mutual fund portfolios tailored to specific customer desires and sourced from “raw materials” such as stocks, corporate and government bonds, and traded commodities are marketed to a much wider customer base. Bank accounts, guided tours, and personal services such as manicures are all similarly subject to careful design and packaging to make the best use of resources and provide benefits customers desire. Is good design important? Expenses related to design account for about 5 to 15 percent of product cost. But about 70 percent of delivery cost results from choices made during design. A poor design process can kill a product by forcing its price to unacceptable levels for the quality delivered or by slowing its design cycle and time to market until the competition has the market share.

What aspect of product design needs to be considered when designing a supply chain? The answer is every aspect—because the traits and features of every product will impact the supply chain process in some manner. Design has implications for all the stakeholders in the supply chain, and it should be approached with the supply chain’s key indicators in mind. Before comparing the traditional design process to a collaborative design process, let’s begin with the end in mind. The end is a welldesigned product that customers consider a great value. Attributes such as the following make up that value: Functionality, which is all about the fitness for use or ability to satisfy customer requirements. Since customers might want very different things, it is important to carefully define what customer segments you want to satisfy. Validity, which can be thought of as the ratio of desired functions to unimportant functions for a given customer segment, relative to the price. Some functions are more targeted to some customer segments than others, so the risk here is trying to be all things to all people and then having to charge so much that no one sees value. Efficiency, which is about the ability to be efficient in the design, manufacture, and distribution of the product so the price can be

low enough to provide value and profit and time to market can be short enough to enable capturing market share. Quality, meaning the product is reliable enough, maintainable enough, available when wanted, and so on. This is also a value judgment relative to price and alternatives. Serviceability, which is the ability to maintain the product to keep it useful over its expected life, such as upgrades to firmware/software, availability of spare parts, or selfdiagnostic/self-service capabilities. Returnability/recyclability, which is how well warranties and return policies/processes are designed and how sustainable the product is at the end of its life.

Traditional Design Process The traditional sequential design process, once almost universal and still used in some companies, incorporates the corporate organization of separate functional areas separated by imaginary walls. This process often goes like this: Marketing sends customer needs and attitude information to engineering along with information on target pricing. Engineering incorporates the information into design drawings and schematics and “tosses those over the wall” to production and purchasing, perhaps having created a design incorporating the finest materials and extra engineering features.

Purchasing sources the materials necessary for production, discovering that some specified parts are not available and others are not affordable. Production looks at the design and realizes that it would require expensive process modifications and costly additions to staff and equipment. Production and purchasing send the designs back to engineering for revisions. After several rounds of sending the designs back and forth to various areas, engineering delivers a workable design and production creates a product that logistics is expected to deliver. Logistics discovers that packaging and shipping costs exceed the original budget and that the system lacks capacity to get the product to market on time. And so it goes until the finished, packaged product arrives at the distributor. This traditional process can result in problems being unknowingly built into the product design. For instance, certain product designs may increase inventory holding or transportation costs relative to other design options, while other designs may require a shorter manufacturing lead time than is feasible.

Collaborative Design Process

Collaborative design breaks down walls between departments and supply chain partners. Here’s how the design team project commonly unfolds: A design team forms, including members from engineering plus other departments and, perhaps, other supply chain partners. The design team considers issues that will arise along the supply chain from raw material to the final stage of the product’s life cycle, making rough approximations of cost differences between alternatives. Once all functions and partners have agreed upon a design, engineering, purchasing, and production go to work to bring the design to fruition. How Much Collaboration? Because organizations can choose the level of involvement they desire from any given supplier or customer, collaborative efforts in product design extend along a continuum. expresses the range of supplier or customer integration as going from over-the-wall design, to informal collaboration, to formal collaboration.

Exhibit 3-12: Spectrum of Approaches to Design

Once the decision is made to forego the over-the-wall approach and instead develop a collaborative approach to design, the question becomes “How much collaboration?” Contributions can be as casual as tips provided in conversation or as formal as fully integrated interorganizational teamwork with assigned roles and responsibilities. In a study of supplier integration funded by the U.S. National Science Foundation and the Global Procurement and Supply Chain Benchmarking Initiative at Michigan State University, researchers identified several general levels of supplier integration and assessed the value of each. The results of a survey conducted during the project showed that greater levels of supplier involvement produced, on average, greater improvements in cost and quality. While one study doesn’t constitute a definitive analysis, it’s fair to say that the trend in designing for the supply chain is toward formal

supplier collaboration and away from the over-the-wall and informal approaches. This is true for the involvement of customers in design as well. Involving representatives of key customers in design or collecting the broad input of many smaller customers using the voice of the customer and other methods will benefit from a formal process to ensure that customer requirements and expectations are represented in the design. It makes sense that the more functions and partners contribute to a design, either casually or in formally organized teams, the better chance you have of getting a product or service that is actually desired by the market into production at a reasonable cost and on time. Note that while suppliers or customers may be asked to be part of a design team, the organization whose brand is at stake should retain responsibility for the overall design rather than allowing anyone else to take the lead. Implementing Design Collaboration Busy managers have tight deadlines, and designers and marketing managers often have performance scorecards that fail to reward supply chain cost reductions. Therefore, a process is needed to gain both internal and extended partner acceptance for design process improvements.

Cargill and Fry describe such a process used at Hewlett Packard, which is paraphrased here: Proof of concept. Small projects are performed, harnessing experts and internal staff to test the concept. Successes are celebrated and internally advertised. Simple graphics are used to make the goals easy to understand and accept. Formalize concepts. Terms are standardized, concerns are addressed, case studies are shared, and formal training and online at-will training are created to educate staff and partners. Formalize processes. Cross-functional teams are created, and individuals are assigned to work a percentage of their time on the teams. Performance metrics, scorecards, and rewards such as formal praise are implemented. Experts are made available. Prioritize opportunities based on best value to encourage adoption. Concepts that have proven the most effective are pushed to other teams. In this way, internal teams and external partners can be led a step at a time toward appreciating the financial and other benefits of collaborating on design, finding real ways to make these concepts work for them, and finally incorporating collaboration into normal

processes so that efforts can turn to sustaining and continuously improving the effort. Benefits of Design Collaboration Integrating suppliers and customers into the design process provides many potential benefits, including those that follow: Fewer cost overruns. Collaboration with the supplier brings greater clarity about manufacturing processes and materials, reducing the likelihood that designs will be impractical to manufacture. Collaboration with customers can help prioritize which design elements to include or exclude. New and improved approaches to design. The supplier brings special expertise in processes, materials, and technologies that can give the designers new ideas and avoid problems caused by reliance on expensive or hard-to-find parts. Customers can indicate if a new process would be perceived as value-added. Improved customer satisfaction. Collaborating with the supplier in the testing of prototypes, models, and preproduction samples reduces the number of product failures. Involvement of customers aligns products with actual customer needs.

Improved efficiency (faster to market). The supplier’s experience in manufacturing and logistics can lead to products that are more easily manufactured, assembled, shipped, and stored. Customer involvement can keep the focus on actual requirements. Higher product quality for the price. Sharing quality requirements with the supplier before final selection of parts and processes results in higher quality and more affordable pricing. Customers can indicate the price/quality level they are willing to pay for. By including perspectives such as those of marketing, production, and supply chain management, designers can develop products that are better matched to customer needs, cheaper to build, easier to transport and store, and easier on the environment. provides a summary of various approaches to design collaboration. These include both broad-based and more specific methods. Note that quality, customization, and sustainability are addressed in a different area.

Exhibit 3-13: Summary of Design Methods

Broad-Based Design Methods There are a number of broad-based approaches to product design, all of which are focused on improving different aspects of the supply chain design. We’ll take a closer look at three broad-based design approaches: design for the supply chain, design for logistics, and design for X (excellence or everything).

Design for the Supply Chain Design for the supply chain refers to “enhancement of a firm’s product design in consideration of the issues that will arise in the supply chain, from raw materials to the final stage of the product’s life cycle” (APICS Dictionary, 16th edition).

The need to meet supply chain goals of faster inventory turnover, lower inventory costs, reduced inventory transit time, and quicker time to market has inspired modifications to the design process. Design for the supply chain incorporates concepts of design related to supply chain standardization, simplification, customization, quality, and sustainability, each of which is discussed in its own area.

Design for Logistics A term closely related to design for the supply chain is design for logistics (DFL). Adding logistics to the design agenda assumes that the supply chain and the product are designed simultaneously to optimize efficiency, affordability, and quality. Design for logistics is concerned with minimizing supply chain costs by Designing to minimize transportation and storage costs: efficient packaging for fast loading/unloading and higher density of items per pallet Designing to minimize manufacture and assembly time Designing to maximize standardization. The first of these principles is discussed next, while design for manufacture and assembly and standardization are discussed elsewhere.

Design to minimize transportation and storage costs may involve designing products to fit into standard box sizes (full size, half size, quarter size, etc.) so that different boxes can fit in a master carton or on a pallet efficiently. This process is called unitization or containerization. For example, four six-packs of beer can be designed to fit into a master carton that holds 24 cans and stacked along with 24-packs. This process allows different assortments to be shipped together. Master carton design should also facilitate loading and unloading by hand without mechanical assistance when feasible. Changing product designs and how items are packed can also reduce overall box sizes. For example, designers could reinforce a product’s internal frame so it requires less cushioning material or store a cable within a printer output tray instead of increasing the packaging. Such size reductions can have huge cost savings, for example, being able to fit an additional row of goods on each pallet. Examples of design for logistics abound in retail stores. Plastic garbage pails that can be stacked one inside the other are a result of DFL. Since they are made of plastic rather than metal, they are lightweight for ease of transport. When nested, they occupy much less storage space and are more economical to ship. Many other products now come in kit form for similar reasons. Ikea’s products,

for example, are shipped unassembled in flat cartons for efficient handling and storage. One unit in each size can be set up in the store for viewing, and customers have easier transportation home. The customer home is the final manufacturing work site. Benefits Benefits of the transportation and storage component of design for logistics include the following: Lowering transportation and warehousing costs increases profit margins. Warehouses can store more goods, relieving capacity pressures. Recognizable master carton design helps retailers when looking for a particular item to restock from storerooms. Packaging design can allow some retailers to sell directly from a pallet. Tradeoffs Tradeoffs of the transportation and storage component of design for logistics include the following: Maximizing items on a pallet needs to be balanced against the needs of retailers; slow-moving goods may not be desired in larger quantities. Product requirements may make standard box sizes problematic.

The density of items may need to be altered to balance between maximum vehicle volume (“cube out”) and vehicle weight restrictions (“weigh out”).

Design for X (DFX) The Dictionary defines design for X (DFX) as follows: Also referred to as design for excellence, a design process that ensures the outcome is manufacturable, maintainable, cost effective, and high quality. Design for X is sometimes called design for everything to describe a need to design a product or service with all of the design considerations that an organization determines are of strategic importance. For example, a particular organization could decide that its critical design goals include universality, design for manufacture and assembly, quality function deployment, postponement, and design for reverse logistics. Each organization will set its own priorities.

Standardization and Modularization Standardization is “the process of designing and altering products, parts, processes, and procedures to establish and use standard

specifications for them and their components” (APICS Dictionary, 16th edition). A related term is standardized product , which is “a product that can be made in large quantities, or continuously, because of very few product designs” (Dictionary). When the standardized product is production equipment, it is called procurement standardization, meaning that equipment is designed to allow for design variance and adaptation to new customer demands. Standardization works hand in hand with modularization, which is the standardization of product components into modules that can be assembled into a wide variety of products that are still essentially standardized. An important step for design teams to take when pursuing standardization and/or modularization is to look at existing product families. Creating a common component or module that will work for an entire line (or using one that was already created for those lines) will multiply the savings from standardization. For example, when Hewlett Packard merged with Compaq, it found that its server racks had incompatible shapes. Customers didn’t place any value on the difference. Hewlett Packard reduced this number to from 12 to five types of kits, for an estimated product lifetime savings of US$32 million.

Types of standardization or modularization include modular design, component commonality, and universality.

Modular Design A module is a part that can be used in multiple products. According to the Dictionary, a modular design strategy is planning and designing products so that components or subassemblies can be used in current and future products or assembled to produce multiple configurations of a product. Modular design is also called modularization. The Dictionary defines modularization as follows: In product development, the use of standardized parts for flexibility and variety. Permits product development cost reductions by using the same item(s) to build a variety of finished goods. Modular design is a type of component commonality, and the terms are sometimes used interchangeably. In addition to design for component reuse, modular design can start by considering existing products on the open market to avoid design and manufacture costs for those parts.

Computers provide a perfect example of modularity. RAM, hard drives, and graphic and audio subsystems are interchangeable among many different computers. Some computer parts—hard drives and RAM, for example—can be added to a machine as upgrades, or they can be replaced with new, improved components. Modular bookshelves that can be stacked vertically or integrated horizontally to fit different spaces provide another example. The opposite of modularity is integral design, in which all components are designed to work together in one specific product. Apple computers focus on integral design, while PCs are modular. Clothing can also illustrate the two types. Trousers, shirts, ties, and sport coats can be mixed and matched because they are modular. A uniform, on the other hand, is an example of integral design. Services can be modular, too. An à la carte menu exemplifies modular design; the special of the day, with all courses determined by the chef and the price set by the house, is an integral design. Breaking down a process can allow various components to be outsourced. For example, some McDonald’s restaurants rely on (possibly offshored) call centers to take drive-through orders to decrease the time involved in filling orders. The call center relays the order to the kitchen with a customer photo to assist in accurate delivery at the drive-up window.

Benefits Benefits of modular design include the following: Reduced cost of design and manufacturing when using modules to create a family of products, possibly leveraging postponement strategies Increased efficiency and decreased cost of production, since multiple products can be created simultaneously from the standard components Expanded customer base, because products can be customized closer to the end user (and sometimes by the end user) Easier, more cost-effective shipping, warehousing, and display of the product if it is designed with packaging in mind (e.g., boxed furniture kits) Tradeoffs There are potential tradeoffs involved in taking a modular approach to design: While modular design may reduce logistics costs, the cost of each product in a family may go up. Errors in module assembly can create a poor end-user experience. Integral design generally allows more emphasis on style, beauty, quality, “fit and finish,” user experience, and customization. Costs

can be higher, but it can be a source of competitive differentiation so a higher price often can be charged.

Component Commonality Component commonality is a form of design standardization where a single part is used to replace a variety of similar parts. For example, instead of using a variety of bolt sizes in an assembly, the assembly can be designed in such a way that the same size bolt will work for all purposes. Benefits Common components can increase efficiency and lower costs in several ways: Lower purchasing costs because less variety allows economies of scale Streamlined production because of fewer process and tool changes Simpler, cheaper storage with less room for errors Tradeoffs Tradeoffs include the following: Cost of product modifications required to accept the new part Less flexibility for designers, who may prefer a variety of similar parts

Less quality if the greater variety of parts would, for example, allow closer tolerances or more attractive design

Universality Universality is “the strategy of designing a product initially intended for one market in such a way that it can also be sold in other markets” (Dictionary). Being a form of standardization, “one-size-fitsall” items exemplify universal, or standardized, design, as do unisex clothes. Sometimes astute marketing can convert a specialized product into a universal one. For example, restaurant-quality kitchen appliances have become popular in homes. Universality can be used for product components, too. For example, power supplies can be made to accept either 110 or 220 power for use in different countries with only a different end cable. Benefits Benefits of universal design include Increased sales volume Reduced design and manufacturing cost compared to marketspecific items. Tradeoffs Universal designs may be less suited to any given market than a specialized product would be. This can translate to a shorter product

life cycle and less customer loyalty.

Simplification Simplification is “improving quality and cutting costs by removing complexity from a product or service” (APICS Dictionary, 16th edition). Less complex products and services have shorter lead times, fewer quality issues, and higher profit margins. Simplification provides synergy with other design approaches such as standardization or customization as well as with manufacturing approaches such as build-to-order. Types of simplification include concurrent engineering, design for manufacture and assembly, and design for service.

Concurrent Engineering (CE) One of the first steps along the path toward supply-chain-oriented design is sometimes called concurrent engineering (CE). Originating in the 1980s, CE has also been called simultaneous engineering or participative design. Whatever the name or particular tactics, concurrent engineering starts from the premise that the product design processes can be shortened and simplified when stakeholders other than just engineers contribute. Variations on that theme are known as early manufacturing involvement and early supplier involvement (ESI). Manufacturing and supplier

representatives can be on a design team together, plus marketing and sales, service, and purchasing. Benefits Benefits of concurrent engineering include the following: Emphasizes design collaboration Shortens the design cycle when events are parallel rather than sequential Can use collaborative design tools such as interactive design tools for virtual meetings Tradeoffs Concurrent engineering has been replaced by more complete methodologies such as design for manufacture and assembly.

Design for Manufacture and Assembly According to the Dictionary, design for manufacture and assembly (DFMA) is a product development approach that involves the manufacturing function in the initial stages of product design to ensure ease of manufacturing and assembly. DFMA is essentially a further development of concurrent engineering. A related term in the Dictionary is design for

manufacturability , which is the “simplification of parts, products, and processes to improve quality and reduce manufacturing costs.” DFMA acknowledges the benefits of including suppliers, manufacturing engineers, and warehouse managers responsible for assembly in the design process. When these other stakeholders review the design as it is being created, they can draw upon their experience and firsthand knowledge of existing manufacturing/assembly processes to catch unrealistic assumptions about production while design change is relatively easy. (Correcting flawed design assumptions is much more costly and time-consuming after the design has been completed.) The result is a high-quality product that remains affordable and is ready for market quickly. The goals of DFMA are as follows: To select materials for ease of production as well as product function To design components so that they do not require extremely tight tolerances To reduce the number of parts To reduce the number of instances parts need to be handled To use concurrent and parallel processing to reduce work-inprocess time To make assembly obvious and easy

To simplify the process steps for assembly To design in easy product testing For example, a U.S.-based pinball machine manufacturing company followed DFMA principles by creating a completed internal assembly harness that could be rotated 360 degrees, giving troubleshooters access to all of the internal wiring for fast repair when performing product testing. Such innovations help them stay competitive with lower-cost labor markets. Benefits The benefits of DFMA include the following: Confusion, complexity, and variability are reduced, in turn reducing production delays, long setup times, and extensive training requirements. Standards and policies, such as requiring evaluation of existing equipment before resorting to a new production line, can enforce DFMA. DFMA makes use of standardization, such as common parts for product families or off-the-shelf parts, whenever possible. It assists lean philosophies, modular design, and mass customization. Software automates many features of DFMA.

Tradeoffs The main tradeoff of DFMA is that it could be at odds with customer demand and marketing desires if simplifications result in some demanded features being omitted. (Usually these are features that fail to increase marginal profits.)

Design for Service (Design for Maintainability) Design for service is the “simplification of parts and processes to improve the after-sale service of a product” (Dictionary). It is also called design for maintainability. Once a purchase has been made, customers’ opinions of a product often hinge on their most recent experiences with it, so serviceability or maintainability strongly impact customer satisfaction and retention of lifetime customers. For products that require regular maintenance, this may involve changing cartridges, filters, or other replacement parts. Parts that need to be replaced frequently should be easily accessible and replaceable by someone with no training. Even when the parts are designed to be replaced by professionals or service teams, faster service reduces maintenance charges. Benefits Design for service lowers the total cost of ownership. For example, if a facility manager can replace all air filters in a building in a day

rather than two days, it saves the organization a great deal of money over the life of the building. Design for service also extends to logistics, since a ready supply of replacement parts must be available. Replacement parts can be a significant source of profit. If the ordering experience is easy, it can be a source of customer satisfaction. Tradeoffs Design for service may compete with other design goals such as aesthetics or minimizing development cost.

Topic 2: Quality, Customization, and Sustainability Product design methods can focus on quality, customization, or sustainability. Each of these design focus areas has specific methodologies that can be adopted.

Quality Quality is defined by the APICS Dictionary, 16th edition, as follows: Conformance to requirements or fitness for use. Quality can be defined through five principal approaches: (1)

Transcendent quality is an ideal, a condition of excellence. (2) Product-based quality is based on a product attribute. (3) User-based quality is fitness for use. (4) Manufacturingbased quality is conformance to requirements. (5) Valuebased quality is the degree of excellence at an acceptable price. Also, quality has two major components: (1) quality of conformance—quality is defined by the absence of defects, and (2) quality of design—quality is measured by the degree of customer satisfaction with a product’s characteristics and features. In other words, quality is a critical issue in product design and manufacture that can be measured and controlled in multiple ways. Methods of incorporating quality into design that are discussed next include design for quality, design for six sigma, and quality function deployment. Design for ergonomics would be another example; it is not addressed further in these materials.

Design for Quality The Dictionary defines design for quality as a product design approach that uses quality measures to capture the extent to which the design meets the needs of the target market (customer attributes), as well as its actual performance, aesthetics, and cost.

Design for quality uses a number of measurements to control quality. Each organization will determine the measurements they wish to use and then set requirements for acceptable quality and goals for exceptional quality. Some of these measurements will be subjective, such as for aesthetics. Benefits Benefits of design for quality include the following: Fewer defects reduces waste and increases customer satisfaction. High quality can move the product from an order qualifier to an order winner if the organization’s strategy is to compete on quality. Tradeoffs Tradeoffs of design for quality include the following: Quality may involve significant initial expense. Over time quality usually lowers total costs, but these savings may be hard to trace back to the quality program.

Design for Six Sigma Design for six sigma is defined by the Dictionary as an approach to designing products and processes that attempts to ensure the firm can provide products or services that meet six sigma quality levels. These quality

levels correspond to approximately 3.4 defects per million opportunities. Six sigma is addressed in more detail within the context of continuous improvement.

Quality Function Deployment Quality function deployment (QFD) is defined by the Dictionary as a methodology designed to ensure that all the major requirements of the customer are identified and subsequently met or exceeded through the resulting product design process and the design and operation of the supporting production management system. QFD is more than just a design for quality philosophy; it extends to operations and support functions. However, QFD must start with design by translating customer segment demand data and the voice of the customer into design requirements. QFD uses precise steps and a methodology such as the “house of quality,” which is essentially a comparative spreadsheet that ranks how a product or service stands up to customer wants as well as to what the competition is offering. All of this is translated into a set of technical specifications to meet customer priorities. The philosophy uses group decision making to make sure that conflicts are resolved with the customer in mind.

Benefits Benefits of QFD include the following: Provides all of the benefits of design for quality Improves customer service Shows relative levels of interactions between desired product characteristics so they can be prioritized when in conflict with one another (e.g., light and sturdy or fast acceleration and low gas mileage) Tradeoffs One issue with QFD is that, like any complex methodology, it requires the organization to wholeheartedly champion, adopt, and maintain it.

Customization Customization is a design goal that allows products or product families to be adapted to changing customer demand over time. Customization that requires engineering-to-order has a very high product cost and long lead times. While this is appropriate for some markets, it cannot be profitable for many products and services. Therefore, methods of customization have been developed to harness mass production as much as possible.

Customization methods include postponement, mass customization, and glocalization.

Postponement Postponement , also called delayed differentiation, is defined in the APICS Dictionary, 16th edition, as a product design or supply chain strategy that deliberately delays final differentiation (i.e., assembly, production, packaging, tagging, etc.) until the latest possible time in the process. This shifts product differentiation closer to the consumer to reduce the anticipatory risk, eliminating excess inventory in the form of finished goods in the supply chain. The Dictionary defines product differentiation as a strategy of making a product distinct from the competition on a nonprice basis such as availability, durability, quality, or reliability. With postponement, the basic product or a set of components remains in undifferentiated form as long as possible before being converted or assembled into a customized, or differentiated, configuration. Sometimes differentiation doesn’t occur until the end customer selects the specific components to be assembled-to-order.

Postponement is an excellent example of a push-pull strategy, where the organization designs the product and manufacturing process so that differentiation can be delayed as long as possible. A generic product or set of modular elements is produced at the start of the manufacturing process and, when demand is determined, only then is it differentiated to a specific product (such as by assembling specific modular components). With this strategy, production starts can be based on aggregate forecasts or actual orders. Thus postponement addresses the uncertainty relative to final demand even if forecasts can’t be improved. Benefits Benefits of postponement include the following: Postponement is a countermeasure against the bullwhip effect because it reduces the need for safety stock in multiple varieties. The amount of in-transit (pipeline or transportation) inventory is reduced, lowering insurance and handling costs and increasing cash flow. Materials needed only locally can be locally sourced and produced to assist with corporate social responsibility initiatives. Tradeoffs Tradeoffs of postponement include the following:

Requires process, equipment, product, and packaging redesign capital expenditures Can actually increase costs if there are few varieties of the end product

Mass Customization Mass customization is the practice of moving final product configuration closer to the customer while still maintaining economies of scale in manufacturing. The Dictionary defines it as the use of mass production techniques to create large volume of products in a wide variety keeping production costs low while enabling customized output primarily utilizing postponement or delayed differentiation. A classic example of mass customization is Hewlett Packard’s decision to stop sending completely assembled, regionally differentiated printers from one plant to all geographic markets and instead to ship modular parts to each regional distributor for assembly closer to the customer. Mass customization benefits from modular design, as shown in this HP printer example. The fewer the modules to be shipped, stored, and assembled, the more efficient the supply chain—and the more easily the final differentiation can be accomplished. University

education, investment portfolios, and restaurant meals are all customized for the individual end customer. In fact, the customer may do the customizing. Making mass customization work efficiently depends upon establishing instantaneous communication among the units that build or supply each module. It may also require the availability of considerable expertise at the point of differentiation, either developed in house or developed as a requirement for a 3PL/4PL. In the HP example, the regional distributors had to acquire the equipment and expertise to assemble printers; before this they only had to warehouse and distribute the printers. Mass customization may also require more expertise by employees at the point of sale, since customers may have to be guided in their selection of custom products. Moreover, the retail salesperson may be the final assembler. It takes greater training, and perhaps aptitude, to build items to order in a retail setting than to sell them supplied as a finished product. Benefits Benefits of mass customization include the following: Savings due to economies of scale Increased efficiency and expertise of workers who learn assembly roles

Increased sales volume because of the appeal of differentiated products to different market segments Reduced inventory costs, because aggregation of demand increases the accuracy of forecasts and allows each region to reduce its inventory Creation of semiskilled jobs to benefit local communities Tradeoffs Tradeoffs of mass customization include the following: Costs of investing in equipment and training to enable distributors to assemble the product Potential friction with distributors who don’t want the added tasks Potential for quality issues if assemblers are poorly trained or designs fail to make assembly foolproof

Glocalization Organizations can meet the particular needs and wants of different markets around the globe either by designing new products or services or by modifying or redesigning existing ones. Glocalization is a hybrid term based on the words globalization and localization, coined by Japanese economists in the 1980s and popularized by sociologist Roland Robertson. According to the APICS Dictionary, 16th edition,

when used in a supply chain context, glocalization is a form of postponement where a product or service is developed for distribution globally but is modified to meet the needs of a local market. The modifications are made to conform with local laws, customs, cultures or preferences. Glocalization is similar to a multicountry strategy, in which “customers have unique product expectations that are addressed by local production capabilities” (Dictionary). Here are some examples of glocalized products from international companies: Some fast-food restaurant chains “glocalize” their menus. For instance, McDonald’s offers different menus to correspond to the tastes of the community or region. In India, they offer more vegetarian options; in Israel, they serve kosher food. Pizza Hut in Macao, China, offers squid rather than pepperoni. General Electric’s handheld electrocardiogram device and a portable PC-based ultrasound machine were developed for rural India and China to provide improved quality, increased access, and less cost. Rural patients no longer have to choose between going to urban medical providers and going without medical care.

MTV, an international cable and satellite television channel, customizes its broadcasts of popular music and promotional music videos to appeal to audiences of all ages and tastes in about 150 countries and nearly 20 languages. Unilever has created more than 400 brands of food and health products that it markets around the globe. One product in particular, mayonnaise, is formulated differently for the variations of tastes preferred by people in the Netherlands, Belgium, and France. Need for Reverse Innovation According to a Harvard Business Review article, “How GE Is Disrupting Itself,” glocalization was successful when wealthy nations comprised the majority of the market and less-developed countries didn’t have much to offer. The authors state that this period of glocalization is over and multinational corporations now need to put effort and funds into global reverse innovation to enable ongoing sales in these countries. Reverse innovation involves developing innovative new products that meet specific needs and budgets of customers in particular markets using a decentralized, local-market focus. According to the article, the following are two glocalization “assumptions” that General Electric learned are in fact not true and

that need to be updated: GE had assumed that emerging economies would evolve the same way as wealthy economies. In fact, developing countries don’t evolve the same way, because they are more willing to adopt breakthrough innovations and they have less money to spend. So, for instance, innovations in low-cost medical devices, alternative wind and solar power, and water desalination are becoming more abundant in emerging markets. In another example, some countries without well-developed telephone lines or good electrical grids are skipping the telephone poles and are instead installing cell towers and use solar power for phone charging. GE had believed that products that address developing countries’ unique needs would not be sellable in developed countries. Instead what has been demonstrated is the ability of these products to create brand-new markets in developed nations. They are able to do this successfully due to their significantly lower price points and novel new applications. GE has embraced reverse innovation and has experienced positive results: It created and placed numerous local growth teams. These teams have helped GE better customize product objectives, customer training, and key metrics.

Sustainable Products and Services Here we look at some sustainable design processes, including design for the environment, design for reverse logistics, and design for remanufacture.

Design for the Environment Design for the environment (DFE) requires “considering health, safety, and environmental aspects of a product during the design and development phase of product development” (APICS Dictionary, 16th edition). It has become a feature of product design due to customer demand for sustainability, increased government regulations, and a greater organizational focus on corporate social responsibility. DFE aims to create a product that lives and ends its life cycle economically, with the least damage to the customer, the company, and the environment. Design for the environment includes the following considerations: Provision for reuse or recycling. Rapidly increasing garbage is one unfortunate feature of the consumer society. Service stations and other businesses that sell motor oil in the United States must agree to receive used oil and recycle it—for a fee. Germany requires domestic beer brewers to use refillable bottles. Reuse is generally easier on the environment than recycling, since it

involves less (or no) processing, but using recyclable materials is better than design for the landfill. Reduced energy consumption. Collaborative teams can design products that use less energy—such as the hybrid gas/electric automobile or an energy-efficient appliance. Manufacturing engineers and logistics specialists can also contribute to designs that take less energy to build and transport. Avoidance or mitigated danger of hazardous materials. Design can make some products less hazardous—taking lead out of paint and gasoline, for example. For inherently dangerous products, designers can consider how to mitigate the hazard. Cars, for instance, can be designed to lessen the likelihood that gasoline in their tanks will explode in a collision—and all along the supply chain, right up to the pump that dispenses gasoline in the service station, careful design of facilities and instruction of handlers can reduce product hazards. Use of lighter components and less material. When it comes to environmentally friendly products, less is definitely more. A lighterweight car gets better mileage. Lighter products have fewer materials in total and lower transportation costs. Benefits

Potential benefits of design for the environment include the following: Consistent with supply chain management’s total product life cycle focus Enhanced corporate reputation and resulting goodwill Limits on corporate liability and legal costs related to environmental issues Increased marketability among ecology-minded consumer segments Tradeoffs Tradeoffs of design for the environment include the following: Increased manufacturing expenses and higher price to the consumer Reduced safety and convenience when some products are small and light Reduced longevity of natural, less-processed products

Design for Reverse Logistics Supply chain managers are aware of the need to reduce the cost of reverse logistics, or the reverse supply chain, which handles products that need to be returned, repaired, replaced, or recycled. This implies several imperatives for the design team. Product packaging can be designed to account for common consumer

frustrations such as not knowing to install a SIM card before a cell phone will start working. Clear instructions or a help line can reduce the number of returns based on user error. If the product has to be returned for repairs or replacement, the process of doing so should be simple for the user. This might include ease of disassembly for repairs, an affordable warranty program, a box that can be used for shipping and return, well-trained and accessible customer service personnel, and comprehensible instructions—as well as a product designed to endure. Benefits Potential benefits of design for reverse logistics include the following: Customer loyalty from ease of repair, replacement, return, and recycling Lower cost of returns Improved product designs through attention to reasons for returns Tradeoffs An issue in design for reverse logistics is that this is a complex system that can often be underestimated. It may not be able to use the forward supply chain logistics infrastructure and has added costs such as warranty expenses and restocking fees.

Design for Remanufacture Design for remanufacture is defined in the APICS Dictionary, 16th edition, as products developed in a manner that allows components to be used in other products. This process is associated with green manufacturing. Design for remanufacture involves a strategic decision during the design phase of a new product to enable remanufacturing the product for resale. In general, 70 percent of the cost to build something new is in the materials and 30 percent is in the labor. Using remanufacturing, companies can effectively address the larger cost component by reclaiming products after they have been used for one or more life cycles. With material and resource costs expected to increase, the cost advantage of remanufacturing lies in the fact that items normally discarded can become raw material for the next product life cycle, eliminating waste and closing the loop on the system. In addition, environmental laws that are being instituted in the European Union and elsewhere may force companies to embrace remanufacturing as a sustainable practice. Remanufacturing is a service business as well as a product business. For the process to work, companies have to form a

replacement relationship with customers. For example, Caterpillar, the heavy equipment company, has created a separate division for remanufacturing. When a customer replaces a product, they are offered a remanufactured one for about half the price. However, the customer will be charged full price until he or she turns in an old product—one that is inspected and certified as remanufacturable. Thus, customers benefit by becoming Caterpillar’s partner. Customers are actually creating assets, in the form of returned products, for their supplier. In return, they receive less expensive replacement parts, so they can keep their fleets running with minimal downtime. Benefits Proven characteristics of design for remanufacturing include lower cost to the customer, lower impact on the environment, and lower product development costs. Also, the increasing costs associated with materials and resources and environmental laws make remanufacturing an attractive option for various companies. Tradeoffs The primary tradeoff of remanufacturing is that rather than receiving full cash, the manufacturer receives parts as partial payment, so cash can be tied up in inventory longer. Note also that in the U.S.,

and possibly elsewhere, a remanufactured product cannot be sold or marketed as a new product.

Section D: Supplier Selection, Contracting, and Use This section is designed to Trace the purchasing process, including supplier selection, negotiation, order placement, and other follow-up and feedback steps Define supplier selection criteria and needed supplier value-added services or sustainability requirements Describe how to use effective negotiation skills to get the most out of relationship management Explain how to deploy and manage contracts to ensure that all parties are living up to mutual agreements Describe basic types of contracts Discuss terms and conditions of contracts that promote relationship building and maintenance on the part of both parties Explain the process and considerations for foreign currency contracts Track the status of open orders in various internal functional areas Understand how invoices are reconciled and approved Understand the options available for expediting and why expediting should be avoided in normal operations as much as

possible Determine if sourcing processes can benefit from using auctions, reverse auctions, exchanges, or portals. Supplier selection, contracting, and use form the purchasing process. The purchasing process is itself part of the larger sourcing process that involves determining what to source and so on. In the purchasing process, specific suppliers are evaluated, negotiated with, selected, and contracted with. Ensuring proper contract deployment and management is critical to ongoing supplier effectiveness. Contracts are an important factor in the success of customer and supplier relationships, so we’ll also examine contract types, terms and conditions, payment terms and methods, and currency issues. Finally, the operational side of purchasing is discussed: creating purchase orders, tracking open order status, reconciling and approving invoices, and expediting as needed.

Topic 1: Supplier Evaluation and Selection Here we address the first few steps in the purchasing process, which occurs after the more strategic decisions related to sourcing have

been made. We get down to the details of supplier selection criteria, including supplier value-added services, negotiation with suppliers, and contract deployment and management.

Purchasing Road Map Exhibit 3-14 shows how supplier selection is the first step in the purchasing function. This step includes evaluations such as developing selection criteria or specifying necessary value-added services. Negotiation and its end result, contracting, are also discussed in this general content area.

Exhibit 3-14: Functions of Purchasing

Once an organization knows what it plans to do itself (its core competencies) and what it plans to use suppliers for and the level of

relationship it desires for each supply need, it engages in the supplier selection process. Supplier searches can use auctions, reverse auctions, portals, exchanges, approved vendor lists, referrals or prior relationships, location-specific consulting organizations, competitive bidding using requests for quotation (RFQs) or invitations to tender (ITTs), or direct negotiation. Optimizing the supply chain may require taking a nontraditional approach to selecting suppliers. Traditional thinking emphasizes making the greatest possible profit for the enterprise without regard to the impact on other parties. Suppliers look for the price that will yield the highest margin for them without regard to customer needs; buyers look for the lowest price without regard to the impact on the suppliers. Contracts may cover only short-term transactional arrangements. Supply chain thinking requires a strategic view of sourcing that focuses on the long-term success of all partners along the supply chain. Pricing, discounts, delivery timing, and related matters can be established cooperatively, taking into account the needs of supplier and buyer. The emphasis is on establishing ongoing relationships rather than simply making a series of transactions, pitting suppliers against one another to drive down prices. The pressures in contemporary markets, from both customers and suppliers,

necessitate forming deeper relationships for many sourcing solutions. Deeper relationships contribute to the profitability of an integrated supply chain as well as that of each partner.

Selection Criteria An organization will use a range of criteria in conducting a supplier search and may place more or less weight on particular criteria to emphasize strategic priorities for the given category of supplier. Possible criteria include strategic supply plans, technical specifications, desired quality, and supplier financial strength. Here we’ll look at four other factors that can be used as selection criteria: costs, alignment with supply chain needs, adherence to corporate social responsibility policies, and ability to provide required valueadded services.

Costs To remain competitive, organizations must develop supplier relationships that allow them to lower total costs and, consequently, increase profits. Businesses must be able to source products and services and operate at the lowest costs possible, and they must partner with efficient and effective suppliers who can deliver goods and services on time and to specifications, especially when using lean or Just-in-Time production methods.

Two cost categories that can be used as selection criteria are total cost of ownership and cost of goods sold. Total Cost of Ownership Total cost of ownership (TCO) is discussed in detail elsewhere. A problem with TCO in a situation involving outsourcing is that too often companies look at the obvious—purchase price, transportation costs, duty costs associated with doing business on a letter of credit, etc.—but ignore the additional lead time. Longer lead times typically involve more inventory in the supply chain, and the carrying cost of that additional inventory needs to be included in the TCO analysis. Let’s look at an example. A company’s initial analysis of copper tubing costs for Brazilian, Korean, Chinese, and U.S. suppliers showed that the supplier from China had the lowest costs, even after all landed costs were considered. However, when the inventory carrying costs due to the longer lead times were included, the U.S. supplier, located only three hours away, actually had the lowest costs. This example is illustrated in .

Exhibit 3-15: TCO Comparative Example

Cost of Goods Sold Lowering the total cost of goods sold (COGS) is of strategic importance to a company. Such costs exert a strong amount of leverage over profits. A dollar decrease in COGS will be reflected as a dollar increase in gross margin. A dollar increase of sales has to be offset by COGS, and only the net will be added to the gross margin. Therefore, reducing the costs of materials, labor, or overhead through efficient supply management is more effective. This point is illustrated in the scenario shown in .

Exhibit 3-16: COGS Example

Alignment with Supply Chain Needs

Oftentimes, the focus on cost reduction leads to global sourcing and procurement. But in order for an organization to have a successful offshore partnership, the potential suppliers must have business processes and efficiencies that complement the strategic goals of the organization’s supply chain, and they must be able to deliver on their capabilities to provide value for the customer. Successful offshore partnering does not happen by chance. Before entering into a strategic global alliance, both organizations need to lay the appropriate groundwork. Site visits should be considered a requirement before establishing onshore or offshore partnerships. All key stakeholders who will be involved in the relationship should participate, and critical processes and technology should be reviewed for the ease of interfacing (i.e., cost and time required for interfaces). Another supply chain factor to consider is the supplier’s technical communications ability so that the supplier can receive real-time information on customer orders and thus reduce supply chain problems such as the bullwhip effect.

Corporate Social Responsibility Policy Since the organization that owns a product brand and image will be held responsible for the activities of its extended supply chain, most

organizations consider how potential partners could affect their reputation. Prior to searching for suppliers, persons responsible for supplier selection should consult an organization’s corporate social responsibility (CSR) policy for guidance. The CSR policy, also called the corporate citizenship policy, is a type of organizational self-regulation that involves adding priorities to an organization’s business model. The model still focuses on profits but also defines success as meeting the needs of the community and the environment. The CSR policy requires that employees and suppliers hold themselves accountable for compliance, but the organization may need to audit prospective suppliers and monitor existing suppliers for compliance. Topics of a CSR policy related to supplier selection could include Customer health and safety (e.g., supplier’s product and service safety relating to legal liability, such as being nontoxic or defectfree) Employee health and safety (e.g., risk exposure of employees of supplier) Environmental sustainability (e.g., supplier’s energy use, carbon footprint, use of recycled or reused materials) Maintainability (e.g., total cost of ownership of supplier’s products)

Employment policy (e.g., supplier’s wages relative to regional averages, abstaining from exploitation such as child labor) Community reinvestment and use of local goods and services (e.g., requiring local supplier search, including transportation cost savings in selection criteria, or ranking local suppliers higher in evaluations). The CSR policy is often based in part upon compliance with international or home-country laws and regulations. Legal review will determine the extent to which such laws or regulations have jurisdiction over supplier methods or products. Product design will also play a role in supplier selection and CSR. Products designed to minimize the need for hazardous materials are an example.

Supplier Value-Added Services A general category of supplier value-added services that many organizations have come to expect can be summarized as worldclass service. As organizations look to right-size their supply base, any new suppliers that are added will need to be as good as or better than existing suppliers in the given category. This could entail excellent on-time delivery performance, ability to meet service level

agreements, and ability to collaborate on designs or ongoing cost improvements. Examples of supplier value-added services include Management of inventory at the buyer’s site Maintaining safety stocks of components so the organization doesn’t have to Quick responses to changing product or volume requirements (e.g., reconfigurable manufacturing equipment) Adopting compatible transfer packaging to eliminate customer process steps (e.g., a product shipped in reels to enable direct loading to a machine) or to be reusable Break-bulking or consolidation of goods from various sources (upstream warehouses) Consulting services, such as input to category market research or evaluating various materials or production methods for potential use E-purchasing and e-commerce capabilities Technology capabilities, ranging from computer-aided design (CAD), to track and trace (e.g., RFID and GPS), to full network integration, plus good cybersecurity Long-term relationship potential, such as a culture that embraces change or a willingness to invest funds in the relationship, share data, or share costs and profits.

Negotiation Negotiation is an important part of contract development. The APICS Dictionary, 16th edition, defines negotiation as “the process by which a buyer and a supplier agree upon the conditions surrounding the purchase of an item or a service.” Negotiation for commodities will differ greatly from negotiation for outsourced functions that have great impact on the supply chain. Typical areas that require negotiation include technical specifications, prices, purchase volumes, delivery lead time, other delivery terms, and many other terms and conditions.

Types of Negotiation Two types of negotiation are competitive bidding and direct negotiation. Competitive bidding for commodities may take the form of online auctions or reverse auctions that are based entirely on price. Even automated purchasing is possible. Competitive bidding can take the form of a formal request for quotation (RFQ) or invitation to tender (ITT) process. These processes set a prerequisite of the supplier being technically qualified to make a bid. Buyers need to be able to provide clear specifications to sellers and give enough time for detailed responses, a round of queries (any responses are provided to all bidders), demonstrations, visits, and so on. The final steps in this process may involve a limited amount of direct

negotiation with a short list of suppliers who meet the selection criteria, or the organization could simply select a supplier based on best overall weighted value. After the winning bidder accepts, other bidders are informed. Internet-enabled sourcing provides a much larger number of sources located across the globe to be evaluated in a shorter span of time than traditional methods. Internet-enabled sourcing is available as a feature of purchased or SaaS (software as a service) supplier relationship management (SRM) software or through enterprise resources planning (ERP) systems. SaaS vendors can host online bidding events while the organization’s senior purchasing managers observe the action and make final decisions. Internet-enabled sourcing can use trading exchanges to find suppliers. Negotiation automation tools include online RFQ or ITT submission and response gathering. An RFQ or ITT can be encoded so that the marketplace lists only qualifying vendors. Product searches can use multiple vendor online catalogs. Direct negotiation may be needed if the RFQ/ITT process would be cumbersome or there is only one supplier being considered. It may be more expensive than competitive bidding because the process often requires more direct interaction. Direct negotiation is often needed instead of competitive bidding for

Materials that have hard-to-define costs, numerous risks, or high complexity Materials with preferred suppliers (if no other suppliers are being considered) Bottleneck materials (The presence of few providers in the marketplace makes the use of RFQs/ITTs difficult.) Core-competency materials and/or relationships that require strategic partnerships or collaborations such as on product design.

Negotiation Principles and Tactics While the level of importance of the relationship will dictate the amount of time and energy spent on negotiation, all negotiation can benefit from sound negotiating principles. This is especially the case when working to transform an organization from traditional adversarial relationships with suppliers to more constructive partnerships. Traditional negotiating tactics include the following forms, which are called position-based tactics: Hard negotiators view other parties as adversaries to be beaten, so they take a position, demand concessions, and give none in return. They threaten, mislead, or pressure the other party. This can endanger long-term success.

Soft negotiators value agreement to the point that they disclose their bottom line, alter their position, or accept one-sided agreements that involve only concessions. Contracts may be won, but this party is left feeling exploited and may be financially at risk. These positions can be described as win/lose or lose/win. Fisher and Ury of the Harvard Negotiation Project developed a third option: a win/win negotiation technique called principled negotiation. Rather than negotiation in which each party sequentially takes and gives up actual or deceitful positions, principled negotiation starts by insisting on several criteria for long-term gain (none of which are typically present in win/lose or lose/win tactics): Negotiation should efficiently solve the underlying issues. Negotiation should preserve or increase positive relationships. Agreements, if reached, should endure, meet both parties’ actual needs to the extent possible, resolve conflicts of interest fairly, and be in the community’s interests. Principled negotiation is a four-step interest-based bargaining style: 1. Separate the people from the problem. Rather than trying to be adversaries or friends, principled negotiators insist on the criteria listed above for long-term gain. They attack the problem rather than the other party.

2. Focus on interests, not positions. Position taking leads to defensiveness. Principled negotiation avoids taking positions or a bottom line at all. Instead, negotiators relate what they are interested in achieving and seek to understand what the other party is interested in achieving. 3. Invent options for mutual gain. Principled negotiators first seek a time frame in which to study the problem rather than bowing to time-based pressure. During this time they devise alternatives that could satisfy the interests of both parties. 4. Insist on the use of objective criteria. Rather than engaging in haggling, principled negotiators guide any disagreement toward deciding upon a fair standard that both parties can agree will be the basis for the decision (e.g., market value, expert opinion, analysis results, the law, ethical standards). Principled negotiation or similar negotiation tactics can result in relationships that are perceived as profitable and indispensable by both parties, which, in turn, means that the buyer is not constantly looking for a new supplier or vice versa. Another negotiation tool, called triangle talk, is discussed by Monczka, et al., in Purchasing and Supply Chain Management, which cites a book by K. Anderson for this method. Basically, negotiation forms a triangle. One point of the triangle is knowing

exactly what you want; this is the first step. The second point of the triangle is knowing exactly what the other party wants; this is the second step. It requires making the other party feel heard. The third triangle point and step is proposing a solution in a way that the other party can accept. This method involves separating wants from needs —in other words, separating definite deal breakers from things a negotiator would like to have. Working to sort out your and the other party’s needs from wants is the key to success in this method. These and other methods share one important negotiation preparation step. Both parties in a negotiation are advised to predetermine their best alternative to a negotiated agreement. This is what the organization would do if the negotiation fails. It might be to manufacture the product in house, partner with an existing supplier to expand their operations, and so on. When the costs and benefits of this alternative are known in advance, the negotiator will know when it is better to walk away (or to take an offer that still beats this best alternative).

Contract Deployment and Management Once a contract has been signed, the contract deployment process is used to get the agreement to function as intended. Organizations

regularly monitor relationships for responsiveness, on-time delivery, order accuracy, product or service quality, and invoicing and payment accuracy. They also informally maintain relationships to anticipate and avoid problems and to develop cooperation and trust.

Deployment The main purpose of contract deployment is to ensure a smooth transition to new partners and successful adoption across the organization. Without diligence in rolling out contracts and continuous monitoring of both internal adoption and performance, contract deployment ultimately will fail to deliver the anticipated economic and other benefits. Because an organization may continually be adding, removing, and replacing partners over time, contract deployment is an ongoing function. Contract deployment activities include Navigating the legal maze involved in creating a new agreement Communicating with the winning supplier Promoting the benefits of new agreements to internal buyers Loading new contracts into a centralized contract management database Implementing order-to-payment procedures Training users and suppliers on new procedures

Validating performance against measures and key performance indicators Integrating and deploying transaction management systems Auditing initial invoices for accuracy and compliance.

Compliance Management Compliance management, which is emerging as a discipline equal in importance to strategic sourcing, consists of Defining and implementing strategies to concentrate purchases with preferred suppliers Monitoring and measuring compliance and identifying off-contract purchases to uncover lost savings opportunities Channeling findings to management for remediation Monitoring and reporting on key performance metrics Auditing pricing to ensure accurate billing Monitoring contract expirations, executing renewals, ensuring proper rebates and early payment discounts Driving continuous process and incremental cost improvements Establishing baselines for new sourcing initiatives. Technology makes it possible to merge data from various sources and make them quickly visible to senior management for analysis and action.

Measuring Success and Avoiding Pitfalls Unsatisfactory performance is a great risk. It can cause an otherwise sound business strategy to fail. To avoid this pitfall, organizations should follow some basic guidelines. Establish clear performance expectations. Clear performance expectations must be addressed up front. For example, a performance indicator may be the volume of customer complaints. Rather than using anecdotal information about complaints, best practices involve a complaint tracking system with monthly reports and specific performance improvement targets. Another best practice is a formal service level agreement (SLA) , which is “a document that represents the terms of performance for organic support” (APICS Dictionary, 16th edition) that is updated each year. Measure against those performance expectations at regular intervals. It is imperative for organizations to monitor performance proactively. Continuous monitoring programs measure performance against predetermined metrics and adjust them as changes in customers’ needs occur. Ensuring that suppliers have adequate internal controls is essential; these controls are needed to capture accurate billing data as well as provide critical information on how suppliers manage their business and process

risks. Consider, for example, an organization that outsources telemarketing services to a supplier. One month, the supplier’s invoice indicates an overbilling of several hundred thousand dollars; however, they cannot provide evidence for the overbilling due to poor internal controls and record keeping. Organizations should consider instituting a policy of reviewing potential suppliers’ internal controls before entering into a contract. Maintain ultimate responsibility. Many organizations have the false idea that once they contract for an activity, they no longer need to be involved. Although the supplier may be fully capable of handling an activity, the organization should not relinquish the complete management of the relationship. For example, if day-today customer care activities are outsourced, the organization should still maintain a close watch over customers’ needs and expectations and monitor the supplier’s overall effectiveness. This fact highlights the increased demand for risk sharing. Partnerships with equal sharing of risk have become a key method for managing new product development and controlling rising operations costs. Coordinate the activities of multiple suppliers and share experience and knowledge. It is essential for organizations

working with multiple suppliers to establish formal sharing of best practices. Maintain an exit strategy. When the need for a new outsourced supplier arises, organizations need to be prepared with a formal backup plan for each key supplier. Although the need for consolidation is important, a best practice is to spread vital activities among multiple suppliers if feasible. This reduces the operational disruptions that come with switching suppliers.

Topic 2: Contracts After defining contracts and related terms, here we describe various contract types as well as a number of common terms and conditions. Other contract considerations discussed here include payment terms, the use of letters of credit for financing, and foreign currency.

Contract Types and Details Sales agreements or contracts are an important part of any business relationship. The APICS Dictionary, 16th edition, defines a contract as an agreement between two or more competent persons or companies to perform or not to perform specific acts or

services or to deliver merchandise. A contract may be oral or written. A purchase order, when accepted by a supplier, operates as the highest level of a contract except where a longer-term contract exists. Acceptance may be in writing or by performance, unless the purchase order requires acceptance in writing. Other contract-related terms defined in the Dictionary include the following: Annualized contract : A negotiated agreement with a supplier for one year that sets pricing, helps ensure a continuous supply of material, and provides the supplier with estimated future requirements. Bilateral contract : An agreement wherein each party makes a promise to the other party. Contracts for the international sale of goods (CISG) : Governs the sale of goods in the international environment. They enable exporters to avoid choice-of-law issues. Trading partner agreement : A contract between trading partners that describes all facets of their business together. This is a legal and binding agreement suitable for legal purposes as well as standard working agreements. The level of relationship will dictate the type of contract that is needed. When buying on the market, a purchase order constitutes

the highest level of contract that will generally exist. Ongoing relationships can use an annualized contract, while partnerships or collaborations/strategic alliances will form a long-term trading partner agreement, which is a type of bilateral contract.

Contract Types Contracts take a few basic forms that need to be differentiated because they strongly affect which party accepts more of the risks if there are cost or schedule overruns. The Dictionary defines various contract types as follows: Cost-based contract : A type of purchasing contract where the price of goods or services is tied to the cost of key inputs or other economic factors, such as interest rates. Cost-plus contract : A pricing method where the buyer agrees to pay the seller all the acceptable costs of the product or service up to a maximum cost plus a fixed fee. Cost-plus-fixed-fee contract : A contract in which the seller is paid for costs specified as allowable in the contract plus a stipulated fixed fee. Cost-plus-incentive-fee contract : A contract in which the seller is paid for costs specified as allowable in the contract plus a profit provided certain provisions are met.

Firm fixed-price contract : A contract in which the seller is paid a set price without regard to costs. A pure cost-based contract minimizes the risk for the supplier because cost overruns are charged to the customer. These types of contracts might be appropriate when it is impossible for either party to accurately assess costs in advance and there is a level of trust between partners. Such contracts need to be audited regularly to ensure that all costs charged are reasonable and appropriate. Firm fixed-price contracts minimize the risk for the customer because the supplier must absorb all cost overruns. These contracts are appropriate for products and services that have a market value that is easy to determine or costs are otherwise reliably estimated. Incentive arrangements and contracts, which provide incentives for desired behavior, can help specifically with customer relationship management and supplier relationship management initiatives or other similar collaborative arrangements between organizations. The Dictionary defines incentive contracts as follows: Incentive contract : A contract where the buyer and seller agree to a target cost and maximum price. Cost savings below the target are shared between buyer and seller. If actual cost exceeds the target cost, the cost overrun is shared between buyer and seller up to the maximum price.

Incentive arrangements : The incentive contract allows for the sharing of the cost responsibility between the buyer and seller. Incentives are incorporated into the contracts to motivate the supplier to improve its performance in areas such as quality, on-time delivery, and customer satisfaction. There are three elements of an incentive agreement: target cost, target profit, and the sharing agreement. Fixed-price-incentive-fee contract : A contract in which the seller is paid a set price and can earn an additional profit if certain stipulations are met. Incentive arrangements and contracts can be part of an overall trading partner agreement or can be negotiated separately. The benefit of such arrangements is that they align collaborative goals with individual motivations. The motivations are the cause that generates the effect of collaboration. Traditional self-centered motivations cannot be expected to generate anything other than selfcentered effects. As stated in the definition of incentive arrangements, the organizations must settle on a desired cost and a profit margin for goods or services. These targets should be challenging but realistic. Both parties will be motivated to find ways to cut costs due to the mutual increase in profitability. The targets can be increased over time as goals are met. The organizations must also determine how

the profits or excess costs will be split among the partners and to what maximum price any cost overruns will be shared among the partners.

Contract Terms and Conditions If a relationship is to be successful, both parties must know and understand their responsibilities. Normal responsibilities must be defined in the form of terms and conditions. The Dictionary defines terms and conditions as “all the provisions and agreements of a contract.” These contract clauses should specify what actions can be taken by each party if unexpected events arise or failures occur. They are both the rules of fair play between the parties and the method of encouraging fulfillment of strategic goals. It is important not to accept another party’s assurances that an undesirable contract clause is simply standard “boilerplate” legalese that won’t be an issue. If negotiations cannot arrive at a fair set of contract details, it is better to walk away. Also, no contract should ever be signed without first being reviewed by your legal representatives, specifically those who have experience with contract law.

The following are some of the common contract terms and conditions that should be clearly spelled out in writing. Hypothetical examples are provided to illustrate the contract concepts. (Note: These examples are not intended to provide actual contract language, which should always be created with the assistance of legal counsel.) Pricing. Accepted price quotes may include more than just price per unit. For example, packaging estimates may be included. Some contracts set fixed prices with certain price increases allowed based on certain contingencies, such as increases in raw materials (called escalation), while other pricing contracts may specify that orders use current market prices. Example: The unit pricing for the product is set forth in Schedule B. Prices for spare parts, accessories, and packaging are set forth in Schedule C. The supplier may increase pricing in Schedules B and C once every 12 months during the term of the agreement, not to exceed 4 percent and provided that the supplier provides 3 months’ written notice prior to any such increase.

Delivery requirements. This should specify dates, locations, and conditions such as how orders will be placed, how a product is to

be protected during shipment, what modes of shipping are to be used, minimum or maximum orders, and the like. Example: The supplier will deliver the products in accordance with the delivery schedules. If the supplier fails to deliver the products in accordance with the schedule, the supplier will provide written notice to the purchaser stating the reason(s) and planned resolution.

Transfer of ownership (Incoterms® trade terms). Incoterms® trade terms stated in the contract will affect when each party is responsible for the freight. This is required only for international transactions, although companies may elect to use the terms for domestic freight as well. Payment terms. These terms should address not only timing and form of payment but special issues such as currency exchange. To manage risk, it may be possible to stipulate the exchange rate to be used in the contract with the supplier or a period of time during which a sampling of exchange rates will be used as a basis for currency exchange. Example: The purchaser agrees to pay the supplier’s invoices within 30 days of receipt. Invoices shall be paid in Hong Kong dollars (HKD).

Performance criteria. How will performance requirements be met? For example, specifications of product or service attributes should be noted along with which attributes are more important and why. Example: The supplier agrees to manufacture the product under ISO standards X and Y. The supplier will maintain the documentation necessary to prove compliance to ISO standards X and Y.

Quality assurance. The management process and performance standards the organization has in place in order to assure quality, including any specific standards with which the supplier must be compliant or registered, should be specified. Example: The supplier agrees to the purchaser’s quality audits of the manufacturing facility at the purchaser’s request and subject to scheduling approval.

Order requirements. This includes measurements of standard deliveries, quantities that a company wants, and the date on which the order is due. The contract may state the company order period (i.e., 60 days), which is the time between when a purchase order is placed and goods are available per the Incoterms® trade terms.

Purchase orders are also considered contracts with stated quantities and pricing confirmed by each party. Example: Deliverables and dates are as specified. Three days early or late is considered acceptable on-time delivery and used for supplier evaluation purposes.

Associated incentives and penalties. The contract should detail how an organization will provide business assistance and/or incentives to a supplier or help them to improve. Incentives may include contractual sharing of cost savings. Any penalties to be assessed when problems occur need to be communicated as well. Example: Failure to deliver the product in accordance with delivery schedules and failure to resolve the issue within 30 days will give the purchaser the option to terminate the agreement, with written notice to the supplier.

Status reporting. A successful partnership depends on good communication. Both parties must establish trust and confidence with each other so that an open exchange of information occurs. The contract should cover provisions for routine communication in terms of frequency and types (e.g., face-to-face meetings, online

conferencing, electronic reports, hubs or dedicated workstations, intranet sites, blogs). Example: The purchaser will establish an internetenabled portal where employees and partners can post daily communication entries and notes to support collaborative planning, forecasting, and replenishment. Regular meetings will be held to review open orders, engineering changes, design issues, production issues, etc.

Channels for resolving problems. In the event of quality or delivery problems, what are the expectations and protocol for corrective actions to enable a swift resolution and prevent a recurrence? If task conflicts arise from disagreements in viewpoints or ideas, what conflict resolution technique will be used that is culturally and contextually appropriate? Example: Following fact finding and the opportunity for both parties to discuss a point of contention, alternate dispute resolution, including a third-party arbiter, shall be used to resolve conflicts. This third party shall be mutually agreed upon before contract signing.

Security requirements. What are the safeguards that must be in place to prevent unauthorized access to proprietary data? Are

there data that need to be classified? Are there specific requirements for sharing data? Are there security issues for the goods in transit that need to be addressed to meet the customs compliance requirements of specific countries? This contract element involves measures to mitigate security risks for both parties. Example: Neither party shall disclose confidential information that has been disclosed to it by the other party to any other third party, without the prior written consent of the disclosing party. Freight forwarders and transportation providers must be C-TPAT-certified.

Language of the contract. Will a contract written in English be acceptable to all parties? Are there are language differences that necessitate translation? Correct translation is critical. It is also beneficial to define all vague wording (multiple meanings) and acronyms. Depending on how many of these terms exist, a separate section may be warranted. Example: The initial contract will be written in English. The document will be translated by the organization’s translator and submitted to the supplier for review. The translator will address any translation questions from the supplier. It should be noted that the term “business day” means a day other than a Saturday or Sunday on which

banks are open for business in New York and Luxembourg City.

Contract termination. The process and terms for contract termination (e.g., when and how, advance notice requirements) should be defined. Example: This agreement may be terminated by the purchaser for any reason with 6 months’ prior notice to the supplier.

Legal authority. In global sourcing, an organization’s relationship with a supplier may be influenced by many layers of laws, regulations, directives, and international treaties. Requirements of particular countries should be specified. Example: The validity of this agreement and any amendments shall be governed by the law of the Czech Republic with the intention that the rules of the United Nations Convention on International Sale of Goods shall not apply with the application of any conflict of principles.

Contract Payment Considerations Contracts need to specify payment terms in ways that address each party’s risk appropriately and provide incentives for desired payment

timing. One type of payment method, a letter of credit, is discussed, since this is a common method for international transactions. Also discussed here are how to address contracts that use foreign currencies.

Payment Terms In any trade or financial transaction, there is a risk that the other party (the counterparty) will fail to honor the terms of the agreement. This is called counterparty risk. The seller always runs the risk that the buyer won’t pay on time or won’t pay at all or will pay but in counterfeit currency, just as the buyer risks taking delivery of inferior goods or no goods at all. Organizations need to specify payment terms in contracts with suppliers or customers. The APICS Dictionary, 16th edition, defines payment terms as “conditions surrounding payment for a sale, providing a time frame in which a customer can pay without late penalties or additional fees.” These terms specify when payment is due, whether shipment will occur before or after payment is made, and the method of payment that is required. Very few transactions, domestically or cross-border, are financed by payment in advance or cash on delivery (COD)—although both do occur, generally if the parties are closely related, as in the case of

subsidiaries or if one party is well established and the other unknown. For example, a well-established industrial HVAC supplier requires all sales be paid in full by wire transfer prior to arranging a shipment. However, for established mutual relationships, trade credit or an open account is often extended, which is essentially an unsecured, trust-based transaction between the parties. Trade credit is the sale of goods or services in which payment is not due right away. Trade credit encourages sales because it is effectively offering free financing over the payment period. The buyer has time to convert the good or service into revenue before making payment. With an open account, a buyer has a credit limit with the organization or a bank and can place orders or write drafts up to the limit to pay for goods or services on receipt or on a deferred basis. When an open account is with the organization, it is synonymous with trade credit. Trade credit and open accounts are offered only to trading partners with good credit records and healthy financials (e.g., financial ratios and reports) because of the possibility of default. In addition to providing a deadline for payment without penalties, many organizations offer a discount to encourage early payment. For example, payment terms of 1/10 net 30 mean that the buying organization will receive a 1 percent discount if payment is made within 10 days but has up to 30 days to make the full (net) payment

with no late penalties. An organization’s accounts payable or treasury personnel can calculate whether taking a discount is worth more or less than the ability to wait longer to make the payment. Similarly, the invoicing organization’s finance professionals will craft any discount to make financial sense for the organization: nearly equivalent either way, with a small tip in the direction they want the buyer to choose. Documentation for domestic business-to-business customers usually includes an invoice and a bill of lading (B/L). Invoicing internationally has far greater documentation requirements, in addition to requiring that payment be made in some secure manner such as a letter of credit.

Letters of Credit Since trade credit or an open account may not offer the risk protection that either party desires in an international transaction, organizations need a more sophisticated form of payment, and in many import-export transactions this takes the form of a letter of credit (L/C). The letter of credit (illustrated in Exhibit 3-17) offers security from counterparty risk in a tidy, but complicated, package.

Exhibit 3-17: Letter of Credit

A letter of credit is just what its name implies: a letter in which a bank assures the seller that the buyer can pay the purchase price of the goods and that the bank will therefore honor the buyer’s checks to the seller up to that amount. The bank makes this assurance either because it has reason to believe that the buyer’s credit is good or because the buyer has an account with the bank. The sequence of events goes something like the following. (Note that the use of two banks instead of just one in this example makes this an example of a confirmed L/C; when just one bank is used, it is an unconfirmed L/C, which has a little more risk.) L/C is issued. After agreeing to the terms of sale, the buyer/importer goes to its bank and gets a letter of credit demonstrating that the bank has faith in the buyer/importer’s ability to pay the purchase price. Seller’s bank is notified. The buyer’s bank notifies the seller’s bank that the L/C has been issued. This assures the seller’s bank

that it can honor drafts from the seller up to the amount of the purchase price as long as the bank receives the proper documentation. Seller ships cargo. Confident of receiving payment when the goods have arrived as specified, the seller has the cargo shipped. The carrier sends a B/L (or waybill for air carriage) to the seller’s bank. Seller asks its banker for money. After shipping the cargo, the seller sends a draft for the purchase price to its banker, who now has the seller’s draft plus the carrier’s B/L. Seller’s bank asks buyer’s banker for money. The seller’s bank forwards the documents to the buyer’s bank. The B/L from the carrier usually assigns ownership of the goods to the buyer’s bank, not directly to the buyer. This provides the bank with some security since it can wait to release the ownership documents to the buyer until it is sure of being repaid. Buyer’s bank waits for cargo (perhaps). When the buyer’s bank receives a draft and B/L (or waybill) from the seller’s bank, the cargo may still be en route (if it has been shipped by marine carrier). Therefore the drafts may be payable at some future date

rather than immediately. Payment may or may not depend upon the buyer’s officially taking delivery of the cargo. Everyone gets paid. At the time specified—say, when the buyer approves the cargo and accepts delivery—all outstanding drafts are honored. The buyer pays its banker; its banker pays the seller’s banker; the seller’s banker pays the seller. The order may not be quite so neat; this is a credit transaction, after all, and some level of trust may be involved. The deal can break down at this point. For example, an unethical buyer might refuse to accept delivery and leave the cargo sitting on the wharf while attempting to negotiate a better price with the seller, who cannot afford to ship the goods back home. In some cases, payment is due before the buyer takes possession. (The contract can specify a grace period.) If the goods turn out to be damaged, substandard, or otherwise unacceptable, the buyer may reject the shipment and is at risk of not getting a refund and having to write the whole deal off on its taxes. Although the L/C is the standard method of financing international trade, other methods are used on occasion, such as trade credit or an open account. In addition, a buyer might pay in advance, taking on the greatest amount of risk. And in a consignment transaction,

goods are shipped for resale—say, from one division of a company to another division in a foreign country. Exhibit 3-18 provides a real-world example of tracking both the physical flow of exported goods and the physical or electronic document trail that accompanies the goods from purchase order on the left to receipt at the final destination on the right. Note the “unexpected events” at the bottom. It’s not always smooth sailing in global trade.

Exhibit 3-18: Export Processes—Administrative and Physical

Source: BASF

Currency Issues Just as cargo can sometimes be tripped up at a border crossing, so can payments have their difficulties getting from one country to the next. (As can information, for that matter.) In multicurrency situations, the buyer and the seller both may experience currency exchange risk—a risk caused by the fluctuating rate of exchange between their two currencies. A buyer might make a commitment to pay the equivalent of 200,000 euros to a Japanese seller (who, of course, wants yen, not euros) and actually wind up paying, say, 215,000 euros when trading the euro for yen to make the payment. If, on the other hand, the yen were to weaken against the euro, the buyer would get, in effect, a discounted price. Impact of Currency Selection Organizations have some leeway under accounting rules to select the primary currency with which they conduct the bulk of their transactions—called their home currency for accounting purposes— and this can minimize the total amount of foreign exchange that is needed. They can also maintain foreign currency bank accounts to buy and sell in the same currencies as their trading partners, thus avoiding the need for foreign exchange. Of course, the value of the funds in these accounts will fluctuate for accounting purposes, but

such accounts do avoid foreign exchange fees. These tactics can work well for the major currencies of the world; organizations tend to avoid working with currencies that have less-established trading markets. Currency exchange risk creates operating exposure for an organization, which the Dictionary defines as the risk introduced by flexible exchange rates when operating in the global environment, including production, storage, and buying and selling prices. Thus currency exchange risk affects not only the effective prices for supplies and for sales to customers but also operating and storage costs and inventory value. The accounting value of one’s inventory will fluctuate if it is produced and valued in the currency of a country that isn’t the organization’s home currency. In such cases, the value of the assets will be adjusted up or down for financial reporting purposes to account for the exchange rates between the countries. This can, in turn, positively or negatively impact the organization’s financial ratios and thus its market value (e.g., stock price) and ability to access credit. The key problem with this type of risk is that it creates volatility while the organization’s owners or lenders desire stability. Often they are willing to trade away the upside of a given currency fluctuation to also limit the downside. In other cases, they

are willing to pay significant fees to limit this volatility. Methods to limit volatility are called hedging, and it is called currency hedging when applied to foreign currency transactions. Currency Hedging If you aren’t dealing in the same currency as your counterparty in an import-export transaction, you have to find ways of making or collecting a payment with minimal risk. One technique is currency hedging, which is used to offset the risks associated with the changing value of currency. An array of financial products can be used toward this end, including forwards, futures, swaps, and options. The most common tool used in currency hedging is currency futures, in which one party agrees to buy/sell a fixed amount of a given currency at a fixed exchange rate on a fixed date in the future. Futures are traded on organized exchanges or clearinghouses; these third parties reduce counterparty risk by serving as intermediaries to both buyer and seller. Currency hedging is not always available, but it is readily found in the major currencies of the world economy. While most large corporations now have entire departments devoted solely to hedging and risk management, small companies often lack the resources necessary to engage in currency hedging. In this case, a broker/dealer organization can perform these services for a fee, Note

that currency hedging can result in large losses if poorly managed, so the process needs experts as well as expert oversight.

Topic 3: Purchase Orders Here we discuss the operational portions of the purchasing process: placing orders, reconciling invoices and approving them for payment, tracking the status of open orders (from an internal functional area perspective), and expediting supply or transportation. After that, we address the various ways that ordering can be automated using e-procurement, including by using auctions, reverse auctions, exchanges, and portals.

Purchase Orders Road Map The process of placing purchase orders is used for the bulk of an organization’s purchases. Some items that are below a monetary threshold may alternately be purchased using a corporate credit card, while strategic or other more important investments may use other types of contracts. The process starts with a purchase requisition, which needs to be approved. Once approved, a purchase order is created. This results in an open order in the organization’s systems. Various types of

purchase orders or e-procurement are discussed next. After the order is received and accepted, the invoice is reconciled and approved for payment, and this part of process is also discussed.

Placing Orders All types of purchase orders or e-procurement constitute a legally binding contract. Two elements of a legally binding contract are contractual offer and contractual acceptance. The first occurs when a purchase order is transmitted; the second occurs when the supplier acknowledges the purchase order. Purchase Orders The APICS Dictionary, 16th edition, defines a purchase order as follows. The purchaser’s authorization used to formalize a purchase transaction with a supplier. A purchase order, when given to a supplier, should contain statements of the name, part number, quantity, description, and price of the goods or services ordered; agreed-to terms as to payment, discounts, date of performance, and transportation; and all other agreements pertinent to the purchase and its execution by the supplier. A purchase order is used for an initial or one-time transaction, so it needs to contain all of the details of the sale and all terms and

conditions, as described in the definition above. Most purchase orders are electronically submitted such as through a cloud-based system, but multiple paper copies could also be sent. In either case, multiple functional areas need to receive information on open purchase orders. Blanket Purchase Orders A blanket purchase order is defined in the Dictionary as a long-term commitment to a supplier for material against which short-term releases will be generated to satisfy requirements; [it] often cover[s] only one item with predetermined delivery dates. The blanket purchase order replaces shopping for competitive bids for the duration of the contract or use of multiple purchase orders with the same supplier. Use of blanket purchase orders is the simplest form of efficiency improvement a purchasing functional area can make, because it significantly reduces ordering costs. The blanket purchase order contains all master terms and conditions, so these parts of the contract do not need review again until the expiration of this master contract. Routine order releases are used for individual purchases under the blanket purchase order. These releases specify the delivery date and receiving functional area,

since these can differ from release to release and cannot be on the blanket purchase order. Important things to negotiate in a blanket purchase order include quantity discounts, delivery lead times, quality, and other terms. It is important for both the buyer and the supplier to forecast the anticipated demand for the material(s) over the course of the agreement, which is often six months, one year, or now often for longer durations. Suppliers use this demand information to ensure that sufficient capacity or inventory will be available at a reasonable cost. Renegotiations can address quantity trends, new prices, new quantity discount schedules, or supply of different items. Blanket purchase orders need exit clauses related to poor supplier performance. E-Procurement E-procurement can be used to place orders. This is addressed elsewhere but involves auctions, reverse auctions, exchanges, or portals.

Reconciling and Approving Invoices for Payment As the receiving and payment process in Exhibit 3-19, a purchase requisition needs to have a check and balance in the form of a supervisory approval. An approved requisition results in a purchase

order. Once the supplier provides the goods (or services), receiving does a three-way match to verify that the quantities and other details on the purchase order in the receiving report match the packing slips and the invoice. When the purchase order is initially created, finance creates an accrual, which is basically a temporary record of the intended payment. After a correct three-way match, the accrual is removed, finalizing the transaction in the system so the payment can be released. If everything is in order, the order is approved for payment.

Exhibit 3-19: Receiving and Payment Process

Receiving is not a value-added activity in the eyes of customers, so it is best to minimize the time spent on this step. While receiving is responsible for counting all the units and inspecting them for damage (the use of digital photos of the goods and regular communications between the parties can speed this process), it might use random sampling for very large shipments as well as automation such as bar-code readers on conveyor belts and so on. Receiving can also develop partnerships and find ways to certify to key suppliers that inspections aren’t needed.

Order Tracking and Expediting Track and trace is needed for providing visibility and a chain of custody for product origins. Since this subject is addressed elsewhere, here the discussion of order tracking is focused on the need for various functional areas to track the status of open orders until their completion. To expedite is “to rush or chase production or purchase orders that are needed in less than the normal lead time; to take extraordinary action because of an increase in relative priority” (APICS Dictionary, 16th edition). Expediting can be applied to any stage of the supply chain. We’ll consider expediting of supply (source and make) and of

transportation (deliver).

Order Tracking (Internal) Tracking the status of open orders is important to the following internal functional areas: Purchasing needs to be the primary party tracking the status of open orders and providing information on exceptions. Sales may need to notify customers of potential delays or other issues. Accounts payable and other finance functions such as treasury need to forecast future accounts payable obligations per period so they can ensure sufficient liquidity or invest excess funds. Accounting needs to ensure that financial records are accurate. The requesting functional area needs to be able to look up open orders by their order number and be kept informed of any issues or delays. Receiving needs to forecast its inbound workload and receiving space requirements per period. Traffic needs to use inbound inventory requirements to schedule carriers or internal delivery capacity and deliveries to avoid bottlenecks. Typically, enterprise resources planning (ERP) systems automatically provide these various status updates. An order

remains open in all of these functional area systems until it been received and properly accepted and, for financial records, until payment has been authorized. One example of an exception that one of these parties can report is a receiving discrepancy report. Receiving will prepare a list of receiving exceptions that need to be investigated or resolved. This can be from incorrect quantities, unacceptable quality, or the wrong items being received. A discrepancy such as this could result in needing to expedite supply or transportation. Expediting could also be initiated by sales or an external party.

Expediting of Supply Expediting of supply is something that should be very rare indeed in a well-managed system, because it often reduces profitability and causes other unintended side effects such as harming customer service for customers being bumped. However, expediting is sometimes necessary because not everything goes according to plan or a customer is important enough or willing to pay enough to make it necessary or worthwhile. What creates the need for expediting (real or apparent)? In many cases, expediting is caused by inventory shortages, which are in turn caused by poor demand forecasting. The result is that salespersons

start competing against one another to get their customers’ needs satisfied at the expense of other salespersons’ customers. Salespersons are often willing to spend a great deal of time expediting, by which we mean cajoling various suppliers or internal staff to get more done in less time or shift priorities. When this fails, salespersons may then escalate their expediting to senior salespersons or a vice president based on the importance of the customer. This scenario is an example of what happens when people focus on the short term and ignore long-term improvements. It creates an atmosphere of one emergency after the next. If they were to spend as much time on improving forecasts as they did at expediting, it would likely produce better and longer-lasting results. Expediting is achieved with suppliers by asking them to prioritize the organization’s needs above those of other customers. Depending on how important you are to them, your results may or may not be successful. They may charge the organization a premium for this priority, unless it is to correct an error on their part. Expediting is achieved with internal production by making requests to the master scheduler. Policy may dictate that this be a formal request with proper paperwork. The master scheduler will not allow for expediting of production in the frozen zone (the time period nearest to production when things have already been ordered and so on), so only production in the slushy or liquid zone should be a possible

candidate for expediting. If expediting is necessary and the slushy zone production will not be ready soon enough, then another option might be to supply it from allocated inventory (e.g., safety stock or convincing another customer to delay receipt of inventory already promised to them).

Expediting of Transportation Expediting of transportation can take the form of the shipper telling the carrier that a particular shipment needs to move to its destination as fast as possible and without any delays. This type of request may involve paying an expediting fee if the goods need to arrive before stipulated in the shipping contract. It may also not be possible to expedite a delivery much if the process is already efficient. Another way to expedite transportation is to ship via a faster mode of transport if the shipment isn’t already in transit. Just as a commuter may use a ride-share service when a bus will take too long, this may involve using an overnight delivery service if the units are small and light enough for these services to handle, or it could involve upgrading from ground to air transport, again depending on what is being shipped. If expediting is being done at the request of the customer, any extra costs, including administrative costs, would normally be passed on to the customer. If it is being done to fix an error or backlog, the organization will need to assume this expense.

Organizations can measure the amount of expediting that is being done and its costs so they can determine the savings that can be gained if these costs can be avoided.

E-Procurement Portals and trading exchanges are not exclusive to procurement; for example, they could be used with customers when the organization is on the selling end of the transaction or with logistics such as for finding transportation carriers. Exhibit 3-20 shows the types of online exchanges and other transaction models by the number of buyers and the number of sellers involved in each transaction.

Exhibit 3-20: Business-to-Business Digital Transaction Models

Portals According to the APICS Dictionary, 16th edition, a portal is a multiservice website that provides access to data that may be secured by each user’s role. Users can aggregate data and perform basic analysis. Portals work over web browsers to enable people to more easily interact with systems or other persons. They provide faster access to information than a person could achieve in collecting, sorting, and aggregating the information on his or her own. Individuals can make custom views and perform self-service functions. Portals can be independently or privately owned, or they can be jointly owned and used by a consortium of organizations. Portals increase information reach and reduce distribution cost. Consumer Versus Business Portals Consumer portals are multiservice websites for consumer interactions, including personalized home pages, email, online shopping and search, and news and entertainment services. Examples include Amazon.com or Yahoo.com. Business portals allow users to aggregate and perform basic analysis on information relative to their job. Organizational intranets and extranets are examples. Portals give employees and trading

partners access to data according to each company’s and each user’s role. To ensure identity authentication and security, some portals are the only allowed method for communications across enterprises. Portals can gather and continually update both external and internal sources of real-time information to determine customer priorities and make employees more productive. External information can be consolidated from external trading partners, the internet, and industry information services; internal information includes all attached transactional and analytical databases. Often portals are connected with or are a direct output of customer relationship management (CRM) or supplier relationship management (SRM) systems. SRM Portals SRM portals allow individuals to view and react to the effects of production changes on supplier product or service availability and to see exception-based information and forecasts based on point-ofsale data. Buyers can see suppliers’ available-to-promise inventory. The data are presented on a dashboard that allows users to configure what items are tracked. Often a user has no ability to modify the data, which is ideal for partners who need the information but should not be able to change it. For example, a company’s suppliers might be given access to a portal to see up-to-the-minute requirements. Suppliers could use the portal to send and receive

communications such as to confirm capacity and order status or receive a demand-pull signal for orders.

Trading Exchanges A physical exchange—such as a stock exchange—creates a space for buyers and sellers to transact business efficiently. Similarly, a trading exchange, also called a B2B marketplace, creates a virtual market in which buyers and sellers can optimize, automate, and coordinate transactions. Automating the procurement process using trading exchanges lowers the cost per transaction and increases market reach for both buyers and suppliers. Exchanges occupy the many-to-many quadrant of the chart in Exhibit 3-20. Exchanges can be called horizontal marketplaces when used across industries and vertical marketplaces when used by only one industry. The APICS Dictionary, 16th edition, defines these terms as follows: Horizontal marketplace : An online marketplace used by buyers and sellers from multiple industries. This marketplace lowers prices by lowering transaction costs. Vertical marketplace : An online marketplace connecting buyers and sellers within the same industry. It enables lower prices by lowering transaction costs.

A successful exchange will result in faster decision making, lower inventory, and better collaboration, planning, and production. Trade exchanges include the following: Supplier and buyer broker services Supplier and product search functions Bidding events, including setup and prequalifying bidders Cost-savings identification Access to a larger market Supplier identification and support Online catalogs listing products, sales promotions, and quantity pricing Online SRM services, including strategic sourcing for direct materials Open, standards-based systems for automated connections Billing and payment processing for faster transfer of funds to suppliers Some exchanges include a full range of SRM services and analytics, and they may also provide supplier certification to give buyers some assurance that suppliers meet certain predefined capabilities. Exhibit 3-21 shows the complex interactions among partners in a trading exchange. The exchange is at the center because it serves as a hub for numerous transactions among the community.

Exchanges facilitate collaboration because members can avoid forming multiple individual interfaces.

Exhibit 3-21: Trading Exchange Community Interactions

A good starting point in this cycle is at the bottom of the diagram where a supplier uploads catalog information to the exchange. The exchange ensures that the catalog is in a format to allow automated searches.

Buyers perform product searches, and matches from suppliers are aggregated. A highly detailed search can use an automated RFQ (request for quotation)/ITT (invitation to tender). Exchanges may help buyers and/or sellers prepare bids or assist buyers in writing more complete queries. Bidding events may require hours of preparation. This may come down to traditional procurement activities or be performed by a third party for many consumers, creating economies of scale. Annualized contract negotiation or a one-time purchase order can be initiated. Supplier availability is communicated to the buyer, and the exchange confirms the order. The transaction is communicated to the bank or financial service provider (FSP), logistics services, and carriers.

Exchange Ownership Models B2B marketplace ownership models include the following: Independent public trade exchange (ITX) or public marketplace. These are public sites often used for indirect materials and commodity purchases where price is the primary factor and where any buyers and sellers for a particular market meet to gain access to a wider mark et and find the best deals. Private trade exchange (PTX) or private marketplace. According to the Dictionary, these are

trade exchange[s] hosted by a single company to facilitate collaborative e-commerce with its trading partners. As opposed to public e-marketplaces, a private exchange provides the host company with control over many factors, including who may participate (and in what manner, how participants may be connected, and what contents should be presented, and to whom). The ultimate goal might be to improve supply chain efficiencies and responsiveness through improved visibility and collaboration, advanced integration platforms, and customization capabilities. Trading may occur between members or only with the owner. PTXs are formed by market-dominant companies. Most private exchanges are members-only sites, but they do not usually charge fees and do not force suppliers to compete on price alone. PTXs have been developed by Volkswagen AG and BMW AG in the automotive industry and by utilities such as the Tennessee Valley Authority and the Kansas City Power and Light Company. Consortia trade exchange (CTX) or consortia-based marketplace. The Dictionary defines a consortia trade exchange as an online marketplace, usually owned by a third party, that allows members to trade with each other. This site

lowers members’ search costs and enables lower prices for the buyer. CTXs are open or member-based sites formed by a consortium of companies, generally within the same industry. These some-tomany sites are semipublic, in that all members are allowed to trade with one another and price is often a major factor in purchases. There is a strong focus on finding new suppliers on these sites. Excess inventory and capacity is frequently traded in a clearinghouse. Ford Motor Company, General Motors Corporation, and DaimlerChrysler AG formed a consortium-based exchange, Covisint, in 2000. Covisint has been owned by a Canadian organization since 2017 so it serves as the third-party intermediary. Covisint has expanded into health care, government, oil and gas, and financial services. Virtual trading exchange. A virtual trading exchange is “an online trading exchange that enables both information integration and collaboration between multiple trading partners” (Dictionary). Private exchanges are very costly; companies with a high transaction volume or a large number of suppliers should consider a private exchange because the larger number of transactions reduces the cost per transaction. Companies with few suppliers or low transaction volume should consider an independent public

marketplace to keep costs down or a consortia-based marketplace to consolidate their supplier base with others. Private exchanges are desirable when partners want high security in data exchange. However, they should determine supplier interest in joining a private exchange. The best candidates are those that have strong market position or exclusive products or services. If the company has market dominance, it cannot gain much from aggregating demand with smaller businesses. The private exchange can help retain the unique brand value. When the company has unique business capabilities such as a unique processing model, then a private exchange can help leverage it.

Auctions Auctions determine the value of a good or service on the open market. Winning a bid constitutes a contract. Most auctions require indifference as to who the buyer or seller is, so they are best for commodities (e.g., copper, wheat). Auctions should be avoided when delivery time, reliability, or quality are important. Auction items are solely differentiated by price, and any special features should be put in the description to show the item’s value. Auctions benefit both buyers and sellers, with a balance of increased revenue, efficiency, and speed and reduced cost.

Types of auctions include the following: Classic or forward auctions. Classic auctions have one seller and multiple buyers who bid up the price for a product until the highest bidder gets the item. Reverse auctions . Reverse auctions are “internet auction[s] in which suppliers attempt to underbid their competitors; company identities are known only by the buyer” (Dictionary). Dutch auctions. Dutch auctions have one seller and multiple buyers for multiple but finite quantities of the same item for sale. The price starts high and is lowered periodically. A bid immediately constitutes a contract for sale at the current price. U.S. Treasury securities are offered by Dutch auction. Demand management auctions. Demand management auctions are clearinghouses to liquidate excess supply (e.g., hotel rooms); buyers and sellers must be indifferent to the other party. Stock-market-style auctions. Stock-market-style auctions have dynamic pricing based on buy and sell offers and multiple buyers and sellers for commodities.

Trading Exchange Benefits and Risks Benefits for buyers include

Better control over negotiated purchasing agreements Standard product specifications that reduce duplicate entries for parts and duplicate suppliers for the same part Reduced administrative costs Lower unit costs Faster response to needs and faster time to market Improved catalog accuracy, reducing billing and pricing errors Reduced logistics and transportation costs due to better volume leverage. Risks to buyers include Lower-quality goods Nonconformance to specifications More product rework and returns Long-term loss of suppliers and fewer skilled suppliers. Forcing supplier concessions could lead, in the long term, to worse supply chain coordination, poor planning, and adversarial relationships. Key suppliers should not be moved to cost-based exchanges. Benefits for suppliers are less clear than those for buyers. They include Automatic connections and lower transaction costs Access to a wider market

Faster payment receipt (order to cash) Ability to offer all available inventory Future bidding improved by knowledge of winning bid; shows need for cost reduction Better and more accurate catalogs for increased order accuracy Volume leverage, reducing logistics and transportation costs Reduction of replenishment lead time Supply and demand planning and collaboration, if offered. However, these benefits must be weighed against significant reductions in revenue. Low bid winners may have unprofitable margins. Risks to suppliers include Possibility that an option contract may lock up the supplier’s capacity even when the business is not guaranteed Fewer investments in improving processes due to tighter margins Possibility of being driven out of business Possibility that the buyer will use the seller’s data to get a lower bid elsewhere Exchange integration costs for software and connectivity. Suppliers whose value is not purely dependent upon low price (e.g., those with brand recognition for quality or dependability) are less likely to participate. If 100 suppliers participate in an online auction

but only one supplier wins the bid, the bid was a waste of time for the other 99 suppliers. Suppliers that do not see results may drop the service, especially with public horizontal exchanges. Suppliers are better off building long-term relationships, reserving exchanges to liquidate excess inventory. Whenever they win bids, their goal should be to start a personal relationship with these companies.

Index A Acquisitions [1] Annualized contracts [1] Auctions Reverse auctions [1]

B B2B marketplaces [1] Bilateral contracts [1] Blanket purchase orders [1] Business portals [1] Buyer-supplier relationships Acquisitions [1] Buy on the market [1] Mergers [1] Ongoing relationships [1] Strategic alliances [1] Buy on the market [1]

C Category strategy [1]

CE [1] COGS [1] Collaboration [1] See also: Collaborative design, Collaborative planning, forecasting, and replenishment (CPFR), Quick-response programs (QRPs) Collaborative design [1] See also: Collaboration Compliance [1] Component commonality [1] See also: Standardization Concurrent design [1] Concurrent engineering [1] Consortia-based marketplaces [1] Consortia trade exchanges [1] Consumer portals [1] Contract deployment [1] Contracting [1] , [3] See also: Subcontracting Contracts Annualized contracts [1] Bilateral contracts [1] Cost-based contracts [1] Cost-plus contracts [1]

Cost-plus-fixed-fee contracts [1] Cost-plus-incentive-fee contracts [1] Firm fixed-price contracts [1] Fixed-price-incentive-fee contracts [1] Incentive arrangements [1] Incentive contracts [1] Trading partner agreements [1] Core capabilities [1] Core competencies [1] Cost-based contracts [1] Cost of goods sold (COGS) [1] Cost-plus contracts [1] Cost-plus-fixed-fee contracts [1] Cost-plus-incentive-fee contracts [1] Costs Net costs [1] Ongoing costs [1] Process change costs [1] CTXs [1] Currency hedging [1] Currency selection [1] Customer desirability matrix [1] Customization Mass customization [1]

D Design for everything [1] Design for logistics (DFL) [1] Design for maintainability [1] Design for manufacturability [1] Design for quality [1] Design for remanufacture [1] Design for reverse logistics [1] Design for service [1] Design for six sigma [1] Design for the environment (DFE) [1] Design for the supply chain [1] Design for X (DFX) [1] DFE [1] DFL [1] DFX [1]

E E-procurement [1] , [2] Expediting [1]

F Firm fixed-price contracts [1] Fixed-price-incentive-fee contracts [1]

G Glocalization [1]

H Hedging Currency hedging [1] Horizontal marketplaces [1] See also: Trading exchanges, Vertical marketplaces

I Incentive arrangements [1] Incentive contracts [1] Independent public trade exchanges [1] Insourcing [1] International strategies Multicountry strategy [1] Inventory costs Landed costs [1] , [2] ITXs [1]

L L/C [1] Landed costs [1] , [2] Letter of credit (L/C) [1]

Logistics relationships Ongoing relationships [1] Strategic alliances [1]

M Make-or-buy analysis [1] Make-or-buy decisions [1] Mass customization [1] Mergers [1] Modular design strategy [1] Modularization [1] See also: Standardization Multicountry strategy [1]

N Negotiation Principled negotiation [1] Net costs [1]

O Offshoring [1] Ongoing costs [1] Ongoing relationships [1] Operating exposure [1]

Orders Purchase orders (POs) [1] Order tracking [1] Outsourcing [1] See also: Subcontracting

P Participative design/engineering [1] Payment [1] Payment methods Letter of credit (L/C) [1] Payment terms [1] Portals Business portals [1] Consumer portals [1] Portfolio analysis [1] POs [1] Postponement [1] Post-transaction costs [1] Pre-transaction costs [1] Principled negotiation [1] Private marketplaces [1] Private trade exchanges [1] Process change costs [1]

Procurement E-procurement [1] , [2] Product design [1] , [2] Product differentiation [1] Products Standardized products [1] PTXs [1] Public marketplaces [1] Purchase orders (POs) Blanket purchase orders [1] Purchasing [1]

Q Quality [1]

R Receiving [1] Reverse auctions [1] Reverse innovation [1] Risk management [1]

S Segmentation Supplier segmentation [1]

Service level agreements (SLAs) [1] Should-cost estimates [1] Simplification Design for service [1] Participative design/engineering [1] SLAs [1] Sourcing Insourcing [1] Outsourcing [1] Standardization [1] See also: Component commonality, Modularization, Standardized products, Universality Standardized products [1] See also: Standardization Strategic alliances [1] Subcontracting [1] See also: Contracting, Outsourcing Supplier alignment [1] Supplier partnerships [1] Supplier segmentation [1] Supplier selection [1] Supply chain capabilities Core competencies [1] Supply chain cost

Cost of goods sold (COGS) [1] Supply plan finalization [1] Supply planning [1] Supply plan refinement [1] Supply plans [1] Supply plan validation [1] Sustainability [1]

T TCO [1] , [2] , [3] Terms and conditions [1] See also: Contracts Total cost of ownership (TCO) [1] , [2] , [3] Trading exchanges Consortia trade exchanges [1] Independent public trade exchanges [1] Private trade exchanges [1] Virtual trading exchanges [1] Trading partner agreements [1] Traditional design [1] Triangle talk [1]

U Universality [1]

See also: Standardization

V Value added [1] Vertical marketplaces [1] See also: Horizontal marketplaces, Trading exchanges Virtual trading exchanges [1]

W Warehouse processes Receiving [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Module 4: Internal Operations and Inventory This module addresses how products and services are produced and how the related inventories are managed and controlled. The processes of master scheduling, material requirements planning, and various levels of capacity checks are discussed at a high level to start the module. Since great inventory management can be a competitive advantage, the module then discusses how to align inventory requirements with demand, manage various types of inventory, set policies for how various classes of inventory will be replenished, audit actual inventory levels, and manage product disposition and obsolescence. Product traceability and chain of custody are hot topics in supply chain management today, both for regulatory compliance and for promoting internal supply chain efficiency. These subjects are discussed here from an internal communications perspective. Another key area of discussion is measuring and assessing the performance of internal operations and inventory management, including financial performance.

The module concludes with a discussion of continuous improvement, total quality management, and many related tools, including general tools such as benchmarking, the seven basic tools of quality, the seven new tools, and systematic methodologies such as lean and six sigma.

Section A: Planning Operations This section is designed to Describe the purpose and objectives of manufacturing planning and control and its major subset, master scheduling Identify master scheduling grid components, including the master production schedule, available-to-promise, and time fences Describe the steps to follow in creating a master production schedule Differentiate independent and dependent demand Describe the purposes of bills of material Define lead time, exploding, and offsetting Define push and pull distribution and distribution requirements planning (DRP) and explain the relative benefits of DRP. Planning operations is how the supply side of operations keeps itself in balance with the demand side. The overall process is called manufacturing planning and control, which includes sales and operations planning, master scheduling, material requirements planning, and execution steps. Learning the logic of master scheduling and materials requirements planning in particular helps supply chain managers understand when this process is operating smoothly versus when it needs attention, such as to reduce frequent

changes that cause expensive disruptions. Distribution requirements planning is also discussed here, which is how distribution networks directly link up with a master scheduling system.

Topic 1: Planning Operations From a supply side, supply chain managers are most concerned with the sales and operations planning (S&OP) process, because it is how they ensure that supply and demand are balanced so supply chain processes can be consistent. However, it is important to place this process into its overall context, so this is presented first. After that, a master scheduling tool called the master scheduling grid is presented, including a discussion of time fences. The process can also be used for allocation of supply because a projected available balance and an available-to-promise amount can be determined.

Planning Operations Road Map The manufacturing planning and control process is used to plan operations. A high-level view of the process is shown in Exhibit 4-1.

Exhibit 4-1: Manufacturing Planning and Control

The collaborative process of sales and operations planning is used to generate the production plan at the level of aggregate supply and demand. It determines production volumes for product families rather than individual products. This process reconciles the needs of demand (activities on the left side of the exhibit) with the needs of supply (the various levels of capacity checks on the right). Master scheduling (MS) is then used to create a master production schedule (MPS) that will commit the company to produce specific

products on particular dates. The master scheduling process, therefore, has to disaggregate the product family data into numbers of individual products based on inventory levels, forecasts, demand plans, order backlogs, orders from distribution centers (DCs) as part of distribution requirements planning (DRP), and other considerations used to decide what you need to produce and how much of each item to produce. From there, material requirements planning (MRP) automatically calculates all of the various materials that will be needed to produce the units that are scheduled. This could then result in purchasing or drawing materials from inventory. In addition to purchasing, production execution involves production activity control, which is the detailed planning and scheduling of shop floor equipment and resources. Each planning stage includes a capacity check: 1. The aggregate production plan is checked against long-term capacity requirements using resource planning. 2. Rough-cut capacity planning at the master scheduling level verifies that the production targets are feasible 3. Capacity requirements planning at the MRP level checks capacity in detail.

4. Capacity control at the execution level validates that each job has the resources needed to run the job. Capacity issues can result in efforts to increase capacity to the degree feasible or in the master scheduler revising the plan if the load exceeds available capacity. The master scheduling process is typically facilitated by IT such as an enterprise resources planning (ERP) system, which creates a master scheduling grid for calculating production based on these data.

Master Scheduling Grid The APICS Dictionary, 16th edition, defines the master schedule as a schedule format that includes time periods (dates), the forecast, customer orders, projected available balance, available-to-promise, and the master production schedule. It takes into account the forecast; the production plan; and other important considerations such as backlog, availability of material, availability of capacity, and management policies and goals. The Dictionary defines a master schedule item as a part number selected to be planned by the master scheduler. The item is deemed critical in its impact on

lower level components or resources such as skilled labor, key machines, or dollars. Therefore, the master scheduler, not the computer, maintains the plan for these items. A master schedule item may be an end item, a component, a pseudo number, or a planning bill of material. The master scheduling grid calculates a projected available balance and available-to-promise amounts for demand prioritization purposes. It also calculates the master production schedule for operations purposes. See Exhibit 4-2.

Exhibit 4-2: Master Scheduling Grid

Source: APICS Master Planning of Resources, Version 3.1.

Master Scheduling Grid Line Items The line items of the master scheduling grid are defined as follows. Forecast

The forecast is the per-period demand plan for the individual end item. It is based on the forecast modified by the presumed effect of planned demand-influencing activities. Customer Orders According to the Dictionary, a customer order is an order from a customer for a particular product or a number of products. It is often referred to as an actual demand to distinguish it from a forecasted demand. Projected Available Balance and Available-to-Promise Projected available balance (PAB) and available-to-promise (ATP) are covered elsewhere, including details on how to calculate these items. Master Production Schedule The Dictionary defines the master production schedule (MPS) as a line on the master schedule grid that reflects the anticipated build schedule for those items assigned to the master scheduler. The master scheduler maintains this schedule, and in turn, it becomes a set of planning numbers that drives material requirements planning. It represents what the company plans to produce expressed in specific configurations, quantities, and dates.

MPS also takes into account interplant demand , a “plant’s need for a part or product that is produced by another plant or division within the same organization” (Dictionary). By providing firm production dates and numbers, the MPS serves as a contract between sales and operations. Putting numbers to the mutual obligations implied by the MPS “contract” offers benefits to both sides: For the sales force, the MPS provides assurance that they may make delivery commitments to customers based on the amount of product that will be available week by week. For operations, the commitment of the sales force to meet its numbers provides assurance that they can avoid problems resulting from overproduction or an excess of orders. Those problems include layoffs and unused plant capacity in the case of overproduction and the need to expand capacity rapidly and temporarily when orders exceed capacity. From the viewpoint of the company and the supply chain, the balance of supply and demand offers several potential benefits: Low holding costs for inventory Fewer stockouts that might back up customer orders, causing frustration and reduced loyalty

Efficient use of plant, labor, and equipment

Weekly Dates for Specific Products Besides disaggregating the product families, master scheduling also determines weekly production dates based on the monthly projections in the production plan. Exhibit 4-3 shows what might happen to monthly S&OP numbers for a family of laser printers when the master scheduler disaggregates the projections into weekly production numbers for specific models. Note that the exhibit shows production numbers only, not demand projections. Exhibit 4-3: Disaggregation of Operations Plan Numbers into Weekly MPS Months Aggregate production plan (S&OP)

July

August

1,000

1,200

(Total production for family of laser printers) Weeks

1

2

3

4

1

2

3

4

LX30—30-ppm

50

50

50

75

75

75

50

100

LX21—21-ppm

75

25

100

75

100 100 100 100

Master production schedule (Shows weekly production numbers for specific models within the product family)

Months LX15—15-ppm

July 50

150 150 150

August 75

125 150 150

Time Fences in Master Scheduling As defined in the APICS Dictionary, 16th edition, a time fence is “a policy or guideline established to note where various restrictions or changes in operating procedures take place.” A time fence marks off a zone in which changes to production may not be made without escalation to the appropriate level such as the master scheduler or the master scheduler’s supervisor. There are two types of time fences: the demand time fence (DTF) and the planning time fence (PTF). The two time fences create three zones, as shown in Exhibit 4-4.

Exhibit 4-4: Time Fences and Zones in Master Scheduling Grid

Source: APICS Master Planning of Resources, Version 3.1.

Demand time fence/frozen zone. In a frozen zone, capacity and materials are committed to specific orders. Orders are therefore “frozen” inside the fence. Any changes require the approval of senior management. Frozen time zones are bounded by a demand time fence like the one in Exhibit 4-4. Planning time fence/slushy zone. A zone marked off by a planning time fence is slushy rather than frozen. Capacity and materials are not as strongly committed as those inside a frozen zone. There is room to negotiate in a slushy zone in the form of tradeoffs, and the master scheduler makes these decisions. Liquid zone. In the liquid zone created by the remaining planning horizon after the planning time fence, all changes are permissible as long as they don’t violate the limits set in the production plan from sales and operations planning.

Time Fences for Material Requirements Planning Time fences for material requirements planning (MRP)—basically, planning for components or subcomponents of a production unit— work similarly to those described for master scheduling, except that each planned component will have its own set of time fences. The purpose of using time fences in MRP is to ensure that materials needed for orders are committed to those orders and not used for

other purposes. The planning time fence is usually set when the material is ordered or production is begun on the component; the demand time fence is usually set when the material is received or production of the component is complete. Time fences in MRP help manage the end item’s cumulative lead time because the operation will have its requisite materials available when they are needed. Cumulative lead time is defined by the APICS Dictionary, 16th edition, as the longest planned length of time to accomplish the activity in question. It is found by reviewing the lead time for each bill of material path below the item; whichever path adds up to the greatest number defines cumulative lead time. Complex products or services often have lengthy production or rollout cycles and thus multiple time fences. For example, a ship’s hull may have one set of time fences, its engines another, and the furnishings for the cabins could have another set much later in production than the first two.

Benefits of Time Fences Time fences can help balance the need for a production system to maintain schedules and control costs against the need for it to be flexible. Costs for changes dramatically increase when nearing the

final deadline of a time horizon. Rescheduling, additional setups, rerouting, expediting, overtime, and disrupted schedules for other items can all be direct costs of late changes, not to mention the toll it takes on the perceived reliability of the master production schedule and on customer service. However, flexibility is needed because customers can cancel orders or request changes, equipment can experience failures or other capacity problems could occur, raw materials could be used at a higher rate than expected (e.g., scrap), or suppliers could fail to deliver goods on time.

Allocation of Supply The APICS Dictionary, 16th edition, defines allocation as 1) The classification of resources or item quantities that have been assigned to specific orders but have not yet been released from the stockroom to production. It is an “uncashed” stockroom requisition. 2) A process used to distribute material in short supply. Allocation of supply involves giving sales staff or downstream supply chain partners a view into the projected available balance and what is available-to-promise to customers. It includes finding ways to commit inventory and scheduled production to specific customer

orders (intermediate customers or ultimate customers), including order promising by salespersons, without needing to move the items from inventory until they are needed for production. As per the second definition, allocation also refers to demand management and prioritization activities. The master scheduling grid that is created during the master scheduling process includes the projected available balance and available-to-promise. Exhibit 4-5 shows a master scheduling grid with a planning horizon of 10 weeks, minimum order quantities of 50, and a safety stock level of zero units. (As defined in the Dictionary, the planning horizon is “the amount of time a plan extends into the future.” It should be at least equal to the cumulative lead time for the product.)

Exhibit 4-5: Time Fences and Zones in Master Scheduling Grid

Source: APICS Master Planning of Resources, Version 3.1.

Projected Available Balance The projected available balance (PAB) is “an inventory balance projected into the future” (Dictionary). Whenever the PAB in a given period falls to a negative value or below the safety stock level, the master production schedule (MPS) must be reevaluated. Exhibit 4-6 shows an amount of 50 to the left of the PAB for period 1. This represents the available inventory at the start of this planning horizon. The MPS logic calculates the PAB for all future periods based on the beginning inventory and the demand for each period. In its simplest form, the PAB is based on a calculation of

For the MPS, this is complicated by having a formula for the periods before the demand time fence and another for after the demand time fence. Exhibit 4-6 uses the data from Exhibit 4-5 to complete the PAB. Prior to the demand time fence, the calculation is as follows (with an example from period 1 in the exhibit):

After the DTF, the calculation is as follows (with an example from period 6):

Exhibit 4-6: Projected Available Balance

Source: APICS Master Planning of Resources, Version 3.1.

As you can see, prior to the DTF we are concerned only with the known component of demand (customer orders). After the DTF it is the greater of forecast or orders. Recall that, in the frozen zone, materials are committed to orders and orders are frozen. The MPS logic therefore considers that only orders we have in hand will consume the on-hand inventory. Beyond the DTF, we can expect to receive more orders than those already booked.

As noted, the MPS logic uses the PAB level to determine when additional product is needed and proposes an MPS activity. (The MPS has to be checked with the rough-cut capacity plan to verify that capacity is available.) In Exhibit 4-6, the MPS reflects a quantity of 50 units to make in period 3. This was developed by calculating the PAB for each period. Using the PAB formula, the first period that would go negative is period 3. (The calculation would result in –1 units in period 3 if no MPS activity had been proposed.) Therefore, production of 50 units (recall that the replenishment for this product is fixed at 50 units) is required in period 3. Calculations for the remaining periods proceed in the same manner. Note the PAB of zero in period 5. Many planners may feel that we need to have replenishment at this point for many valid reasons. Understand, however, that the basic MPS logic is for the PAB to go negative before ordering. In an actual software configuration, planners could make adjustments to system variables to include replenishment at this point, or they could set a safety stock level.

Available-to-Promise The APICS Dictionary, 16th edition, defines available-to-promise (ATP) as “the uncommitted portion of a company’s inventory and planned production maintained in the master schedule to support customer order promising.” The Dictionary defines order promising

as “the process of making a delivery commitment (i.e., answering the question ‘When can you ship?’).” The methods used to compute ATP are discrete ATP (or noncumulative), cumulative ATP with look-ahead, and cumulative ATP without look-ahead. For our example, we will use the noncumulative (discrete) method, because it is the base method that the other methods build upon. Noncumulative methods are used for products that have an expiration date, such as milk, vegetables, pharmaceuticals, or beer. Beer, for example, has a six-month time frame. The other methods account for unsold ATP from prior periods and backlogs in their calculations and are used for nonperishable items. At the beginning of the planning horizon, the ATP amount includes inventory on hand plus the items scheduled to arrive in the form of an MPS receipt or scheduled receipts from a supplier. As customer orders come in and consume the uncommitted inventory, the number of available items goes down. When all the items have either been delivered or committed for delivery, nothing is left to promise. Exhibit 4-7 uses the data from Exhibit 4-6 to complete the ATP row. ATP for the first period of the planning horizon is calculated as follows (with an example from period 1 of the exhibit):

Exhibit 4-7: Available-to-Promise

Source: APICS Master Planning of Resources, Version 3.1.

For all other periods in which there is an MPS, the ATP does not include inventory on hand, so the formula is as follows (with an example from period 3 of the exhibit):

Commitment Decision Points Two situations could frustrate buyer-supplier relationships when actual demand data and demand plans are shared:

When the supplier apparently does not use the demand information and has not developed sufficient capacity (or maintains too much capacity) despite being given time and motivation make the necessary changes When the supplier builds sufficient capacity or inventory but the organization fails to order in that quantity because the plans overstate demand (or they understated demand and the supplier has insufficient capacity) Since these problems affect both ends of the relationship, organizations that choose to collaborate should clearly set expectations and obligations in the form of a bilateral contract or trading partner agreement. Such agreements can specify how demand information will be communicated and what is expected of each organization in terms of building capacity or ordering what was requested. The agreement should specify development of formal processes to support the collaborative effort. Such an agreement should specify when demand information represents a commitment to purchase goods or services and when it does not. This can be done using decision points similar to the time fences that were introduced previously. Exhibit 4-8 shows how decision points could be used to create three zones of purchase

commitment so that sellers can feel comfortable committing to produce the requested orders on schedule.

Exhibit 4-8: Use of Decision Points to Create Purchase Commitment Zones

In this example, the organization negotiates two decision points with a supplier: a firm commitment decision point and a volume commitment decision point. The firm commitment decision point is set three weeks out, and this creates a frozen zone where the buyer commits to communicate purchase orders and makes firm requests for delivery timing on specific days. The buyer and the supplier negotiate a second decision point at 16 weeks out, a volume commitment decision point, which creates a slushy zone before the point and a liquid zone after the point. Within the slushy zone, demand that is communicated is treated as an agreement to specify

weekly quantities to deliver. The buyer can rearrange priorities or change timing of orders but must buy the specified quantity of goods or services during those weeks. The liquid zone is used to communicate updates to the demand plan over whatever remains of the demand plan’s planning horizon (five to 18 months in this example). Demand information communicated for these periods represents no contractual commitments for purchasing or production on the part of the buyer or the supplier. If negotiations take this format, the subjects for negotiation will include where each decision point should be placed, based on the given industry, the supplier and buyer lead times, and the amount of flexibility or continuity each partner desires in the relationship. These negotiations should occur at the executive level with input from both organizations’ supply and demand professionals. This will ensure that the plan encompasses all technical requirements for order timing while getting top support for the agreement. This type of agreement allows the organizations to have a long-term focus and provides some amount of stability for the buyer and the supplier and perceived fairness for both parties.

Topic 2: Materials and Inventory

After finished goods are scheduled for production to satisfy demand, the necessary raw materials and components are calculated using material requirements planning (MRP). Also, inventory levels at specific locations are planned using distribution requirements planning (DRP). Besides discussing MRP and DRP, here we explain a number of manufacturing specifics: routing files, lot-for-lot or fixed order quantity replenishment, and offsetting.

Material Requirements Planning Material requirements planning is defined in the APICS Dictionary, 16th edition, as a set of techniques that uses bill of material data, inventory data, and the master production schedule to calculate requirements for materials. MRP plans dependent demand items—the raw materials and components needed to produce finished goods for consumers. The Dictionary defines dependent demand as demand that is directly related to or derived from the bill of material structure for other items or end products. Such demands are therefore calculated and need not and should not be forecast. The Dictionary defines independent demand as

the demand for an item that is unrelated to the demand for other items. Demand for finished goods, parts required for destructive testing, and service parts requirements are examples of independent demand. While independent demand is the subject of demand forecasts, dependent demand is not. Before you can talk about dependent demand for pockets and zippers and bolts of denim, there has to be independent consumer demand for jeans—or at least a demand plan based on a forecast. There can, however, be independent and dependent demand for the same item. For example, an item may be used as a component in finished production but also sold independently as a repair part or upgrade item. Auto parts stores stock replacement parts for independent sales to individuals and repair shops. Shelves in electronics stores contain numerous computer subsystems sold as upgrades. Those items are subject to independent sales and production forecasts. The same items are also ordered by manufacturers who base their orders for components on demand forecasts for the finished computers. Dependent demand doesn’t require estimation, only calculation. A scheduled demand for 1,000 pairs of blue jeans to be delivered in March to a major chain store creates a dependent demand for 1,000 right legs, 1,000 left legs, 2,000 front pockets, 1,000 zippers, 1,000 snaps, several thousand belt loops and rivets, and, further up the

supply chain, bolts of denim, tons of cotton, kilograms of metal, and so on. MRP plans all the orders that will get those materials to the right work centers or suppliers at the right times to get those blue jeans put together on the dates specified in the MPS. Exhibit 4-9 illustrates the data inputs required for MRP and the resulting outputs.

Exhibit 4-9: Material Requirements Planning

MRP Inputs

As you can see from Exhibit 4-9, inputs to MRP include the master production schedule, inventory status, planning factors, and bills of material. The master production schedule lists planned or scheduled orders for end items—tables, computers, automobiles, finished clothing, etc. The Dictionary defines the following terms related to item orders. Planned orders are a suggested order quantity, release date, and due date created by the planning system’s logic when it encounters net requirements in processing MRP. In some cases, it can also be created by a master scheduling module. Planned orders are created by the computer, exist only within the computer, and may be changed or deleted by the computer during subsequent processing if conditions change. Planned orders at one level will be exploded into gross requirements for components at the next level. Planned orders, along with released orders, serve as input to capacity requirements planning to show the total capacity requirements by work center in future time periods. Note that to be more precise, references to “the computer” in this and the next definition could be replaced by “MRP

software.” Firm planned orders (FPOs) are planned order[s] that can be frozen in quantity and time. The computer is not allowed to change [them] automatically; this is the responsibility of the planner in charge of the item that is being planned. This technique can aid planners working with MRP systems to respond to material and capacity problems by firming up selected planned orders. In addition, firm planned orders are the normal method of stating the master production schedule.

An open order (released order) is “a released manufacturing order or purchase order.” A scheduled receipt is “an open order that has an assigned due date.” Inventory status is what materials are already available for use in manufacturing the finished goods and what finished goods exist now. Planning factors include safety stock concerns and lead times (how long it will take to get each component after it has been ordered; this is necessary for proper timing of orders).

The bill of material (BOM) is a complete list of components and the quantities of each needed to make one unit of the end item— the “product tree.” A BOM provides the basis for answering the questions “What do we need?” and “How many of them do we need?” In its simplest configuration, a bill of material is an ingredient list, enumerating quantities of every component required to manufacture an item. It can also do a great deal more, such as enabling building modular components. provides an example of a multilevel bill of material for a ½horsepower electric motor.

Exhibit 4-10: Multilevel BOM for Electric Motor

The APICS Dictionary, 16th edition, defines a multilevel bill of material as a display of all the components directly or indirectly used in a parent, together with the quantity required of each component. If a component is a subassembly, blend, intermediate, etc., all its components and all their components also will be exhibited, down to purchased parts and raw materials.

The Dictionary defines a parent item as “the item produced from one or more components,” while a component is “the raw material, part, or subassembly that goes into a higher level assembly, compound, or other item; this term may also include packaging materials for finished items.” shows that the motor parent JTE-5000 3000 1 01 contains the following components, some of which are parents to other components: One stator assembly (part number 0010 L JTE-4001) One rotor assembly (part number 0020 L JTE-4002) One end bell-top (part number 0030 L JTE-4003) One end bell-bottom (part number 0040 L JTE-4004) Four six-inch screws (part number 0050 L JTE-4005) The user can click the arrows to the left of the part numbers (far left of the screen) to reveal the parts needed to assemble those components. In the exhibit, the arrows pointing downward have already been clicked to reveal their components, while the arrows pointing to the right could still be clicked to drill further down into the details for each component. In this way a user can see the steady “explosion” of the parts tree for all the components of the BOM or keep the BOM at a high level as needed.

Another type of BOM is the modular (planning) bill that pertains to the construction of a module that is not a finished product but is a component for use in a product. In a mass customization situation, operations may focus on the creation of a number of modules for later assembly. The MRP in that case schedules orders for the materials used in constructing the modules. Companies can also use a configure-to-order process that presents modular options when the sales order is being entered.

MRP Outputs With the information from the master production schedule and bill of material and on inventory status and planning factors, it is possible to develop a complete schedule for ordering (and delivering) all the components and materials necessary to create the items in the master schedule. The MRP process results in planned orders for making or buying all the components required. It typically includes the following specifications as defined in the APICS Dictionary, 16th edition: Planned order receipts . A planned order receipt (planned receipt) is “the quantity planned to be received at a future date as a result of a planned order release. Planned order receipts differ from scheduled receipts in that they have not been released.”

Planned order releases . A planned order release is “a row on an MRP table that is derived from planned order receipts by taking the planned receipt quantity and offsetting to the left by the appropriate lead time.” Planned order releases may differ depending on whether the order needs to be manufactured or purchased. An exception report . This is “a report that lists or flags only those items that deviate from the plan.” When the planning system calculates net requirements in MRP, it generates a set of planned orders, which are subject to change until orders are either made into firm planned orders by the planner or are released to become open orders or scheduled receipts (if assigned a due date). A planned order receipt is the same as a scheduled receipt except that it is used for planned orders (i.e., not yet released) and so there is still some uncertainty whether the order will be released. Note that when a family of related items is released as if it were one item, it is considered a joint replenishment system. According to the Dictionary, joint replenishment is a process of coordinating the lot sizing and order release decision for related items and treating them as a family of items. The objective is to achieve lower costs because of ordering,

setup, shipping, and quantity discount economies. This term applies equally to joint ordering (family contracts) and to composite part (group technology) fabrication scheduling.

Manufacturing Specifics Other aspects of manufacturing related to MRP are the routing file, lot-for-lot or fixed order quantity replenishment, and offsetting. Routing File When planning a trip, travelers can refer to route on a map. In manufacturing, we also look for the route, which is found in a routing file (router file or route sheet). The router maps the journey of a component from work center to work center, specifying all the operations it undergoes on the way to completion. It indicates each of the manufacturing steps required, the sequence of the steps, and the time required. There will be one entry for each operation. This can be very simple, such as the process shown in for an orange juice operation, or very complex, such as if the component travels around a global supply network with numerous partners. Note that this complexity would be broken down to be more palatable by having major part numbers each have their own set of routings.

Exhibit 4-11: Routing for Orange Juice

Lot-for-Lot or Fixed Order Quantity Replenishment While inventory replenishment for independent demand may include some safety stock as a buffer against demand uncertainty, that sort of variability doesn’t affect dependent demand. There’s no buffer necessary, so any safety stock would only be a waste of money for storage space, handling, and production capacity. Also, using a fixed order quantity (FOQ) often makes sense for the production of end items because it can provide production efficiencies. However, if each dependent demand component were ordered in lots, this can result in a huge number of components accumulating that may not experience any demand for a long time. Therefore, a lot-for-lot replenishment technique is typically used for most dependent demand. In lot-for-lot replenishment, the exact number of

components needed for production is the number that should be produced and delivered when needed. When operations for filling dependent demand orders allow batch sizes to vary, lot-for-lot is the favored technique. However, an FOQ technique must be used rather than lot-for-lot for operations that require fixed batch sizes and order quantities (e.g., accommodating a fixed vat size for beer brewing). Lot-for-lot scheduling depends upon the following essential information: Gross delivery required Projected amounts on hand for delivery Scheduled receipts (more potential deliverables) Net requirements (gross minus on-hand items and scheduled receipts) Lead time (so operations can be scheduled in time to meet the delivery date) With that information, you can specify the date to release the order and the date it will be received. The example in assumes weekly deliveries and a one-week lead time.

Exhibit 4-12: Lot-for-Lot Scheduling

Note in the exhibit that planned order releases (bottom row) are always equal to planned order receipts in the next column to the right and up one row. The orders released always equal the orders to be received—because in this example there is a one-week offset for lead time to produce the order. In week 1, you will see that there is no net requirement even though the gross requirement is 35 units. That’s because the week starts with 35 units projected on hand—enough inventory to fill the order without setting up for production. After that first week, gross and net requirements are equal because there is no more inventory on hand. Offsetting We just looked at a series of orders for one component. Scheduling the orders for all components for a product is more complicated. Why? Because the components are likely to have different lead

times. If you want them all to arrive simultaneously at one work site or work center, you have to schedule different release dates based on the different lead times. This process of counting backward from a due date to accommodate lead time is called offsetting. If you had a simple product with two components, product A with a lead time of one week and product B with a lead time of two weeks, you would release the order for A one week before the order receipt date and you would release B two weeks before the order receipt date. Real products can be complex, of course, with the components themselves having components, and those components having components, and all of them having different lead times. As shown in , let’s say product A is constructed from components B and C over a lead time of one week. Assume that component B has a lead time of two weeks and is itself constructed from components D and E, with lead times of one and two weeks respectively. Similarly, component C has a lead time of one week but is also assembled from components E and F with lead times of two and three weeks respectively. Finally, component F has to be constructed of components D and G, with lead times of one and two weeks.

Exhibit 4-13: Component Orders Offset by Lead Times for Simultaneous Arrival

Managing MRP There is a degree of inflexibility built into MRP, because it uses fixed lead times. MRP has ease of replanning among its strong points, especially if you’re using software that sorts out the impact that a change in one part of a schedule can have on the other parts. In the net change approach, only those parts of the MRP that require changes have to be altered. Regeneration of the entire plan is the more difficult alternative.

Feedback Loops and System Nervousness Good supply chain planning contains numerous feedback loops so that one level of planning can test the assumptions of the previous level and ask for changes if the plan seems impracticable. Regular S&OP meetings are one place where feedback can be received and processed almost continuously. The MRP is also subject to change when events such as changes in design or the master production schedule make alterations seem necessary. The plan may be revised as often as daily to keep current with changing data. However, too frequent alteration of the plans can be extremely expensive and demoralizing to staff, such as purchasers and production schedulers. Frequent and often frantic adjustments to MRP are known as system nervousness. Each change can result in multiple components needing to be rescheduled or expedited. To avoid this consequence, managers should consider possible problems before allowing too many changes. Time fences in the master schedule are one way to ease the system nervousness. They designate cutoff when automatic rescheduling is not allowed even if changes are made to the MRP—unless an exception order receives specific authorization. Another way to mitigate excessive nervousness is pegging each component to its parent in the bill of material. The APICS Dictionary,

16th edition, defines pegging as follows: In MRP and MPS, the capability to identify for a given item the sources of its gross requirements and/or allocations. Pegging can be thought of as active where-used information. When a pegged component is affected by a schedule change, someone can easily check to see what happened to its parent. It may turn out that the schedule change for the component was a mistake. Or, if there is an availability issue with a lower-level item, the planner can quickly check which end items will be affected and take countermeasures to minimize harm to the overall production schedule. System nervousness is not always a mere annoyance to be suppressed. Nervousness can make an otherwise sound system costly and inefficient. Sometimes it’s a symptom of excessive reprioritizing on the shop floor or in purchasing. This can underlie a variety of problems, such as quality issues or other conditions, and root causes should be sought to see if the nervousness is a result of problems in those areas. Reconciling Just-in-Time or Lean with MRP

The fixed lead times in MRP can come into conflict with JIT’s or lean’s commitment to moving materials as fast as possible to reduce inventory costs. Two ways to reconcile MRP and JIT or lean are the small bucket or bucketless approach and balanced flow: Small bucket or bucketless systems. MRP typically uses a bucket system of timing orders. For instance, an MRP might schedule all the orders in week-long time buckets. Reducing the bucket size from a week to a day or even less speeds up the flow considerably by allowing material releases to stagger. Some work centers don’t use buckets for scheduling at all but attach dates to each item. In bucketless systems, orders can move through the work area on a JIT basis. As soon as an operation is complete, the item moves into inventory, reducing the quantity of scheduled receipts in the MRP system. Inventory balances are then reduced by backflushing, which means using the bill of material to deduct component quantities from inventory as soon as the unit has been completed. Balanced flow. Another way of combining JIT and MRP, called balanced flow, is used in repetitive work centers such as assembly lines. MRP takes care of the scheduling and planning for delivery of parts to the line in small lots. JIT pulls the materials through the facility with visual signals such as kanban cards or empty bins.

Evolution of MRP Software Software to manage MRP has been evolving for a long time. Before MRP software existed, developing material requirements was a timeconsuming and arduous task. With the software, planners were freed of the manual tasks and could dedicate more time to actual planning decisions. Early forays into MRP steadily evolved until MRP II (defined below) crossed the functional borderline out of manufacturing and into other areas. And beyond that, ERP (enterprise resources planning) software, starting basically as an extension of MRP II across all the functions of an enterprise, has now developed modules that link all business functions and even multiple supply chain partners. Here are the highlights of MRP, closed-loop MRP, and MRP II—steps in the evolution of software from those first bills of material toward resource planning across the supply chain and linking of material planning with actual demand. MRP Software Material requirements planning software programs take information based on bills of material, component lead times, and incoming orders to schedule manufacturing dates.

One difficulty operations managers have experienced with MRP systems is the software’s assumption that all work centers in the chain have infinite capacity. This assumption can result in the generation of impossible schedules. Setting aside that problem, MRP systems provide very important benefits: They can improve on-time delivery percentages, thereby reducing component inventories and holding costs. They can free a scheduler to spend less time on scheduling tasks and more time on planning and exception resolution. Closed-Loop MRP Closed-loop MRP refines basic MRP because it incorporates feedback on available capacity. It calculates the impact of each order on the work center that is scheduled to complete the order, and, if it finds too little capacity at that center, it may send the order to another work center or site, outsource it, or change the order date. Closed-loop MRP also leverages feedback from the execution functions to the planning functions to ensure that replanning occurs. Both status information (order status, inventory balances, etc.) and warning signals/exception messages (behind schedule, overloaded, etc.) are passed back to planning. This facilitates the maintenance of valid plans and schedules.

MRP II Manufacturing resource planning (MRP II) is defined by the APICS Dictionary, 16th edition, as a method for the effective planning of all resources of a manufacturing company. Ideally, it addresses operational planning in units, financial planning in dollars, and has a simulation capability to answer what-if questions. MRP II is the first upgrade of MRP to include other functions such as sales and finance. To recognize this advance in scope and power, it is generally called manufacturing resource planning, a term coined in 1979 by Oliver Wight, instead of material requirements planning. MRP II incorporates the following function upgrades: It includes financials—a separate functional area from manufacturing. It provides visibility of material and capacity requirements defined in an operations plan. It provides detailed activity information and translates activities to financial statements. It suggests ways to bring activities back into line with planned priorities. It integrates long-term planning (business planning and methodologies that evolved into S&OP) with operational planning.

Distribution Requirements Planning Distribution requirements planning (DRP) is “the function of determining the need to replenish inventory at branch warehouses” (APICS Dictionary, 16th edition). DRP organizes inventory requirements so the organization has time to plan for when and how many goods will be required.

Pull versus Push Distribution Before we look more closely at DRP, we’ll draw a distinction between systems that pull inventory through the distribution chain toward the retail end and systems that push inventory down the chain. In reality, most distribution chains include elements of both push and pull. The questions for supply chain managers are Which system is best adapted to the needs of the supply chain? Where should the line of demarcation between push and pull be located? Note that manufacturing also uses push and pull to describe whether operations are pulled by actual demand (as in JIT) or pushed by forecast demand, but push versus pull manufacturing strategies are not necessarily related to push versus pull distribution strategies. For example, a JIT environment could operate based on actual demand pull and then perform centralized push distribution to get those orders to the correct customers.

In terms of distribution, the Dictionary defines a push system as “a system for replenishing field warehouse inventories where replenishment decision making is centralized, usually at the manufacturing site or central supply facility.” This traditional approach to distribution replenishment pushes inventory through manufacturing to the company distribution centers. Determination of product requirements is done by a central planning organization and pushed out. Inventory is then in storage until a customer (distributor, wholesaler, retailer) pulls material to meet projected demand. The Dictionary defines a pull system as “a system for replenishing field warehouse inventories where replenishment decisions are made at the field warehouse itself, not at the central warehouse or plant.” The benefit of this decentralized inventory planning approach accrues mostly to the entity doing the ordering, because it is able to operate independently to balance its supply and demand requirements as it sees fit. This assumes that the company orders intelligently. At the retail end, for example, the company might be a hardware franchise with a history in the community and good forecasting instincts. You might call this a system of serial autonomy, with each partner along the distribution chain making its own ordering decisions. As a system, however, it’s not especially systematic. It doesn’t take

advantage of the essential strengths of supply chain management, which are collaboration and mutual decision making. There are three particular drawbacks to the pull system: Orders are likely to increase as they travel up the chain (the bullwhip effect). The company doing the ordering knows nothing about the needs and plans of the other chain partners, who may have a greater need for the stock to meet customer service goals. The order doesn’t take into account the supplier’s situation. Push systems solve some of these problems but with a tradeoff. The downstream partners receive shipments on schedules developed elsewhere in the network rather than when they order it. While this can be beneficial to the supply chain by providing systemwide coordination of inventory management, it is less likely than the pull system to be sensitive to local market conditions. DRP is a hybrid system because it contains both push and pull elements. Hybrid systems are push-pull systems in which push distribution is pursued through centralized planning down to a particular supply chain level or echelon but pull distribution through decentralized planning is used after this point. For example, centralized planning could use information on demand from the retail end of the chain, aggregate this demand at the regional distribution

centers (DCs), and push inventory to these DCs. The customers of these DCs, perhaps wholesalers and retailers, then order inventory from these DCs as they see fit. This very common replenishment strategy can increase centralized control by moving the point of push to pull down the chain or increase decentralized control by moving the point up the chain.

DRP Components Distribution requirements planning combines the following inputs: Demand forecasts from distribution centers to determine the gross requirement Safety stock for customer service Accurate lead time information Overall knowledge of the distribution system (a mapping akin to a bill of material that shows how the distribution network is configured) Exhibit 4-14 shows what goes into and comes out of a DRP system.

Exhibit 4-14: Distribution Requirements Planning Input/Output Diagram

DRP Logic DRP system logic translates DC demand into forecasts for use in factory master scheduling. DRP logic typically uses time-phased netting of requirements (net requirements per period or bucket) rather than a decentralized order point (pull) system. Exhibit 4-15 illustrates DRP logic using distribution centers A and B, a central supply location, and a master schedule grid for a factory.

Exhibit 4-15: Distribution Requirements Planning

Source: APICS CPIM Basics of Supply Chain Management.

Planned order releases from DCs A and B are released to central supply according to each DC’s demand requirements and lead times. In the exhibit, DC A and DC B release planned orders in week 6 for 400 and 500 units respectively. Central supply has a three-

week lead time, a projected available balance of 500 units, and a lot size (order quantity) of 600 units. Therefore, to fill the planned order releases of 900 units, central supply releases a planned order for 600 units in week 3 (to account for the three-week lead time and lot size), which will leave a projected available balance of 200 units (equal to its safety stock requirement). Central supply’s planned order release of 600 units becomes a gross requirement in the master schedule grid. This allows the distribution centers’ timephased requirements to be factored into the factory’s master production schedule.

Benefits of Push and Pull Elements in DRP Distribution requirements planning combines the coordinated planning and control offered by push systems with the responsiveness to local demand that characterizes pull systems. Although orders originate downstream (that is, toward the retail end), they are evaluated at the supplying locations before being released to determine the actual need at the ordering location and the availability of goods at the sites receiving the order. This helps prevent shortages at supplying sites and overstock at ordering sites. In this way, DRP keeps inventory in balance around the network.

Because the hybrid DRP system combines information from both supplying and ordering locations, it can, in theory, provide more accurate allocations of stock than either straight pull or push systems, which take into account the needs of only the ordering or the supplying location. Because the DRP system is based on more accurate data and more thorough assessments of need and available supply, it should allow release of smaller, more frequent orders than straight pull or push arrangements. And this in turn provides the supply chain with the benefit of better customer service and lower inventory costs.

Section B: Capacity and Production Activity Control This section is designed to Understand the role of planning, management, and control in relation to an organization’s capacity Describe the levels of capacity checks: resource planning at the sales and operations planning level, rough-cut capacity planning at the master scheduling level, capacity requirements planning (CRP) at the material requirements planning level, and capacity control at the execution level Understand how long-term capacity can be increased by leading or lagging actual demand and in multiple steps or in one big step Enumerate the objectives of CRP Explain the purpose of production activity control and its activities Measure capacity using available time, utilization, and efficiency data to produce rated capacity Compare rated capacity to demonstrated capacity or capacity requirements Explore ways to improve production activity control such as by using the theory of constraints or kanbans.

A key way to balance supply with demand is to use capacity planning, management, and control. These are internal checks to create or verify capacity that are done over the long term for things that take a long time to change and over shorter and shorter time frames as we get closer to actual execution. Production activity control is where actual production execution occurs, and this is also addressed in this section. Part of this process involves detailed capacity planning at the work center level, and this requires knowing how to measure rated capacity against demonstrated capacity and actual requirements.

Topic 1: Capacity Capacity is the primary constraint of supply, and it needs to be planned, managed, and controlled at multiple levels. After providing an overview of capacity, three levels of capacity checks are discussed: resource planning, rough-cut capacity planning, and capacity requirements planning.

Capacity Road Map In order to satisfy significant shifts in demand or to roll out a new product or service, an organization must ensure that it will have the

required capacity in time. For example, in a manufacturing setting, the organization must have the plants, equipment, production lines, and workers to produce the output dictated by the production plan within the time allowed. Capacity planning, capacity management, and capacity control are tools that help ensure success in the planning and execution of supply. These concepts are shown in Exhibit 4-16.

Exhibit 4-16: Capacity Management, Planning, and Control

The APICS Dictionary, 16th edition, defines capacity planning as the process of determining the amount of capacity required to produce in the future. This process may be performed at an aggregate or product-line level (resource requirements planning), at the master scheduling level (rough-cut capacity planning), and at the material requirements planning level (capacity requirements planning).

Capacity planning involves identifying required resources and selecting the best method available to increase capacity when needed. According to the Dictionary, capacity management is the function of establishing, measuring, monitoring, and adjusting limits or levels of capacity in order to execute all manufacturing schedules (i.e., the production plan, master production schedule, material requirements plan, and dispatch list). Capacity management is executed at four levels: Resource planning, Rough-cut capacity planning, Capacity requirements planning, and Input/output control. Maintaining proper capacity levels in the most efficient configuration possible enables serving customers in a costeffective manner. The goal is to prevent an imbalance between supply and demand. The Dictionary defines capacity control as the process of measuring production output and comparing it with the capacity plan, determining if the variance exceeds pre-established limits, and taking

corrective action to get back on plan if the limits are exceeded. Capacity control takes place at the level of everyday activity, as a form of input/output control. It corrects imbalances that may begin at the single part or hour level before they become a bigger problem. Attempts to balance capacity with load can result in too little capacity, too much capacity, or the correct amount of capacity. Too little capacity. If any site or work center in your supply network has too little capacity for the production goals assigned to it, demand at that point in the chain will exceed supply and you will have to either add capacity (if that is possible), shift work elsewhere, or endure stockouts, long backlogs, or backorders. Too much capacity. If an organization overbuilds or over-staffs a work center or plant, supply exceeds demand. If full capacity is used anyway, this results in high inventories. If capacity is reduced to actual demand levels, available labor hours, work centers, and warehouse space are wasted. Maintaining overcapacity means that some costs such as salaries, lease or interest payments, and insurance will remain at a high level, reducing profits or creating losses. When load and capacity are not in balance, the

organization is inefficient. Serious oversupply can lead to enormous write-downs, plunging stock prices, bankruptcies, and layoffs. Correct amount of capacity. When organizations get capacity management right, supply and demand stay in balance, deadlines are met, orders are filled on time with quality items, overtime is minimal, and they are generally making optimal use of labor, equipment, and space. Continuous improvement practices can improve organizational performance, even as an organization continually works to maintain accurate levels of capacity.

Planning Horizons Capacity planning begins with the sales and operations planning (S&OP)/production planning process and continues through production activity control (PAC). Exhibit 4-17 illustrates the levels of capacity planning as they correspond to the levels of manufacturing planning and control.

Exhibit 4-17: Planning Horizons

Capacity planning starts at a high level, looking at long-range activities. It continues all the way through short-range, daily activities.

Resource Planning Resource planning (also called resource requirements planning) is capacity planning over the longest time frame. Resource planning results in a resource plan, which identifies the resources needed to meet production priorities one, two, or even five years into the future. The highest level of inputs are the strategic and business plans and their long-range demand forecasts, information that is used to plan long-term capital investments. This part of the resource plan is a long-range assessment of capacity requirements at an aggregate

level. Another key input is the production plan (an outcome of sales and operations planning), which provides demand information for up to 18 months out or so. The resources that are needed—including plant, labor, and equipment—must be identified and acquired to create enough supply to match projected demand. Resource planning might identify the number of labor hours required quarterly to meet operations goals. If those goals seem impossible to meet with realistic capacity projections, plans may have to be altered. If organizations don’t already have the resources in the network to meet demand at this aggregate level, then they must make decisions about modifying capacity, modifying the production plan, or managing demand differently. For the longer end of long-term capacity requirements, resource planning may involve generating business cases for capital expenditures such as infrastructure improvements, winning approval for them at the executive level, and producing project plans and performing project management to build or acquire the resources needed for long-term strategic business development. It can also involve strategic hiring and workforce training. Exhibit 4-18 shows the part that capacity planning plays in relationship to resource planning (which interacts with the production plan from S&OP).

Exhibit 4-18: Capacity Planning at Level of Resource Plan

The APICS Dictionary, 16th edition, defines a resource profile as the standard hours of load placed on a resource by time period. Production lead-time data are taken into account to provide time-phased projections of the capacity requirements for individual production facilities. Standard costing is a common tool used in capacity analysis because it enables estimating how much load is created by the demand for a given number of units of each family. Standard hours may be the cost driver for some operations. For example, assume that manufacturing an average laptop requires 0.75 standard hours

of assembly time. If the production plan for the period calls for 100,000 units, then there is a planned load of 75,000 standard hours of assembly time. This load is then compared to the available capacity over the same period. A resource profile can also use measures specific to a given operation, such as standard milliliters of a chemical, standard hours of drying time, or standard kilograms of raw material.

Capacity Strategies If an organization decides to increase capacity to match expected growth in demand, it can decide on the best strategy to stage the investments. For example, it may be necessary to build a new facility to accommodate types of work the organization isn’t doing for current projects or to purchase expensive equipment. When the organization does so, it will develop excess capacity, and there will be a lag before demand catches up. Organizations might instead decide that they have the basic capacity they need but some upgrades will be required. In that case, they may be able to stage the upgrades to match expected growth in demand, either staying a little ahead (leading), a little behind (lagging), or a little of each (so that demand and supply average out) as capacity is increased in stages to reach a future goal.

Exhibit 4-19 shows four ways to stage growth in capacity: One-step lead strategy: expanding all at once ahead of demand Stepwise lead strategy: expanding in steps ahead of demand Stepwise lag strategy: expanding in steps behind demand (to catch up, in other words) Stepwise overlapping strategy: expanding in steps that are sometimes ahead of and sometimes behind forecast demand Exhibit 4-19: Four Ways to Stage Capacity Growth

No matter which strategy is employed to stage growth in capacity, they will all ultimately involve some form of resource management. The Dictionary defines resource management as follows: (1) The planning and validation of all organizational resources. (2) The effective identification, planning, scheduling, execution, and control of all organizational resources to produce a good or service that provides customer satisfaction and supports the organization’s competitive edge and, ultimately, organizational goals. (3) An emerging field of study emphasizing the systems perspective, encompassing both the product and process life cycles, and focusing on the integration of organizational resources toward the effective realization of organizational goals.

Rough-Cut Capacity Planning Rough-cut capacity planning (RCCP) is defined by the APICS Dictionary, 16th edition, as the process of converting the master production schedule into requirements for key resources, often including labor; machinery; warehouse space; suppliers’ capabilities; and, in some cases, money. Comparison to available or demonstrated capacity is usually done for each key resource. This comparison assists the master scheduler in establishing a feasible master production schedule.

Rough-cut capacity planning takes a more detailed, medium-term look at production priorities as they are described in the master production schedule (MPS) and determines whether capacity is available to carry out the scheduled activities. If it does not appear that production targets are realistic within specified tolerances as agreed to by the S&OP policy, the plan goes back to the master scheduler for revision. The master scheduler can alter either the schedule or the capacity. Similarly, if there is too much capacity in the system, adjustments may be needed. The back-and-forth nature of rough-cut capacity planning is often facilitated by supply chain managers, who can represent various parties’ interests. Typically bottlenecks, gateway work centers, and critical suppliers are the only capacity checks that are done at this point. The Dictionary defines a bottleneck as “a facility, function, department, or resource whose capacity is less than the demand placed upon it.” In other words, at this stage RCCP reviews key resources and bottleneck areas; it is not a review of every component of operational capacity. RCCP examines critical resources in the plants on the premise that if any bottleneck points can generate sufficient capacity (or key materials are sufficiently available), non-bottleneck capacities and materials are normally also sufficient.

An example of a bottleneck work center could include a situation in which an operation’s throughput (rate of production) is constrained by a particular component’s fixed oven-curing time. Speeding up production before or after this point would only increase work-inprocess (WIP) inventory without increasing throughput. A steady supply of components should be ready to be cured (a buffer), but otherwise excess WIP inventory is unnecessary. (These concepts are part of the theory of constraints, discussed elsewhere.) While resource planning could be used to indicate a need for new ovens, the RCCP process works within current capacity limitations. These limits may be flexible, however. For example, the master scheduler could add a second shift to keep the ovens running longer each day. In this way, the rough-cut check is matched against bottleneck capacity and the load specified in the MPS. If there’s a gap, the master scheduler must specify what is required to bridge it. Exhibit 4-20 shows the part RCCP plays in capacity planning.

Exhibit 4-20: Capacity Planning at Level of Rough-Cut Capacity Planning

Similar to resource planning, RCCP has inputs for critical resources and standard resource capacities (bills of resources versus resource profiles). The difference is that for RCCP these inputs specify individual items rather than product families. According to the Dictionary, a bill of resources (bill of capacity) is a listing of the required capacity and key resources needed to manufacture one unit of a selected item. Rough-cut capacity planning uses these bills to calculate the approximate capacity requirements of the master

production schedule. Resource planning may use a form of this bill.

Measuring Capacity Capacity at a work center is measured using the standards that were set for sites and work centers (equipment and workers) to produce a product. Capacity may be measured in a variety of ways besides items per unit of time (widgets per hour). For example, hospital capacity is rated by number of beds. Additionally, some organizations rate a work center’s capacity only according to the standard hours of work time available. (100 workers at 40 hours per week is 4,000 hours of work time.) Capacity is never measured is in monetary units—euros, dollars, yen.

Goals of RCCP for Master Production Schedule Output The output of the RCCP process is a workable master production schedule. An MPS is considered workable if the master scheduler has verified that Bottleneck capacity per item per time period is sufficient. The plan makes the best use of resources. Customer delivery promises can be kept. The plan is still economical given all excess costs that will be incurred, such as overtime.

Capacity Requirements Planning Capacity requirements planning (CRP) determines in detail the amount of labor and machinery required to carry out production tasks specified in the material requirements plan (MRP), translating MRP orders (measured in units) into hours of work for each work center in each time period. CRP is the most detailed level of capacity planning. At this point in the process, planning looks at orders and work schedules to see how available capacity will or will not translate into the work center production necessary to meet demand. The amount of work scheduled for a work center is determined by a system that reviews all of the work released to that center by MRP and MPS, adds up the standard hours required for each order, and compares it to capacity. Another purpose of capacity requirements planning is to assign each facility, work center, and operation a load and perform load leveling. The APICS Dictionary, 16th edition, defines load and load leveling as follows. Load : The amount of planned work scheduled for and actual work released to a facility, work center, or operation for a specific span of time. Load leveling : Spreading orders out in time or rescheduling operations so that the amount of work to be

done in sequential time periods tends to be distributed evenly and is achievable. Although both material and labor are ideally level loaded, specific businesses and industries may load to one or the other exclusively (e.g., service industries).

Steps in CRP Four steps are required to determine the capacity available at a work center: check the open order file, planned order releases, the routing file, and the work center file. Step 1: Check the Open Order File. The open order file contains all active shop orders, with quantities, operations, and due dates. The open orders are recognized in the MRP grid on the “Scheduled receipts” line. Taken together, these orders tell you how much capacity is already scheduled at the work center. However, since manufacturing has already begun working on these orders, only the load of the remaining operations needs to be taken into account. Step 2: Check Planned Order Releases. The planned orders will be released on the release dates planned by MRP. Since these orders are not yet released, all operations still need to be performed and taken into account.

Step 3: Check the Routing File. The routing file follows each component’s progress through the center or centers. The file may be electronic or a paper copy, and it contains the following for each component: Operations to be performed Sequence of operations Work centers Alternate work centers Tooling needed for each operation Standard times, including setup time for each piece as well as run time Taken together, the routing file plus planned order releases provide the information necessary to calculate the amount of time in the schedule for any work center. The routing file includes information on the operation numbers and sequence, the operation descriptions with timing (e.g., mix: one hour/batch), the work centers, and other requirements. By adding the open orders and the planned order releases, the total commitment of time for the work center can be calculated. Step 4: Check the Work Center File. The work center file provides capacity information about the center, which includes a collection of people and/or machines engaged in

one type of work. The file contains all the information needed to calculate the amount of manufacturing lead time to complete one order at the work center. At a minimum, the file will contain data on queue time, wait time, and move time. These times, together with the setup and run times from the routing file, constitute the lead time for the component. Dividing the total time available during a scheduled period at the work center by the run time tells you how many units can be produced at the center in that period. Lead times can be further broken down. The Dictionary defines manufacturing lead time as the total time required to manufacture an item, exclusive of lower level purchasing lead time. For make-to-order products, it is the length of time between the release of an order to the production process and shipment to the final customer. For make-to-stock products, it is the length of time between the release of an order to the production process and receipt into inventory. Included here are order preparation time, queue time, setup time, run time, move time, inspection time, and put-away time. These manufacturing lead time components, along with wait time, can be summarized as follows:

Order preparation time is the administrative time spent processing an order. Queue time is the time spent waiting for an operation to start. (It can be a significant percentage of manufacturing lead time.) Setup time is the time spent preparing work centers for different operations. Run time is the time spent performing an operation. Wait time is the time spent at a work center before going to the next center. Move time is the time spent physically moving items among work centers. Inspection time is the time spent on quality assurance. Put-away time is the time spent moving the item to its storage location. (It is part of move time.) The work center file also contains data on work center efficiency and utilization.

Topic 2: Production Activity Control Production activity control (PAC) is control of production execution, including related work center capacity checks. After introducing PAC, the specifics of how capacity is measured are addressed. The last area of discussion relates to how to continuously improve PAC.

Production Activity Control Road Map Production activity control (PAC), of which capacity control is one part, consists of all those activities meant to ensure that actual production goes according to plan. Capacity control is the level of capacity planning that has the shortest horizon and takes place closest to the daily action of manufacturing. Within PAC, capacity control takes the form of input-output control and operations sequencing. While it isn’t the purpose of this course to go into the details of manufacturing activity, we cover the basic objectives of PAC and look at some control strategies that can help keep things running smoothly. If activities at each work center don’t run smoothly, missed production schedules will affect the supply chain from one end to the other.

Control Objectives PAC has four main objectives: Execute the master production schedule and the material requirements plan. Make the best use of resources. Minimize work-in-process (WIP). Maintain customer service.

Control Functions Production activity control’s functions can be put under three headings, as follows: Plan. Planning at this level means ensuring that resources are available and scheduling start and completion dates. Execute. Execution of the plan requires gathering relevant information for the shop order and releasing the orders. Control. Controlling the workflow requires Establishing and maintaining order priority Tracking actual performance (so you know where any problems are) Monitoring and controlling work-in-process, lead times, run times, and queues Reporting work center performance. These three functions take place in a continuous loop (as shown in Exhibit 4-21), with the data gathering and analysis that takes place in the control function feeding information to the planning function to enable continuous improvement.

Exhibit 4-21: Planning, Executing, and Control

Source: CPIM Workbook.

Measuring Capacity If we want to measure available capacity for a given period of time, we need to know three things: Available time. Available time is a product of hours of operation and numbers of workers or equipment in use during those hours. (For instance, four machines producing eight hours a day, five days per week, yield a weekly available time of 4 × 8 × 5 = 160 hours.) Utilization. The APICS Dictionary, 16th edition, defines utilization as “a measure (usually expressed as a percentage) of how intensively a resource is being used to produce a good or service.” Utilization is calculated as the percentage of available time that the

work center is actually being used ([hours actually worked/available hours] x 100%). A work center with an available time of 120 hours per week that operates at 90 hours has a utilization rate of 75 percent [(90/120) x 100]. Efficiency. The Dictionary defines efficiency as follows: A measurement (usually expressed as a percentage) of the actual output to the standard output expected. Efficiency measures how well something is performing relative to existing standards. Efficiency can be calculated as

For example, a work center that produces 110 standard hours of work while operating for only 100 hours has an efficiency rate of 110 percent. Standard hours or time (from standard costing) refers to the amount of time an average worker or piece of equipment is expected to need, following prescribed methods, to produce one unit of output. Standard time allows for ordinary delays and rest periods.

Note also that efficiency calculations may be used to determine bonus pay. Productivity is one measure that can be derived from these metrics.

This information can also be used to calculate rated capacity and capacity requirements.

Rated Capacity Rated capacity for a work center is the available time multiplied by the utilization rate and the efficiency percentage:

If the work center has 160 hours of available time and its utilization rate is 85 percent with an efficiency rating of 90 percent, the available capacity would be 122.4 standard hours per week (160 x 0.85 x 0.90 = 122.4 standard hours). Note that rated capacity calculations result in standard hours.

Demonstrated Capacity Another way of measuring capacity available determines the demonstrated capacity; you could consider this the practical counterpart of rated capacity. It is simply the average output measured over a period of time.

For instance, let’s say the work center rated above at 122.4 standard hours of available capacity had this performance during six consecutive weeks (n = 6): Week 1

120.0

Week 2

118.5

Week 3

119.0

Week 4

123.0

Week 5

119.2

Week 6

122.5

Its demonstrated capacity would be the average of the weekly output for those six weeks, or 120.4 standard hours.

Capacity Requirements Once you know the available capacity at a work center, you can compare it to the load. If you don’t have the capacity at a work center to match or exceed the load, then there is a capacity constraint. Exhibit 4-22 shows how a constraint might appear on a load profile tracking the capacity hours required in the first six weeks of the upcoming year. Week 4 turns out to be the week when the question

“Can we do that?” is answered “No, we can’t.” The planner will have to talk to the work center manager about possible changes in available capacity—adding temporary labor, improving efficiency if possible, or producing extra goods early if the excess demand can be anticipated far enough in advance and there is available capacity earlier (as there is in this example).

Exhibit 4-22: Capacity Requirements

When Load and Capacity Are Out of Balance If you find that there is more load than capacity or more capacity than load, you can choose to either change capacity, change the load, or change a combination of the two.

Change Capacity to Match the Load. You can select one or a combination of the following means to alter the capacity: Add or reduce work hours. Use overtime hours to handle the extra load or undertime hours to reduce the cost of excess capacity. Hire or lay off workers. This is an inefficient way to handle a shortterm problem (e.g., severance to outgoing employees or training new ones). Using temporary workers is an option if you have an agency that can provide workers with the requisite skills. Shift the workforce. If you have work centers that are over capacity and others that are under, you may be able to move workers with compatible skills. Job rotation techniques can prepare the workforce for this. Change the routings. Instead of moving workers around, reroute the work to take advantage of overutilized and underutilized stations. Change the Load to Match Capacity. It may be possible to reduce (or increase) the load to bridge a gap between load and capacity, but this can be done only if it doesn’t complicate matters too much at other work centers. You have a few possible tactics: Subcontract extra work to a third party (contracting out is not an increase of your capacity so it is a form of reducing load on your

resources) or reduce subcontracting to increase internal load. Change lot sizes. Lot size ( order quantity ) is “the amount of a particular item that is ordered from the plant or a supplier or issued as a standard quantity to the production process” (APICS Dictionary, 16th edition). Change the schedule.

Continuous Improvement of Production Activity Control In addition to carrying out production plans according to schedule, production activity control can engage in continuous improvement by adopting techniques associated with six sigma, kanban, lean manufacturing, and other tried and true systems. Here are a few strategies employed to speed up manufacturing (and other) processes.

Concentrate on Constraints. According to Goldratt’s theory of constraints, a production process is no faster than its slowest function, known as the constraint (or bottleneck). Capacity is limited by the constraint the way traffic flow is constrained by traffic jams. Cars headed into the jam can speed

up without helping a bit; they just make the traffic queue longer, sooner. So here are a few principles for handling the constraint in a system: Elevate the constraint, which means working to remove the constraint. For example, if you have only one machine to do a constrained task, buy another one. (Need would typically be identified in resource planning.) Put some inventory in a queue before the constraint as a time buffer. You want to make sure the constraint always has inventory so it never stops functioning, because that will make the system slow down even more. Control the rate of material feeding into the constraint. You want material coming in at the rate required to maintain the time buffer. Anything less depletes the buffer; anything more causes an expensive queue. Improve the flow at the constraint in any way possible, for instance, reduce setup time or increase utilization. Adjust loads to avoid the constraint when you can. (A lack of proactive planning soon enough to make a difference is itself a type of constraint.) There may be a cost tradeoff such as needing to use more expensive work centers, but this justifies itself if the added expense buys even more valuable throughput. Throughput

time is “the length of time from when material enters a production facility until it exits” (Dictionary). Change the schedule—as a last resort.

Use Visual Signals. The kanban system from Japan speeds up operations by pulling inventory through the work center instead of pushing it up to the next workstation where it sits in a queue. As defined in the Dictionary, kanban is a method of Just-in-Time production that uses standard containers or lot sizes with a single card attached to each. It is a pull system in which work centers signal with a card that they wish to withdraw parts from feeding operations or suppliers. The term demand pull is defined in the Dictionary as the triggering of material movement to a work center only when that work center is ready to begin the next job. It in effect eliminates the queue from in front of a work center, but it can cause a queue at the end of a previous work center. Kanban systems often use display cards as the visual signal to tell a workstation to begin operations. The idea is to keep the lot sizes as small as possible to optimize use of space and labor.

Many plants have adopted the system and modified it to use a signal other than a card. An empty space can do for a signal to begin operations. At Harley-Davidson, for instance, components are placed in special containers. An empty container signals the need for more parts. Exhibit 4-23 illustrates a kanban system that pulls inventory all the way through the supply chain, from raw material to finished goods.

Exhibit 4-23: Kanban System with Visual Signals

Develop Pull Partnerships and Learn to Be Lean. Kanban’s visual signals are one example of a pull system of production control. These systems, often part of lean or Just-in-Time systems, depend upon having supply partners who understand the vision and are willing and able to cooperate. Having a supplier who delivers small lots of inventory to your plants on an as-needed basis can help you save space and avoid slowdowns due to material

shortages and can save on labor costs at the docks. but this level of coordination does require all parties have a high level of supply chain maturity. Developing lean thinking focuses on taking only value-added steps and eliminating wasted efforts and resource waste. A simple example: Reduce the distance between work centers with the heaviest traffic. Fewer steps taken by many employees can add up to considerable savings of time and money. (Organizing the entire work site this way is called JIT layout.) Produce only what customer demand requires. Quality is in the eyes of the customer so they define what is value added and what isn’t.

Section C: Inventory This section is designed to Define inventory and inventory management Identify the main types of inventory Describe valid reasons for holding inventory Identify key performance indicators relevant to inventory management Describe the factors to be weighed when setting inventory policy Identify why inventory is managed in aggregate and at the item level Explain ABC analysis and how it shapes aggregate levels of inventory Differentiate between inventory cost categories Describe the effects of inventory on financial statements Describe how inventory can be given different values on the balance sheet based on how it is valued by accountants Understand the use of inventory turnover as an inventory control tool Explain how product traceability and chain-of-custody data assist with risk reduction and compliance Define centralized and decentralized inventory planning

Discuss how locations of inventory can be optimized by echelon, number, and geographic location Explain assumptions and processes of lot-for-lot, fixed order quantity, and economic order quantity (EOQ) methods of determining order quantities Describe ordering systems, including order point, periodic review, min-max, time-phased order point, and demand-driven MRP Describe the functions and drawbacks of using safety stock and safety lead time Explain how and why inventory is tracked Distinguish between period and cycle counting Manage product disposition and obsolescence. Inventory is an expensive asset when considered in the aggregate, and so it needs a great deal of attention from supply chain managers. After addressing inventory basics, this section looks at important policies that can help provide nuance to how inventory is managed, such as by using an ABC inventory analysis or managing product disposition and obsolescence. Supply chain managers will learn here how to present their inventory management improvements in financial terms. Since inventory across the entire supply chain is of interest to supply chain managers, methods of replenishment are addressed here at a high level along with other tools such as setting safety stock levels.

Topic 1: Inventory Inventory is a major investment for many organizations, so it is important to know its forms, functions, and costs; how to plan and position it in the supply chain; how to manage it properly at both the aggregate and the item level; and how it is viewed by finance professionals and other stakeholders who use financial statements.

Inventory Road Map The APICS Dictionary, 16th edition, defines inventory as those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies), and customer service (finished goods and spare parts). Organizations that carry inventory do so because it is a necessary cost of doing business. However, since it is a cost, organizations are continually working to find the optimum levels of inventory—those that can maximize profits, production efficiency, and customer service. Inventory can also be seen as an investment that, if managed correctly, can be a strategic asset to the organization. For example, inventory can decouple demand and supply, so proper management of inventory can provide protection against variability in either.

Since using inventory to protect against variability costs money and consumes space, management may consider alternatives to carrying more inventory than desired, for example: Improved demand forecasting and/or use of actual demand orders Reduced variability in the quality, amount, and timing of supply deliveries Shorter production cycle times Careful maintenance of production equipment Keeping inventory in motion as much as possible rather than allowing it to wait in queues, in warehouses, and so on. A basic understanding of inventory depends upon knowing the types of inventory and the functions performed by each type.

Types of Inventory Inventory can be classified according to where along the supply chain it is being held. Classification of inventory type depends on the point of reference, meaning that a raw material supplier’s finished good becomes a manufacturer’s raw material upon transfer. Each type serves particular functions, all of them adding to the supply chain’s flexibility when maintained at optimum levels. The types are as follows:

Raw materials inventory includes purchased parts, materials, or subassemblies to a production process that have been acquired but have not yet entered production. Work-in-process (WIP) inventory is defined in the APICS Dictionary, 16th edition, as goods in various stages of completion throughout the plant, including all material from raw material that has been released for initial processing up to completely processed material awaiting final inspection and acceptance as finished goods inventory. In other words, work-in-process inventory is inventory to which value has been added, but it is not yet a finished good. WIP can also include subassemblies for a BOM that are held in inventory. Finished goods inventory includes the finished, ready-to-use products waiting to be purchased by the customer. In-transit inventory (distribution inventory) is “inventory in the transportation network and the distribution system, including the flow through intermediate stocking points” (Dictionary). Some amount of inventory of each other type is in transit at any given time due to the never-ending cycle of production and replenishment; an example is inventory on containerships for

international shipments. Counting only the inventory that is currently in stock could be omitting a significant percentage of total inventory. In-transit inventory is measured by the average annual inventory in transit, which is a function of transit time in days and annual demand. Reducing this cost requires finding ways to reduce transit time, because less volume needs to be in transit at a given time. MRO (maintenance/repair/operating supplies) inventory includes spare parts, lubricants, hand tools, and cleaning supplies that are needed to maintain production but are not in the final product. Because of this, MRO is expensed rather than being an asset on the balance sheet like the other types of inventory. Maintaining reliable production requires keeping an inventory of supplies for both routine maintenance and emergency repairs. Attention to production machinery and MRO forecasting can reduce equipment costs and downtime. MRO inventory has its own inventory management challenges. It is often kept in multiple dispersed locations at a facility, making it hard to accurately account for its accumulation or use. This creates risks of obsolescence, unnecessary purchasing of items already in stock, and unnoticed pilferage. Purchase requisitions are often the only trigger to order more MRO inventory, but their frequency and small

order size make these an administrative burden. Organizations could realize significant benefits from investing management time in optimizing the size of this inventory investment, the number of suppliers being used, the controls over MRO inventory, or the MRO ordering process. Many organizations rely on corporate credit cards for small-value MRO items. Some organizations partner with fullservice distributors to create an online requisition system. Given enough volume, a distributor may keep an employee on site to help the organization avoid stocking so much MRO inventory because they can offer fast replenishment. Another improvement example is to centralize MRO inventory storage.

Functions of Inventory Inventory can be seen as both an asset and a liability. The following functions, or purposes, of inventory answer the question “Why have inventory in the supply chain?” Cycle stock or lot-size inventory. The APICS Dictionary, 16th edition, defines cycle stock as inventory that “depletes gradually as customer orders are received and is replenished cyclically when supplier orders are received.” These available-for-sale or sold goods constitute the main function of inventory. When referring to aggregate inventory in the supply chain, cycle stock may be called pipeline inventory. Cycle stock is called lot-size

inventory when the inventory is purchased or manufactured in quantities greater than needed, such as to receive quantity or full truck discounts or to match batch sizes for production. Anticipation inventory is “additional inventory above basic pipeline stock to cover projected trends of increasing sales, planned sales promotion programs, seasonal fluctuations, plant shutdowns, and vacations” (Dictionary). It is intended to cover the demand projected in the organization’s demand plan. The demand plan will include anticipation of demand peaks and valleys due to promotions or changes in seasonal demand. In a level production strategy, anticipation inventory may require building additional inventory before it is needed in order to cover the anticipated increased demand later in the year. Buffer inventory includes materials maintained to keep throughput steady at work centers. The Dictionary defines a buffer as a quantity of materials awaiting further processing. It can refer to raw materials, semifinished stores or hold points, or a work backlog that is purposely maintained behind a work center. The term is also related to the theory of constraints. Some organizations dynamically adjust their buffer sizes as a control

lever to manage constraints and keep throughput a priority so it can remain as high as possible. Safety stock (fluctuation inventory) is defined in the Dictionary as follows: 1) In general, a quantity of stock planned to be in inventory to protect against fluctuations in demand or supply. 2) In the context of master production scheduling, the additional inventory and capacity planned as protection against forecast errors and short-term changes in the backlog. Overplanning can be used to create safety stock. Safety stock is inventory held to protect against miscalculations of timing or quantity. It is used to reduce variability in demand and/or supply. If a supplier goes bankrupt suddenly, for instance, safety stock can be used to continue production while looking for a replacement supplier. Safety stock helps meet customer service targets and reduces stockout costs. Use of safety stock to satisfy unplanned demand should be considered normal to a point. Inventory policy can be used to set an acceptable frequency for use of safety stock; increased frequency of use over this target is an exception indicating that there may not be enough planned cycle stock. Decreased frequency of use or non-use under this target may indicate that there may be too much safety stock.

Note: When the delivery times fluctuate, safety stock may be used for A and B items (fast and medium-fast movers) in the ABC inventory method. However, when applied to C items (slow movers), inventory will increase too much because the inventory is rarely needed. In this case, safety lead time should be used. Hedge inventory. Hedge inventory is not a commonly used term, but many organizations do practice hedging when it comes to inventory. Hedging involves managing risk by building, buying, or contractually guaranteeing additional inventory at a set price if supply could be threatened or prices could rise. These decisions involve speculating on events such as the weather, the economy, labor strikes, civil strife, or political actions. A key concept related to buffer inventory and safety stock is decoupling. Decoupling is defined in the Dictionary as creating independence between supply and use of material. Commonly denotes providing inventory between operations so that fluctuations in the production rate of the supplying operation do not constrain production or use rates of the next operation. Decoupling allows supply and demand functions to operate at differing, independent rates. Holding a supply of raw materials inventory, for example, decouples the manufacturer from its

suppliers. The sawmill operator wants to have a ready supply of trees to turn into dimensional lumber. The furniture manufacturer wants enough dimensional lumber to process. Since many products are produced in batches when there are competing uses for the same work centers, decoupling also allows scheduling use of a work center so that some production may occur earlier than needed to avoid bottlenecks in overall production. While this adds to inventory build-up because some WIP inventory will be ready for the next work center before it is needed, it is an example of the need to optimize the overall flow of inventory in production. While decoupling is often necessary, supply chain managers look for ways to achieve the same goals without the holding costs by reducing variability in quality, quantity, or delivery time.

Inventory Costs A number of specific costs are associated with inventory. It is important to understand up front that these costs are interrelated and a decrease in one cost could result in an increase in a different cost. Inventory managers set order amounts and timing to reduce acquisition, carrying, and ordering costs without sacrificing customer service. This process is needed in each part of the supply chain. The retailer and the distributor order more finished goods, the

manufacturer orders more components and supplies, the supplier orders its own materials and supplies, and so on. An order schedule can help coordinate these flows.

Acquisition Costs The APICS Dictionary, 16th edition, defines acquisition cost as the cost required to obtain one or more units of an item. It is order quantity times unit cost. Acquisition cost is also referred to as product cost or purchase price.

Landed Costs According to the Dictionary, landed costs include “the product cost plus the costs of logistics, such as warehousing, transportation, and handling fees.” Landed costs for purchased inventory are the sum of all direct costs, including the price paid (i.e., acquisition cost), transportation to the site, customs, and insurance. Landed costs for internally sourced inventory include direct labor, direct materials, and factory overhead costs.

Carrying Costs Carrying cost (also called holding cost) is “a percentage of the dollar value of inventory per unit of time (generally one year)” (Dictionary). It is a variable cost that increases as the level of

inventory increases. Carrying costs may be as high as 40 percent of the value of the inventory and are unlikely to be less than 15 percent. They include all the expenses involved in housing the inventory, such as the following: Storage costs. Storage costs include allocations for rent, operating cost, taxes, material-handling costs, lease payments for equipment, depreciation, power costs, and operating costs. These material, labor, and overhead costs for storing and moving inventory are allocated to individual SKUs (stock keeping units) based on their volume (called cube), weight, or density. Large, dense, or difficult-to-handle goods have higher storage costs. Capital costs. Inventory requires financing, and capital costs refer to the return expected by creditors and investors because the money could be invested elsewhere (called opportunity cost). Companies acquire financing from debt or equity sources. Debt sources include borrowing arrangements that charge interest and require repayment; equity sources include money from investors (who get an ownership stake in the organization) plus retained earnings (past profits). The relative proportion or weight of each of these sources is called the weighted average cost of capital (WACC). WACC can be used as a required percentage return on inventory sales that must be exceeded.

Risk costs. Risk is related to the sensitivity of the inventory to loss of value, such as its perishability, speed of obsolescence, or likelihood of theft. Risk costs include the cost of insurance, inventory value reductions, and inventory write-offs. Subjective quantifications of risk can be added to inventory, such as a two percent per day decline in inventory value due to obsolescence. In this example, inventory remaining in stock for more than 50 days is considered valueless.

Ordering Costs The Dictionary defines ordering costs as follows: Used in calculating order quantities, the costs that increase as the number of orders placed increases. It includes costs related to the clerical work of preparing, releasing, monitoring, and receiving orders, the physical handling of goods, inspections, and setup costs, as applicable. Ordering costs are all those costs that do not vary due to quantities ordered but vary only by the frequency of ordering. Ordering costs include costs incurred when ordering inventory and setup costs resulting from the process of preparing to go into production to fill the order. For purchased materials, ordering costs include all the costs associated with the purchasing process. Use of electronic forms and payment transfers can reduce these ordering

costs; less frequent ordering can also reduce these costs but at the price of additional inventory holding costs. Setup costs include labor for cleaning machinery and making any necessary adjustments or modifications. This requires shutting down the machines, but it is sometimes possible to reduce the shutdown time by doing some preparation work off the work site while the machines are still processing previous orders.

Backorder, Lost Sale, and Lost Customer Costs The cost of backorders, lost sales, and lost customers are costs related to customer service. A backorder (also known as a stockout) is “an unfilled customer order or commitment…an immediate (or past due) demand against an item whose inventory is insufficient to satisfy the demand” (Dictionary). The cost of backorders, lost sales, and lost customers can be difficult to quantify financially but can be measured using various means such as percentage of orders shipped on schedule, which can help quantify the safety stock investment needed for a particular item at a particular location to keep this risk at acceptable levels.

Capacity Variance Costs Capacity variance costs are the costs of changing capacity beyond a “normal” range, including the costs of overtime, additional shifts, layoffs, or plant closings. Capacity variance costs can be minimized

by production leveling strategies (producing a consistent amount throughout the year), but this strategy increases inventory holding costs during periods of low demand.

Inventory Planning According to the APICS Dictionary, 16th edition, inventory planning is the activities and techniques of determining the desired levels of items, whether raw materials, work in process, or finished products including order quantities and safety stock levels. Inventory planning can be centralized or decentralized or a hybrid of the two. In centralized inventory planning, inventory is pushed out to later stages in the supply chain by the lead organization or channel master. Later stages such as distribution centers have no say in what they receive, but the central system usually attempts to replace inventory that is sold and to plan for seasonal effects or other trends. Centralized planning can minimize overall inventory levels but may respond slowly to local demand. Decentralized inventory planning involves each supply chain stage determining its own inventory requirements and placing orders

independently, so there is no coordination expense. Hybrid systems use centralized planning up to a certain point in the supply chain (such as the distribution centers), followed by decentralized inventory planning at all later points. Decentralized inventory planning can lead to the bullwhip effect and other problems, especially if actual customer demand isn’t available to all stages of the supply chain. Therefore, centralized or hybrid planning has grown in popularity. Inventory planning has two major components: where to locate inventory and the desired levels of items at each selected location.

Locations of Inventory Where should inventory be located? Inventory should be located in any place in the distribution network structure where it can serve a valid purpose as a buffer between stages of the supply chain, reduce overall costs, and meet customer service goals. Warehouses, Distribution Centers, in Transit Inventory can be stored in warehouses and in retail locations. The APICS Dictionary, 16th edition, defines warehouses as facilities used to store inventory. Decisions driving warehouse management include site selection, number of

facilities in the system, layout, and methods of receiving, storing, and retrieving goods. Distribution centers are a type of warehouse. According to the Dictionary, a distribution center is “a location used to store inventory.” Inventory can also be located in transit. Echelons How can these inventory locations be optimized to minimize total inventory and maximize customer service? Treating each stage of inventory handling as an echelon is a good way to start understanding how to manage inventory locations. According to the Dictionary, an echelon is a level of supply chain nodes. For example, a supply chain with two independent factory warehouses and nine wholesale warehouses delivering product to 350 retail stores is a supply chain with three echelons between the factory and the end customer. One echelon consists of the two independent factory warehouses, one echelon consists of the nine wholesale warehouses, and one echelon consists of the 350 retail stores. Each echelon adds operating expense, holds inventory, adds to the cycle time, and expects to make a profit. illustrates the possible locations of inventory by these supply chain nodes.

Exhibit 4-24: Locations of Inventory by Echelon

Echelons can be helpful in planning the locations of inventory because organizations can decide how many echelons to have. Some organizations will not have as many as others, since each adds to material, labor, overhead, and inventory costs. Consolidation warehouses could be omitted entirely. A direct-to-customer business model would not contain any wholesalers or retailers. The same could be true for any other echelon. The organization performs strategic network design to determine the optimum number of echelons, followed by analysis of the number and geographic location of specific sites. Usually this analysis makes use of network modeling, operations research, and decision support systems to calculate the lowest total cost of ownership of all storage locations, handling costs, and transportation costs for a selected level of customer service. Each echelon can provide particular benefits, such as the following:

Suppliers’ warehouses provide a buffer against manufacturing orders. Consolidation warehouses lower transportation costs by grouping shipments from multiple sources into fewer shipments to a manufacturer/assembler. Manufacturing warehouses provide a buffer for manufacturing processes as raw materials and WIP and for later echelons as finished goods. That is, the buffer provides decoupling between these supply chain nodes. Distribution centers provide a buffer for later echelons. When they serve as break-bulk warehouses, they lower transportation costs by receiving large shipments (economy of scale) while shipping out individual orders. They can also serve as consolidation warehouses by grouping shipments from multiple vendors into fewer shipments to a wholesaler or retailer. Wholesalers may provide buffering, consolidation, or break-bulk services. Retailers provide immediate access to inventory and possibly other services. Consolidation and break-bulking not only reduce transportation costs but can reduce inventory, especially slow-moving inventory, since it can be shipped in smaller quantities when consolidated with other inventory.

In addition to buffering, consolidation, and break-bulking, storage locations can provide three other benefits: Sorting (cross-docking, assembly, and mixing) Seasonal storage (produce inventory year-round; sell in one season) Reverse logistics (sites for returns, remanufacturing, repair, remarketing, and disposal or recycling) Echelons can also be used to aggregate inventory for centralized inventory planning purposes—if inventory planning decisions can be made for the entire supply chain and/or decision makers have access to visibility of inventory information at each location. Hybrid systems can use this policy up to the point where centralized planning ends and may rely on visibility after that. Echelon inventory policy considers inventory at a particular point to include all inventory at that echelon and at all later points in the supply chain, including all transit inventory after the given point. The benefit of thinking in this way is that the demand from all lower points can be aggregated for more accurate calculation of order quantities and order levels. At each lower echelon, this process can be repeated and will be more and more detailed.

Levels of Inventory

In addition to determining the number and location of warehouses, supply chain managers oversee the stocking of warehouses with an optimal level of inventory. They also establish transportation links that ensure timely arrival at and departure from warehouses. In the ideal network, raw materials, components, and other resources might never be at rest in a warehouse. Instead, they would always be in motion until arriving, just in time, at each location along the supply chain. One reason this ideal state is difficult, or impossible, to achieve is the fluctuation in demand all along the supply chain, beginning with the ultimate customer. Unpredictable demand, along with other factors such as accidents and adverse weather conditions, means that maintaining some levels of inventory at various locations along the supply chain is generally necessary. The supply chain manager’s challenge in the area of inventory level planning, therefore, involves assessing future demand as accurately as possible and keeping inventory as low as possible without disruptions in delivery to customers. Inventory level planning requires demand management and forecasting, distribution requirements planning systems, warehouse management systems, and transportation management systems, as discussed elsewhere.

Inventory Management The APICS Dictionary, 16th edition, defines inventory management as “the branch of business management concerned with planning and controlling inventories.” Inventory management is required at any organization that carries inventory. This role involves planning and controlling inventory from a supply chain perspective and an internal process perspective. The supply chain perspective of inventory management is concerned with the inflows and outflows at each stage, from the ordering of raw materials to customer handoff of finished goods. Therefore this area can benefit strongly from inventory visibility and supply chain collaboration. Inventory visibility is “the extent to which inventory information is shared within a firm and with supply chain partners” (Dictionary). Inventory management is also integrally connected to production management, so the second perspective of inventory management is an enterprisewide view of inventory processing. Inventory feeds into production and/or is a result of production, so planners, master planners, and production schedulers coordinate with each other at each level of production planning refinement.

Inventory management may be the responsibility or concern of many different competing interests at an organization, as shown in Exhibit 4-25. Exhibit 4-25: Inventory Management Roles Purchasing and materials management

Adequate raw materials at low inventory cost

Manufacturing and finance

Efficient and low-cost production balanced against low inventory cost

Sales and marketing

Sufficient inventory to meet customer delivery requests and service levels

Inventory is managed as an overall strategic concern (in aggregate) and at the individual item level. Each method is necessary. Together these two methods provide inventory managers with sufficient information to meet both strategic and operational requirements. Inventory policy may be set at both the aggregate and item levels, so it is discussed first.

Inventory Policy Inventory policy is a way of formalizing the results of strategic inventory decisions so that they can be implemented consistently. Inventory policy codifies both broad and specific inventory management decisions. On a broad level, inventory policy could specify centralized or decentralized inventory planning and/or

warehousing, frequency of communications and coordination, or a geographical inventory positioning strategy such as postponement. On a more specific level, inventory policy can specify rules for order quantities, order timing, when to act on exceptions to rules, and amounts of specific items to purchase versus produce. Organizations weigh a number of factors when setting an inventory policy: Customer demand. Customer demand is known in advance of production and/or is forecasted. Inventory policy must compensate for demand forecast variability. Planning horizon. The duration of the planning horizon affects necessary inventory levels; long-term plans may provide time to change system capacity. Replenishment lead time. The time required to replenish stock at various locations in the supply chain is a key inventory policy input, especially for long or highly variable lead times. Product variety. Similar products may compete for budget allocations or retail shelf space and thus need interconnected inventory policies. Product families are planned together in part as a way to reduce the impact of product variety on planning. An excess of variety can produce far too many SKUs (stock keeping

units), which results in a significant increase in inventory holding costs for make-to-stock products. Inventory costs. Inventory costs include order costs (production and transportation) and inventory carrying costs. Customer service requirements. Inventory policy specifies a level of safety stock per item and location that balances minimizing failure to fill customer orders within an acceptable time (e.g., stockouts) against increasing inventory costs.

Aggregate Inventory Management Aggregate inventory management is primarily concerned with the financial impact of inventories, which means getting to an optimal level of inventory that can produce the greatest overall profit for the organization and the supply chain. The objectives of aggregate inventory management are shown in Exhibit 4-26.

Exhibit 4-26: Objectives of Aggregate Inventory Management

Inventory is aggregated, or grouped, prior to analysis not only because the large number of individual items in some organizations would be impractical to analyze individually but also because, when forecasting supply and demand patterns, aggregate-level forecasts are more accurate than item-level forecasts. (Aggregation reduces the variability in data.) Note that aggregation is performed only to the level that the groupings provide effective analysis. Aggregate inventory management can be used to Determine the types of inventory to hold Optimize the flow of inventory and provide suitable buffers between stages Match supply with demand Set inventory objectives and inventory policy Calculate inventory costs by category

Perform sales and operations planning (including production planning), demand management, and resource planning. Aggregating inventory helps inventory managers determine the costs and benefits of a particular group of inventory. Inventory can be aggregated by Demand pattern (e.g., women’s running shoes versus men’s running shoes) Production process (e.g., men’s and women’s running shoes produced on the same production line) Stage of production flow (e.g., raw materials, finished goods) Product or SKU family or type (e.g., finished goods with similar functions but variations in models, packaging, colors, or styles) Distribution pattern (e.g., products that originate at the same source and/or are to be delivered to the same location or customer zone) Relative value to the organization (e.g., ABC inventory classification). Let’s take a closer look at ABC inventory classification. ABC Inventory Classification ABC classification , also known as ABC analysis, is defined by the APICS Dictionary, 16th edition, as follows:

The classification of a group of items in decreasing order of annual dollar volume (price [more typically standard cost] multiplied by projected volume) or other criteria. This array is then split into three classes, called A, B, and C. The A group usually represents 10% to 20% by number of items and 50% to 70% by projected dollar volume. The next grouping, B, usually represents about 20% of the items and about 20% of the dollar volume. The C class contains 60% to 70% of the items and represents about 10% to 30% of the dollar volume. The ABC principle states that effort and money can be saved through applying looser controls to the low-dollar-volume class items than will be applied to high-dollar-volume class items. ABC classification is often based upon the monetary value of inventory, which is usually a standard cost. The A grouping has the greatest value and qualifies for the most careful treatment and highest level of controls. Dividing inventory into A, B, and C groupings is an application of the Pareto principle, which asserts that in any population (customers, inventory items, etc.), a small percentage of the population (about 20 percent) will be responsible for a large portion of the group’s impact (about 80 percent). It is a general rule, of course, but it often proves to be meaningful enough as an estimate that it is worth applying.

The ABC application of Pareto analysis, or the 80/20 rule, reads this way: The Class A inventory items are those with the highest value in terms of annualized monetary volume. A classic Pareto analysis would determine that 80 percent of the inventory’s monetary value would reside in 20 percent of the part numbers in the inventory. (The prior definition lists alternate values.) The Class B inventory items are those with the next highest value in terms of annualized monetary volume. Approximately 15 percent of the inventory’s monetary value would reside in 30 percent of the part numbers in the inventory. The Class C inventory items are those with the lowest value in terms of annualized monetary volume. Approximately 5 percent of the inventory’s monetary value would reside in 50 percent of the part numbers in the inventory. shows an ABC classification that uses an 80/15/5 split.

Exhibit 4-27: ABC Classification in Inventory Management

Annual monetary volume is just one criterion used to assess value. Class A items could be high-profit-margin goods or lower-margin goods that have high turnover. Other considerations, such as quality concerns or anticipated upgrades, may suggest altering the classes. Some organizations further refine this type of classification system. For example, one organization found that one percent of their items accounted for 50 percent of their annual monetary volume, so they made an additional class and called their system an ABCD inventory classification to highlight this inventory’s importance.

An ABC inventory classification might be used as a foundation for any of the following policies: Putting more time, effort, and money into cultivating relationships with the suppliers of the A items (and none into working with C suppliers) Warehousing the A items in the most secure part of the facilities, taking more care in transporting them, providing quick access to fast-turnover goods, etc. Conducting more rigorous demand forecasts for A items than for other items Prioritizing cycle counting activities (Note that enterprise resources planning systems usually segregate ABC systems for the purpose of counting. Using ABC as an inventory policy may require using a different identification data field.) There are also various other methods for aggregate inventory classification according to specific criteria, for example, individual cost or utility value.

Item Inventory Management Item inventory management is used in short-term operational decision making. Management specifies rules to follow for individual inventory items using inventory policy and/or information technology systems. These rules specify

When to order inventory How to determine order size Relative importance of each inventory item Inventory control procedures for individual items. The goal of item inventory management is to enable planners to translate strategic inventory goals into measurable results: proper production and distribution of each product or SKU. While sales and operations planning plans production at the family (aggregate) level, master scheduling plans inventory production at the item level (involving generation of the item-level master production schedule). Item inventory management is also necessary at retail locations, which must anticipate demand for inventory both at the aggregate and item level to ensure that individual items are available for purchase. Item inventory management is implemented through inventory planning, inventory models, and inventory control.

Effects of Inventory on Financial Statements In addition to inventory describing the things the company owns that are available for sale or that are used in the production of things available for sale, inventory can be viewed as all the money currently tied up in the supply chain. What is critical to know is this: As much

as 40 to 50 percent of a supply chain’s invested working capital can be tied up in inventory. While inventory can be seen as the buffer that hides the flaws in the supply chain, it can also be seen as the lubricant that keeps a supply chain flexible. A flexible supply chain is able to respond quickly to internal or external (market) changes, such as fluctuations in demand. Therefore, inventory management is an integral supply chain management role because it strongly affects the company’s cash flows and financial position. The goal of the supply chain professional is to efficiently manage the company’s inventory level and cost while maintaining and improving customer satisfaction. If a company has fast delivery and strong customer satisfaction because it keeps a large inventory, it can also face financial failure because of all the cash tied up in inventory. On the other hand, if a company does a great job at reducing its inventory and associated costs down to next to nothing, it may run the risk of being unable to deliver the requested products. This may cause customers to take their business elsewhere. Balancing cost, inventory level, and customer service is vital. A key way to do this without going too high or too low in terms of overall inventory is to keep the inventory moving and the cash flow turning over—in other words, having a relatively high inventory turnover ratio (the number

of times per year that cash is invested into inventory and returned in the form of revenue) and a relatively short cash-to-cash cycle time (this includes the effect of accounts payable and accounts receivable). Use of the financial statements is an exercise in inventory management at the aggregate level to determine if the flow of materials through the various inventory classifications is efficient and effective enough to maximize profits. Discussions surrounding the financial impacts of inventory are generally framed around reducing inventory, reducing inventory costs, or increasing inventory turnover or cash-to-cash cycle time.

Balance Sheet The balance sheet, or statement of financial position, has two major sections that have to be in balance as per the accounting equation:

Exhibit 4-28 displays a balance sheet. Inventory is a current asset that is broken down in this example by raw materials, work-inprocess (WIP) inventory, and finished goods inventory. Note that most externally available balance sheets will list only total inventory (but breakdowns could be listed in a supporting schedule), while

internal reports made for management purposes often have more details such as these.

Exhibit 4-28: Sample Balance Sheet Showing Two Years of Results

Inventory as Asset Raw materials, WIP, and finished goods are carried as current assets on the balance sheet. MRO (maintenance/repair/operating) inventory is a period expense; it is expensed on the income

statement during the period in which it is purchased. The balance sheet items do not impact the income statement until the inventory is sold, reduced to fair market value, or written off (when inventory becomes obsolete). While it sounds good that inventory is an asset, what this means to finance is that more liabilities are needed to finance those assets. Also, some amount of the organization’s current assets will be less liquid than others. (Liquidity is how quickly assets can be converted into cash.) Therefore, optimum inventory holdings are those that equal projected sales in the organization’s demand plan (plus an optimal amount of safety stock), because inventory that is projected to be sold soon is considered more liquid while inventory in excess of the demand plan is less liquid. Risks of Carrying Too Much Inventory The value of the inventory on the balance sheet includes the costs involved in producing the inventory. However, when the inventory is sold, the portion of inventory value that comprises direct materials (the raw materials), direct labor, and factory overhead will become an expense on the income statement that offsets revenue and reduces cash (an asset). In other words, inventory is an asset on the balance sheet until it is sold, at which point only its profit margin contributes to net income.

Unnecessary inventory can also magnify quality issues. If a defect or other quality issue is discovered, more inventory with the same defect will magnify the quality issue and quality costs for scrap, repair, and/or replacement. An additional risk of carrying too much inventory is the risk of obsolescence or spoilage. As a general rule, the longer the inventory remains on the books, the more likely it will not be sold and will have to be written down to fair market value (what the market will currently pay) or written off completely. Inventory that has to be written off requires physical removal of the items and financial recording of the direct materials, direct labor, and factory overhead as an expense without any offsetting revenue. Note that there are strict accounting rules for inventory write-offs that organizations will need to follow. Accountants will often create an inventory reserve account to reduce the value of inventory in anticipation of write-offs. Finding Average Inventory on Balance Sheet A calculation of average inventory for a period of time is frequently used in managing inventory. With today’s software systems, average inventory can easily be determined at any time. However, to quickly estimate average inventory levels one can add the inventory value at the start of a period to the value at the end of the period and divide by two.

As an example, using the data in the balance sheet shown in Exhibit 4-28, we can calculate the average inventory for year 2 as follows (amounts in thousands):

Average inventory (however your organization calculates it) is used in performance measures and calculations for inventory space requirements. Financial and Managerial Accounting Value of Inventory How is the value of inventory on the balance sheet calculated? Inventory valuation is a financial accounting process that follows specific rules based on the age distribution of inventory. Various financial accounting methods can cause the accounting value of inventory over time to be more or less in alignment with its actual market value—first-in, first-out (FIFO); last-in, first-out (LIFO); weighted average cost; or specific identification. Also, inventory can be valued for managerial accounting purposes using standard costing. Standard costing applies the standard cost to inventory valuation; any variances from actual costs are adjusted at the period end and would be reflected in the financial statements. These accounting methods are addressed elsewhere.

Other reasons that the reported level of inventory on the balance sheet could differ from the actual market value is that this reported amount may include inventory that is reserved, obsolete, damaged, or otherwise unsalable. Some of this obsolete or damaged inventory will be written off as it becomes clear that it cannot be sold. Since changes to inventory levels can affect the accounting values of inventory and financing needed to sustain the inventory, supply chain managers should consult with financial managers with enough advance notice so the organization can determine how to change inventory levels while keeping the organization solvent and in good standing with creditors and investors.

Income Statement An income statement, such as the one shown in Exhibit 4-29, reflects the cumulative, dynamic relationship of earnings to expenses over a given period of time.

Exhibit 4-29: Sample Income Statement Showing Two Years of Results

Managers, investors, and creditors use the income statement to determine whether the company has made or lost money during some period of time, such as a quarter or a year. An income statement measures profitability in more than one way. Gross profit is determined by subtracting cost of goods sold (COGS) from revenues. COGS includes inventory costs of direct labor, direct materials, and factory overhead for all goods that sold that year. Reducing elements in COGS can therefore directly increase gross profit.

Reducing these costs is more effective in increasing profits than increasing revenues through an increase in sales volume, because variable costs increase as revenues increase. By reducing costs, you are effectively increasing the profit margin on inventory without having to raise prices. This shows that increasing sales cannot produce higher profits as quickly as lowering costs. It also shows that lowering variable costs in the supply chain can strongly impact profits. COGS is an expense that is matched to the revenue being generated. Strategies that build inventory far in advance of actual sales can defer accounting for expenses that make up COGS until that inventory is sold. However, supply chain managers should understand that operating expenses (see Exhibit 4-29) are expensed on a periodic basis. These immediately booked expenses could cause problems with maintaining financial ratios at the proper levels. However, the actual cash outflows for both the product (depending on payment terms) and period costs would occur as the inventory is being built up (e.g., salaries, utilities, maintenance), so cash flow could be an issue without proper advance planning for the inventory build-up on the part of finance.

Statement of Cash Flows

Exhibit 4-30 is the statement of cash flows. Remember that a company does not want all of its capital tied up in inventory. Insufficient cash can result in expensive borrowing or cause an organization to fail quickly if it cannot raise funds. Note that a net increase in inventory lowers the cash position, while a net decrease in inventory increases the cash position. (The parentheses show which actions reduce cash.)

Exhibit 4-30: Sample Statement of Cash Flows Showing Two Years of Results

Changes to Inventory Affect Cash Flows

Inventory can strongly affect cash flows, which, in turn, can affect covenants with lenders (contractual agreements that may include lender requirements that the borrower maintain certain financial ratios at certain levels). Even a reduction in inventory can create one-time adjustments for finance that impact reporting. However, once the adjustments are made, the long-term financial impact of inventory reductions is usually positive. For example, consider a situation in which a supply chain manager discovers that some types of inventory at the organization are not selling and have been held for too long. The manager suggests that reducing these types of inventory will allow the organization to reduce inventory by €60 million (m). However, the organization’s chief financial officer raises a major concern. The organization’s bank has a financial covenant on its loans that requires the organization to maintain a ratio of 2:1 between owners’ equity and liabilities (twice as much in equity). If inventory is reduced by €60m, in the best case, cash would increase by a few million euros and, in the worst case, the organization would have to pay to scrap the inventory. Assuming that the transaction could be completed with no net change in income, in order to keep the balance sheet in balance, owners’ equity (retained earnings) would be lowered by the same €60m. To maintain the financial covenant, the organization would need to decrease its liabilities by half as much, or €30m. These

requirements could put a large burden on cash flow. Failure to maintain the covenant would place the organization in technical default, and its debts could become immediately due and payable. The result is that the organization is unable to perform the change immediately. The supply chain manager learns the value of consulting with finance prior to making suggestions for a major change in inventory so that finance can determine ways to accommodate the change while keeping the company solvent. The financial officer recommends that to prevent such a situation from recurring the organization should make financial reservations for obsolete stock, which would help the finance department understand how to prepare for the inventory write-off.

Topic 2: Replenishment Strategies Replenishment strategies help control inventory levels at various supply chain echelons by providing guidance on how much to order and when to order resupply. Setting levels of safety stock or safety lead time in ways that balance customer service levels against inventory costs is another area requiring inventory control.

Inventory Control and Replenishment

The APICS Dictionary, 16th edition, defines inventory control as “the activities and techniques of maintaining the desired levels of items, whether raw materials, work in process, or finished products.” Inventory control determines how much to order and when (how often) to order. Setting proper levels of safety stock or safety lead times is an additional type of inventory control. Inventory control aims to determine order amounts and timing with an objective of reducing carrying, ordering, and setup costs—without sacrificing customer service goals. Remember, an order schedule is necessary for managers all along the supply chain—the retailer and the distributor order more finished goods, the manufacturer orders more components and supplies, the supplier orders its own materials and supplies, and so on.

Determining Order Quantities Ordering can be haphazard or disciplined, but there are enough unknowns in real life that managers will need to review their ordering model regularly. Since a haphazard system amounts to little more than guesswork, any disciplined method will be an improvement over that. Two models managers can use to determine how much to order are lot-for-lot and fixed order quantity (FOQ). These models are used with independent demand forecasts. The models were generally designed to be used with decentralized inventory planning, but they

can be adapted for use in centralized planning (or echelon inventory policies could be used). Exhibit 4-31 shows the relationship between these two ordering types.

Exhibit 4-31: Lot-for-Lot versus Fixed Order Quantity (FOQ)

The lot-for-lot ordering technique is defined by the Dictionary as a lot-sizing technique that generates planned orders in quantities equal to the net requirements in each period. That is, organizations order no more and no less inventory than is needed. In this ordering system, the quantity ordered will differ in each period depending upon the current requirements.

Common uses for lot-for-lot include Just-in-Time manufacturing environments and ordering A items in the ABC inventory classification system. Lot-for-lot in retail environments is called consumption-driven replacement. According to the Dictionary, fixed order quantity is a lot-sizing technique in MRP or inventory management that will always cause planned or actual orders to be generated for a predetermined fixed quantity, or multiples thereof, if net requirements for the period exceed the fixed order quantity. The fixed amount may be determined by the amount in a box or on a pallet or the need to fill shipping containers to achieve full container discounts. A fixed order quantity can be delivered on a fixed schedule, or a variable schedule can be based on inventory levels. While this method is straightforward and inexpensive, it won’t produce satisfactory results unless customer demand is very stable over the long term. One improvement that can be made to the method is to use an economic order quantity. Economic Order Quantity (EOQ) Economic order quantity (EOQ) is a refinement of FOQ that determines the most cost-effective fixed order size when replenishing inventory. The EOQ is the order size with the lowest

total cost for carrying plus ordering (or setup) costs. Carrying costs tend to go up with larger order quantities, while ordering costs go down due to fewer orders being placed. In , the EOQ is the lowest point on the total cost curve.

Exhibit 4-32: Determining the Economic Order Quantity

You can see some general quantity-cost relationships from the graph: The total costs tend to drop until they reach a minimum, and then they start rising again. So there is an incentive to increase order quantity—but only to a point. The minimum total cost occurs where carrying and ordering costs are equal—just above where the cost lines intersect. If you shift the costs in either curve such as by reducing the costs per order (as lean manufacturing works to do) or the inventory

carrying costs (e.g., taller warehouse racks for more storage), the EOQ will also shift. The formula for EOQ is as follows:

The first equation above shows the carrying cost formula set as equal to the ordering cost formula, which would be true at the point of intersection in the graph. When the costs are equal, solving for Q results in the EOQ formula as shown above. EOQ is a simple model and so depends upon the following set of assumptions: Demand is constant and known. Lead time is constant and known. (The same amount of time always elapses between order placement and arrival.) The items ordered arrive all at once, not in stages. There are no quantity discounts.

The variable costs in the calculation model are limited to carrying costs and ordering costs (whereas in reality other variable costs exist). There will be no stockouts if you place orders on schedule. The beauty of the EOQ model is that even if there are considerable variations in the cost figures, the economic order quantity tends to vary within a fairly small range. Therefore, while the model’s assumptions will no doubt be violated in the real world, the EOQ model is still considered useful. Supply chains with significant volatility may need to create a more complex model or frequently recalculate EOQ.

Ordering Systems (Determining When to Order) In addition to picking an order quantity, an ordering system determines when orders should be placed. The APICS Dictionary, 16th edition, defines inventory ordering systems as “inventory models for the replenishment of inventory.” Inventory control models differ for independent versus dependent demand. Ways to determine when to order independent demand inventory include the order point, periodic review, min-max, timephased order point, and demand-driven material requirements planning (DDMRP) systems. Material requirements planning

(discussed elsewhere) is used for dependent demand, but DDMRP could also be used in conjunction with MRP. DDMRP highlights the strategic positioning of inventory (acting as a decoupling point) in a bill of material or a supply chain. Order Point System An order point system determines the inventory level, or point, at which a reorder must be placed. The order point is the point at which we have enough inventory to cover anticipated demand that will be consumed during the replenishment process. This point is our demand during the lead time plus safety stock:

For example, if demand during the lead time averages 100 units a week, lead time is two weeks, and safety stock is 50 units, then the order point is when inventory falls to 250 units:

The sawtooth diagram in illustrates an order point system.

Exhibit 4-33: Inventory Level Fluctuations in Order Point System

In an order point system, the time between replenishment orders is not fixed but varies based on the actual demand during the reorder cycle. Since the order point is based on the average demand during the lead time, if either the average demand or the lead time changes, the order point should also be changed or the level of safety stock will automatically change. A system based on average demand means that, at maximum demand, stockouts could occur, so some amount of safety stock is useful. Periodic Review System In a periodic review system, order intervals are fixed, such as each week, month, or quarter, and order quantities (shown as Q1, Q2, and Q3 in ) vary. The method sets a base stock level, or maximum level

of inventory, based on what is needed to maintain effective and continuous operations. This is the inventory target, or “order-up-to” level. The inventory position is reviewed each period, and order size is just enough to raise the inventory position to the base stock (target) level. shows how the sawtooth diagram has fixed-width “teeth” that vary in height according to the amount ordered.

Exhibit 4-34: Inventory Level Fluctuations in Periodic Review System

The quantity in stock plus the quantity ordered must be enough to prevent stockouts, which means non–safety stock inventory has to last until the next review period plus the lead time required for the next shipment. The quantity ordered is the maximum amount less the quantity of inventory on hand at the order period:

For example, if average demand is 50 units per week and there are 5 working days, demand per day is 10 units/day. Assume that orders are placed every 10 working days and lead time duration is 3 days. If safety stock should be 4 days’ supply, at 10/units per day this would be 40 units. If there are 42 units on hand at the order point, then the maximum-level inventory and order quantity are calculated as follows:

Periodic review systems are useful for supermarkets or retailers with many items to sell because it keeps inventory tracking cost down and helps fill truckload assortments, assuming that the assortments can all be shipped from the same source such as a consolidation warehouse. Min-Max System With a min-max system, both order timing and order amount are allowed to vary. Orders are submitted after inventory has fallen

below the minimum point, but inventory isn’t allowed to go over a maximum. If, for example, the minimum is 300 items, the maximum is 1,000 items, and the periodic review reveals that inventory has dropped to 275 items, it would be time to place an order for 725 items. (This assumes that the order would arrive immediately—i.e., no lead time.) Time-Phased Order Point System (TPOP) The APICS Dictionary, 16th edition, defines a time-phased order point (TPOP) system as MRP-like time planning logic for independent demand items, where gross requirements come from a forecast, not via explosion. This technique can be used to plan distribution center inventories as well as to plan for service (repair) parts, because MRP logic can readily handle items with dependent demand, independent demand, or a combination of both. Time-phased order point is an approach that uses time periods, thus allowing for lumpy withdrawals instead of average demand. When used in distribution environments, the planned order releases are input to the master schedule dependent demands. Rather than waiting until inventory drops below the order point, a TPOP system will check whether the item will fall below the order point during the order horizon. When used for a shop floor

warehouse, it checks not only available inventory but also planned deliveries during the order horizon and the planned reorder point. If the available plus planned inventory is below the reorder point, a replenishment order is placed. “Lumpy withdrawals” in the above definition refers to situations such as promotions that create demand variability that order point systems have trouble adapting to because they are based on average demand. Time-phased order point systems are useful for parts maintained in low volumes, slow movers, irregular demand items, and large parts. The shop floor warehouse needs visibility to its own inventory levels so it can allocate parts for assembly orders from the warehouse and backflush these orders against the shop floor warehouse. Note that when a time-phased order point system is used for independent demand items at distribution centers, it is called distribution requirements planning. Demand-Driven MRP System Demand-driven material requirements planning (DDMRP) is a relatively new type of ordering system that can be used for dependent and independent demand items at any point in the supply chain. Note that DDMRP is part of a larger process called demanddriven planning (DDP); DDMRP is its ordering system. DDMRP strategically positions inventory to achieve all the benefits of modern

supply chain management (reduce inventory, customer lead times, and the bullwhip effect; increase customer service and utilization) without needing to rely on safety stocks. Instead, DDMRP determines how to shrink total lead times by creating buffer inventories of key components with longer lead times. DDMRP dynamically determines the best places to position inventory and dynamically adjusts the size of the buffer inventories to maximize return on investment for the inventory. To do this, it performs daily reviews that account for how long customers will wait for their orders, whether faster lead time would generate new sales, and whether certain inventory positions would leave the organization with more options for dynamic lead time compression. To minimize risk, it also factors in information on the item’s supply variability and demand variability and the need to maintain buffer inventories before any bottleneck work centers as per the theory of constraints. Further information can be obtained at www.demanddriveninstitute.com. Another resource is Demand Driven Material Requirements Planning (DDMRP), Version 3, by Ptak and Smith.

Safety Stock and Safety Lead Time

Safety stock is extra inventory each partner along the supply chain may keep to reduce risks of unpredicted supply and demand fluctuations during the lead time. Safety lead time is ordering supplies earlier than needed as a measure of security against unpredicted manufacturing and transportation lead time fluctuations. For slow-moving items, safety lead times are preferred, because using safety stock will result in a larger overall inventory investment.

Safety Stock The APICS Dictionary, 16th edition, defines safety stock as follows: 1) In general, a quantity of stock planned to be in inventory to protect against fluctuations in demand or supply. 2) In the context of master production scheduling, the additional inventory and capacity planned as protection against forecast errors and short-term changes in the backlog. Overplanning can be used to create safety stock. Safety stock is there to be used, but always needing it typically means that cycle stock levels are not high enough while never needing it means too much cycle stock is being maintained. (The latter is usually the more expensive problem.) Organizations usually set a target frequency at which safety stock can be accessed, such as once per month. Needing to use safety stock at a given location

more or less frequently than this target or never using safety stock at a location would trigger an exception needing review. The amount of necessary safety stock or buffer stock depends upon several variables: Frequency of ordering. Stockout risk is highest at the time of replenishment because of the uncertainty of order receipt. If you need to replenish only once a year, you have one point of vulnerability, while replenishing weekly creates 52 potential stockout situations. Therefore, more frequent ordering typically requires higher levels of safety stock. However, infrequent ordering involves larger orders and average inventory levels at a high cost (except for very inexpensive items). Variability of demand during lead time. High variability of demand means high sales might occur while waiting for an order. Length of lead time. Longer waits have more chance for variability. Accuracy of forecasting. Higher confidence in the demand forecast reduces the need for safety stock. Organizational, regulatory, or industry requirements. Some organizations simply have to keep a minimum level of safety stock.

For example, medical and pharmaceutical companies need to keep high levels of some safety stocks to address the risk of a pandemic. There are three basic methods for determining the amount of safety stock to maintain: Fixed amount. Using experience or intuition to set or periodically review a fixed amount for a location’s safety stock may be acceptable for stable demand items. Coverage. A coverage method sets safety stock for a given period at the level of inventory requested in the demand plan. If the demand plan forecasts a need for 10 units a day, safety stock for 30 days is 300 units. The advantage of coverage is that the safety stock will adjust itself based on the average (seasonal) demand. Statistical. A statistical safety stock calculation involves calculating a normal distribution (bell curve) of the variation in demand with average demand at the center. The standard deviations (sigmas) show analysts how high or low demand can get from the center. Safety stock is set to match the maximum variation in demand at a desired customer service level; it can be based on the most probable scenario or increased for less and less probable scenarios (1 sigma, 2 sigma, etc.).

Safety stock can enhance the customer service level by increasing availability or enabling meeting quoted lead times. A certain amount of safety stock is beneficial to the supply chain because it helps decouple supply from demand. If demand shoots up unexpectedly, warehouse safety stock can be shipped to the retailer. Retailer safety stock may also be in the back room or on shelves. If supply is suddenly lacking, you have that inventory in the pipeline to keep filling orders until the flow of supply resumes. The prudent manager will look for ways to balance the costs related to holding safety stock and expenses related to stockouts—such as the cost of lost customers, needing to rapidly ramp up production, or needing to pay for expensive special deliveries. While the costs of stockouts are difficult to project accurately, management should set an acceptable cost level for stockouts and predetermine methods for dealing with them. The total cost of carrying safety stock plus the cost of stockouts should be tracked and minimized together. While it may be tempting to shoot for 100 percent order fulfillment, Exhibit 4-35 shows how it takes a very large increase in safety stock to approach perfection. It shows that moving from 95 percent order completion to 98 percent requires a very large jump in safety stock,

whereas relatively little safety stock was required to achieve 95 percent. (These are typical numbers, but they are not the same for all businesses.)

Exhibit 4-35: Safety Stock Increases Versus Order Fulfillment

Some companies have found a way to reduce inventory—not just safety stock—almost to zero while actually improving customer service on at least some measures. Dell Computer is a prime example. Dell is able to deliver custom computers rapidly. If, like Dell, a business can essentially source and make or assemble a product to order and deliver it within a reasonable time, it may eliminate its inventory while enhancing its reputation and customer loyalty. (A company may achieve these goals by shifting inventory back up the supply chain to its suppliers, in which case it’s possible that nothing has been gained for the supply chain as a whole.)

Safety Lead Time The Dictionary defines safety lead time as an element of time added to normal lead time to protect against fluctuations in lead time so that an order can be completed before its real need date. When used, the MRP system, in offsetting for lead time, will plan both order release and order completion for earlier dates than it would otherwise. When order lead times vary significantly or are lengthy, the longer wait increases the chances that a stockout could occur. Some organizations solve these risks by placing orders early (or late if orders consistently arrive too early). The safety lead time is the amount of time the order is placed ahead of the normal order point. Exhibit 4-36 shows how safety lead time could be used in an order point system.

Exhibit 4-36: Use of Safety Lead Time in Order Point System

In order point systems that can vary the timing of orders, the amount of safety lead time used can be hard to determine, for example, when studying ordering patterns of retailers. Reducing unnecessary safety lead time can reduce the bullwhip effect. Safety lead times also require performing the same balancing act between ordering too soon and having overstocks and ordering too late and risking stockouts. For example, materials shipped overseas often have lead times of 60 days or more. Ordering too soon can result in a serious overstock because orders arrive by the container load. However, delays from weather, labor unrest, or other factors could cause a serious stockout (also due to the large order size).

Topic 3: Traceability, Accuracy, and Disposition Product traceability helps provide a chain of custody and component origin information. Configuration management helps document product characteristics and control changes. Inventory accuracy is important for financial records and supply chain efficiency. Periodic or cycle counting can be used. Inventory that faces obsolescence or is returned may need to go through a decision process regarding its final disposition.

Product Traceability and Configuration Management Product traceability refers to the ability to provide a chain of custody for a product and its components or ingredients. Traceability tracks a product’s source materials and the finished good itself by their national origin and production facility, through each point of distribution, possibly to the specific final customer. The APICS Dictionary, 16th edition, defines a configuration management system as “formal procedures to identify and document the physical characteristics of a product or project, control changes, and support an audit to verify conformance.” Configuration

management can ensure that product engineering specifications or product versions are properly maintained and distributed to the necessary parties so everyone is working from the same version. Product traceability and configuration management software exists, and one feature is often a change control system with related approvals. Product traceability and configuration management Reduce the size of product recalls to just those items affected rather than having to expand the recall (and customer anxieties) Differentiate goods when region-specific bans on goods are put in place in response to contamination or food-borne disease epidemic risks Assist compliance audits, such as when verifying a claim that milk is free from bovine growth hormones as advertised Provide evidence that conflict minerals were not used Help with compliance with free trade zone agreements and labels such as “Made in the U.S.A.” (All or virtually all components must be U.S.-sourced.) Assist with customs inspections Help establish a chain of custody for sensitive goods such as pharmaceuticals as they move between countries and supply chain points so that each stage and the specific parties involved in the journey can be on record. Blockchain is being used to ensure

that these records can be securely created at multiple points in the supply chain, and it can even track things like temperature records for a cold chain. An auditable chain of custody is important to control counterfeits, to detect pilferage, and to prove safety compliance (e.g., compliance with U.S. Food and Drug Administration regulations). Product traceability and configuration management also affect trade agreements such as free trade zones. These agreements provide special benefits for goods originating within the trade zone country but have limits on the number of components or ingredients that can come from outside the zone. Tracing the national origins of product components may be necessary. Traceability and configuration management are enabled by technology systems such as some types of bar codes, radio frequency identification (RFID), global positioning systems (GPS), blockchain, and information systems such as transportation management systems (TMS) and warehouse management systems (WMS).

Assessing Inventory Accuracy The APICS Dictionary, 16th edition, defines physical inventory as follows:

(1) The actual inventory itself. (2) The determination of inventory quantity by actual count. Can be taken on a continuous, periodic, or annual basis. No amount of forecast accuracy, ABC analysis, secure storage, or automated ordering adds up to successful inventory management without an accurate, current count of the physical inventory on hand. If you don’t know how much you have, you don’t know how much or when you should order. It is also vital to be able to accurately represent the amount of inventory on financial statements for compliance reasons. The Dictionary defines inventory accuracy as follows: When the on-hand quantity is within an allowed tolerance of the recorded balance. This important metric usually is measured as the percent of items with inventory levels that fall within tolerance. Target values usually are 95 percent to 99 percent, depending on the value of the item. For logistical operations (location management) purposes, it is sometimes measured as the number of storage locations with errors divided by the total number of storage locations. If inventory is inaccurate, it requires an inventory adjustment. The Dictionary defines inventory adjustment as a change made to an inventory record to correct the balance, to bring it in line with actual physical inventory

balances. The adjustment either increases or decreases the item record on-hand balance. There are two general approaches to keeping accurate inventory records, the results of which are used to make inventory adjustments when errors are found: periodic counts of all items and continuous cycle counts of specific items. Cycle counting is often preferred, but periodic counting still has its place. Periodic counting. Periodic counting involves shutting down the facility once a year and sending a large group of employees or temps into the area to count every item and calculate the dollar value of the items on the shelves. It’s disruptive, expensive, and prone to inaccuracy because of the low expertise of the counters. (They may do it only once a year, after all.) However, for facilities that lack the control and advanced technology found in many upto-date warehouses, periodic counting may be the only way to get the job done. Cycle counting . Cycle counting is defined in the Dictionary as an inventory accuracy audit technique where inventory is counted on a cyclic schedule rather than once a year...The key purpose of cycle counting is to identify items in error, thus triggering research, identification, and elimination of the cause of the errors.

Cycle counting is a more reliable method to determine the value of the items in storage and to facilitate the cost-effective, timely ordering needed for the most reliable customer service. Here’s how it works: Some items are counted every day to verify records and record any inaccuracies. All items are counted a set number of times per year. A items are counted most frequently—perhaps once a month, while B and C items are counted less often. Smart rules are used in deciding when to count. Before a replacement order arrives, existing inventory is low and is easy to count. The same is true when inventory is zero. If the system says it is negative, it must be an error. This continuous, limited counting doesn’t require the facility or retail location to shut down for the count, so there is little or no disruption of ordinary business. Unlike the once-a-year count, cycle counting allows timely detection and correction of problems. It is much easier to find inventory error root causes when issues are found in real time. Attempting to problem-solve for transaction errors that occurred months ago is much more difficult. Cycle counting also eliminates the need for annual inventory adjustments.

Exhibit 4-37 provides an example of cycle counting. For this scenario, assume that a fictitious company, King Hospital Supplies, has an inventory of 10,000 items, of which there are 1,000 A items, 3,500 B items, and 5,500 C items. Cycle counting policy is to count A items once per month (20 working days), B items once per quarter (60 working days), and C items every six months (120 working days). Counts are distributed evenly over the year. Exhibit 4-37: Cycle Counting Example Item Class

Quantity

Cycle Counting Policy

Number of Items Counted per Day

A

1,000

Each month (20 days)

1,000/20 = 50/day

B

3,500

Each quarter (60 days)

3,500/60 = 58/day

C

5,500

Semiannually (120 days)

5,500/120 = 46/day 154/day

The design and control of the warehouse is the beginning of accurate record keeping. Here are a few points to consider about keeping a secure storage space that makes tracking and counting inventory easier: Keep it secure. Small employee thefts add up, and, of course, large-scale vandalism or theft can wipe out inventory overnight. Limit access to the stockroom and keep it under observation. Keep a special high-security area as needed.

Keep it neat. There should be a place for everything, and everything should always be in its place. In a busy environment, this can be a major challenge, but counting is much easier if areas are consistently used for the same type of items. Random systems can be secure if the record locators are kept accurate. Make labels easily visible and put them on everything. Labels can be designed for both fast visual identification and for automatic identification, such as using bar codes or radio frequency identification (RFID). Use bins and space arrangements that make counting easy. If storage bins and containers are limited to a certain number of items, you can estimate at a glance and count by groups instead of individual items. Treat A, B, and C items appropriately depending on their classification. A items require tighter control on security and reordering. You don’t want to lose them or run out of them. Make technology your friend. Counting is something machines do better than people. With bar codes/RFID, readers, and realtime updates, you can keep a running tally of what goes into a facility, what goes out, what remains, how much should be on hand, and when you need to submit an order.

Product End of Life, Returns, and Disposition The APICS Dictionary, 16th edition, defines end-of-life management as follows. Planning for the phase-out of one product and the phase-in of a new product to avoid both the excessive inventory of and an out-of-stock situation with the old product before the replacement product is available. An end-of-life plan is needed for the point at which a product is no longer profitable due to lack of demand caused by obsolescence, market saturation, or supply/manufacturing issues such as rising costs (also affected by the level of competition). These plans need senior management support, consensus, and approval. A best practice is to standardize the process so that important details such as communications will be timely and professional. An end-of-life plan can include the following steps: Determine an end-of-sales strategy and schedule. At the appropriate time, communicate the strategy and schedule to suppliers, supply chain customers, end customers, and other stakeholders. Often the end of sales is a closely guarded secret until the time of official communication, because it can ruin sales of the old product. Customers will wait for the new product, and

this can result in unsold inventory. The strategy may provide time to sell off remaining inventory (including in the distribution network), sell it in bulk to a third party, reuse components, recycle products, or responsibly dispose of them. Marketing may reduce prices or provide upgrade incentives and support. Determine an end-of-service strategy and schedule, including customer service, technical support, repairs, and/or service parts. This will need to be communicated well in advance. Service could remain profitable for an extended period, or, as an investment in customer loyalty, there could be a strategic decision to provide support for the expected life of the final products sold. Service parts might be outsourced or the designs sold to other organizations. Less-expensive forms of service could be substituted. Determine changes to manufacturing equipment or spaces that will no longer be needed, such as selling the equipment, retooling it for a new product introduction, or reallocating space. The product manufacturing rights and equipment could also be sold to a third party. Incorporate end-of-life plans, such as plans for backward compatibility or the timing of the introduction of new products, into new product introduction plans.

Manage programs to accept products back at the end of their lives. Such programs could be based on regulatory requirements, be voluntary for sustainability, or enable recovery of rare materials such as gold. Perform risk and crisis management such as for product recalls, lawsuits, or unhappy customers. Supply chain management professionals can provide valuable input or analysis for end-of-life plans. This includes reviewing minimum order quantity requirements, other contractual requirements, lifetime sales quantities and timing, and obsolescence timing. Products in decline can delay their end-of-life date by cutting costs, often at the expense of customer service. However, other costs might increase as suppliers also work to cut costs, since components may also be in decline. Supply chain management professionals therefore need to review minimum order quantity (MOQ) requirements from suppliers and for customers. Suppliers may increase their MOQ in order to cut their manufacturing and supply chain costs, and this will lower the organization’s ordering cost but increase inventory carrying costs. Suppliers could instead lower the MOQ to promote sales if customers are no longer willing to buy in bulk. The organization can also alter its MOQs for customers

for the same reasons. The net changes in costs will need to be analyzed for their impact on profitability. Contractual promises may have been made to suppliers to buy their components or materials or for them to provide products and/or support to customers for a particular period, such as for a warranty period. It is important to review exit clauses to determine if there are ways to end a product per a desired time frame. Reviewing lifetime sales quantities and timing involves estimating how many more units customers will purchase or can be convinced to purchase as a product is in decline/nearing obsolescence. The purpose is to help determine the timing of how many more units of the old product to produce and when to stop production. If the product has a direct replacement, the replacement needs to be available at that time. (This could be a new product or an existing one that could be a substitute and may be subject to increased demand.) Lifetime sales quantities are also used to estimate the quantities of components such as spare parts that will be needed to repair the existing products in use during their remaining useful life. Often, customers need to calculate a “lifetime buy quantity” for equipment they own. This is the quantity of spare parts that the customer will need to purchase now in order to maintain a product to

the end of its life cycle. It is used when spare parts for the product are being discontinued. The timing of end of sales will not necessarily be obvious. Managers and salespersons will be invested in the status quo. Reviewing lifetime sales history can help provide information on where a product is in its life cycle. Historical sales trend data and sales pipeline information from the sales organization can be used to help reach consensus regarding a product’s end-of-sales point. The information can also be used for product life cycle analysis for future products that are similar. Note that this is the basic process used in a life cycle analysis, defined in the Dictionary as follows. A quantitative forecasting technique based on applying past patterns of demand data covering introduction, growth, maturity, saturation, and decline of similar products to a new product family. Obsolescence can be planned or market-based. Planned obsolescence is part of a new product introduction strategy to release a replacement product and market it as an essential upgrade. Market-based obsolescence is based on a steady or sudden drop in demand, often due to competitor actions. Reviewing obsolescence timing involves forecasting when a product should or must reach its end-of-sales point. It is also important to ensure that

material requirements planning components are planned accordingly as part of the end-of-sales plan, including: Managing and updating effectivity dates (effective date of new engineering specifications) Removing safety stocks and buffers Reducing lot sizes Forecasting amounts of excess or obsolete inventory and making plans for their disposition. Products that have been determined to be obsolete or expired or are otherwise unsaleable can be handled in a way similar way to product returns in that they might be returned up the supply chain if this is possible, or they could be donated, recycled, or disposed of. Disposal may have associated costs, especially for items with hazardous materials. The following returns process lists these and other possible methods for disposition.

Product Returns and Disposition Process When handling returns, an organization must first assess and categorize returned items, based on their condition and status. To do so, returned products are first centralized in a single location. Then disposition takes place. Disposition is the process of determining the appropriate disposal category for each returned item or for items that are no longer saleable. Returned products would use the entire

flowchart seen in Exhibit 4-38, while products that are to be disposed of internally could use portions of this process, such as, “Can you reuse the parts?”

Exhibit 4-38: Disposition of Returned Products

Adapted from © “Reverse Logistics Process Flow,” Greve-Davis. Used with permission.

The disposition of each item is an important decision, since about 80 percent of the value of the reverse logistics process depends on matching the product with the best disposition option. Making wise

decisions regarding internal products to be disposed of can likewise result in greater or lesser costs and could help with other goals such as sustainability. The exhibit shows six options for how a returned item can be handled. (Internal items to be disposed cannot use the first option.) Return to stock (e.g., an unsold item still in its original package or a sold item that is unused) Return to manufacturer or producer (e.g., refillable beverage and liquor bottles, packing crates, or items that are contractually allowed to be returned after authorization for an allowed return reason) Liquidate (sell to a secondary seller or market) Donate (e.g., to a charitable organization as a tax write-off) Recycle Dispose (e.g., bury in landfill, incinerate) Any revenue earned from liquidations or tax benefits from donation can be tracked along with related disposition expenses. This information then results in either a net gain or a net loss from the disposition. The accounting department will then use this information when writing off the inventory.

Section D: Performance and Continuous Improvement This section is designed to Define continuous improvement and its role in total quality management Describe the key aspects of continuous improvement Identify the stages in the continuous improvement model Explain the rationale for adopting continuous improvement Describe continuous improvement philosophies and how they can enhance the competitiveness of a supply chain Describe and distinguish between the approaches to benchmarking: competitive, best-in-class, and process Identify the seven basic tools of quality and the seven new tools and discuss their uses in continuous improvement initiatives Explain major approaches to continuous improvement: lean, Justin-Time, six sigma, and the theory of constraints. Operations are complex and can easily start out or become inefficient or ineffective over time, so it is vital to learn how to use continuous improvement philosophies and tools to keep the overall supply chain running smoothly.

Topic 1: Operations, Inventory, and Financial Performance Operations, inventory, and financial performance metrics help ensure that operations goes according to plan, inventory levels stay efficient while being effective at meeting customer service goals, and financial performance is acceptable. Metrics also indicate when plans are not being met so course adjustments can be made. Metrics and key performance indicators (KPIs) are discussed first from a big-picture perspective.

Metrics and KPIs Road Map Here we address the nature of metrics and key performance indicators.

Metrics So how are improvements measured? It depends on what is being measured. As the saying goes, “You get what you measure.” While there is no guarantee of achieving a goal a company or team decides to measure, it’s very likely that it won’t achieve what it fails to measure. Regardless of the initiative, decision makers need to determine their objectives first. Then they define what criteria need to be achieved

for the initiative to be considered a success. While not all of these criteria will be directly measurable, many will be, and others might be approximated. The metrics that are selected determine how progress will (and will not) be measured. After selecting the appropriate set of metrics, managers then need to set challenging but feasible targets for them. A best practice is to set goals in consultation with the persons who will be doing the work. The next step in the process is ensuring that the measurements are made. The measurements then need to be consolidated, analyzed, and reported. The level of summary needs to be just right so as to highlight the key action areas promptly. Summary at too high a level may not enable getting down to the root causes of an issue, such as a customer quality claim. Reports that have the ability to drill down to the details are one way of providing both a summary and actionable information. Or one level of management may be focused on the details and another on the bigger picture. A good measurement process helps motivate the persons being measured to achieve the desired goals if there is sufficient communication and buy-in. Once the objectives, metrics, targets, and reporting requirements have been set or revised, they need to be communicated throughout the extended enterprise along with the benefits of achieving them. Getting everyone to use a consistent set

of metrics helps everyone share the same vision of what success looks like. Note that metrics rely on sufficient, accurate, and regularly or automatically collected data. Data are crucial as a basis for executive decisions at the highest level and operations at the most minute level. For example, without customer data, what customers value is a mystery, so you can’t design processes with any assurance that you are targeting their needs. Without accurate financial data, it will be impossible to know the contribution of process improvements toward improving the bottom line.

Key Performance Indicators Strategic attributes of supply chains may include velocity, visibility, variability, collaboration, trust, customer focus, flexibility, security (risk management), compliance with regulations, reverse supply chain efficiency, and environmental excellence. Any of these attributes could be woven into strategy, expanded into specific objectives, and subjected to measurement. For the most important strategic goals of an organization or group, a small set of key performance indicators can be developed to promote the success of that strategy.

As defined in the APICS Dictionary, 16th edition, a key performance indicator (KPI) is a financial or nonfinancial measure that is used to define and assess progress toward specific organizational goals and typically is tied to an organization's strategy and business stakeholders. A KPI should not be contradictory to other departmental or strategic business unit performance measures. A metric used to measure the overall performance or state-of-affairs. SCOR level 1 metrics are considered KPIs. How does a team determine which key performance indicators are appropriate for a particular initiative and which are not because they would dilute the key metrics, make analysis less decisive, or add measurement expense without much benefit? The key is to predetermine what a reasonable number of key performance indicators would be (such as no more than 20) and then ensure that each one chosen can be clearly linked back to one or more specific strategic objectives. Here are some guidelines for working with KPIs: Understand that while all KPIs are metrics, not all metrics are KPIs. Establish a set of KPIs using a balanced scorecard approach and determine baselines for each indicator.

Limit the KPIs to a workable number. Be sure to include the four general areas of the balanced scorecard: business process improvement (which you should have covered in the design of your initiative), customer considerations, financial impact, and growth and learning. Growth and learning can be crucial to the success of supply chain process improvements. Establish baseline measures for each KPI and set targets (using benchmarks as you did for process improvement). Be sure the change has a measurable, positive effect on customers and your bottom line. Monitor the performance of the KPIs. If an improvement initiative is supposed to increase the velocity with which information flows from the end customer back through the supply chain, we could develop technology-related objectives, assess the current state of the system, and identify metrics to measure progress toward a velocity goal. The KPI might be a measure of the actual velocity of communications. Perhaps demand data are aggregated monthly and communicated in face-to-face S&OP meetings. The goal could be to substitute the status quo with direct transfer of data from the point-of-sale via scanners, bar codes, and the internet. Enabling objectives might be put in place (buying equipment, training staff, and so on), but the KPI would be a

measure of velocity. This KPI would be a true supply chain metric, because the process it measures crosses tiers. Since higher information velocity could result in tradeoffs, we would also need to track customer satisfaction and financial impact. Does the faster communication and sharing of demand data pay off in terms of customer service and profitability? A KPI for variability might be the extent of the bullwhip effect. In addition to the commonly used KPIs of profitability and customer satisfaction, supply chain managers have developed many others: For sourcing—price performance, quality, delivery metrics, responsiveness, innovation, sustainability, supply chain and inventory integration, and internal customer satisfaction For new product introductions—internal failure rate, scrap, external failure rate, warranties, returns, and introduction lead time For merchandising products—market share, volume growth, and total supply chain inventory turns (aggregate inventory across the supply chain) For replenishment—order fill rate, on-time delivery, forecast accuracy, and order fulfillment lead time The key point about KPIs is that they have to be applied to supply chain processes that directly enable the organizational and supply chain strategies. A great supply chain KPI must go beyond internal

silos and possibly external organizations. KPIs that measure activity within only one internal silo will not promote collaborative behavior. Inventory holding costs at one warehouse, cost containment on one leg of a cross-country shipment, or increased production at one plant are all too disconnected to provide useful information on whether the action benefits the supply chain as a whole.

Operations and Inventory Performance Measures Operations metrics include those related to efficiency, utilization, throughput, inventory, and operating expenses. Inventory metrics reduce ordering and holding costs while maintaining customer service.

Operations Key Performance Indicators The APICS Dictionary, 16th edition, defines operational performance measurements as follows 1) In traditional management, performance measurements related to machine, worker, or department efficiency or utilization. These performance measurements are usually poorly correlated with organizational performance. 2) In theory of constraints, performance measurements that link causally to organizational performance measurements.

Throughput, inventory, and operating expense are examples. Some key operational measures include the following: Percentage of master production schedule completed as scheduled Number of time fence violations (i.e., late and expensive replanning) Production yield (standard or maximum yield versus actual yield due to scrap, waste, or other shrinkage) Quality metrics Inventory turnover broken down by raw material turns, work-inprocess turns, etc. Operational measures may include SCOR metrics as discussed elsewhere. Other operational measures include measuring capacity using efficiency and utilization metrics, and these are also addressed elsewhere. Including inventory measurements as part of operational metrics helps counterbalance metrics that promote high utilization, because increasing utilization will increase inventory unless there is sufficient demand for that inventory.

Inventory Management Key Performance Indicators

From the supply chain management perspective, there are two KPIs for inventory: Reduction of inventory costs related to holding, ordering, and transporting materials, supplies, and finished goods at various points along the supply chain Achievement of customer service targets related to the quality, availability, and on-time delivery of products and services (which may depend upon availability of supplies) Since inventory represents such a large investment, improving inventory management promises a significant boost in return on investment. Keeping too little inventory in the system can result in frustratingly long lead times, broken orders, lost customers, and lower market share. On the other hand, too much inventory could have a negative financial impact and increases the risk of holding distressed goods. Goods that are held too long may face a reduction in inventory value, write-offs, or disposal costs. In some industries, the obsolescence or spoilage rate is quite rapid. The tightrope you walk with inventory management is to reduce the cost of holding and transporting goods while meeting or exceeding customer service goals. Setting and regularly updating an inventory policy is one way organizations perform this balancing act, because it keeps the aggregate and item levels at specific locations from

growing too large. Metrics related to process improvements can reduce the costs per inventory movement or transaction.

Methods of Tracking Inventory Tracking is necessary to keep inventory secure and accounted for. Inventory shrinkage is defined in the APICS Dictionary, 16th edition, as Reductions of actual quantities of items in stock, in process or in transit. The loss may be caused by scrap, theft, deterioration, evaporation, and so forth. Inventory tracking can help minimize the losses from pilferage or misplacement because an organized system makes it difficult for items to be misplaced or stolen. A tracking system can also identify damaged or obsolete goods so that inventory can be properly valued. Finally, tracking inventory is necessary for accounting since inventory is an asset that must be recorded accurately. A proper inventory tracking process assists with keeping accurate counts of inventory. Most organizations track inventory through the use of a warehouse management system while in storage and a transportation management system while in transit. Any inventory tracking system will have certain steps:

1. Identify the item. Items are identified through the stock keeping unit (SKU) . The Dictionary defines a SKU as follows: 1) An inventory item. For example, a shirt in six colors and five sizes would represent 30 different SKUs. 2) In a distribution system, an item at a particular geographic location. For example, one product stocked at the plant and at six different distribution centers would represent seven SKUs. Items are also identified by association with a purchase order, which indicates expected quantity and location. 2. Verify the quantity. Inbound and outbound items must be physically counted and verified against the purchase order. 3. Obtain an order to make a move, or request a move and obtain approval. A transaction record is initiated when either of these occurs. 4. Execute the inventory movement. Inventory is moved between locations. 5. Create a record of the transaction completion. The transaction record is finalized after material movement, unless done electronically using tools such as radio frequency identification (RFID) that occur simultaneously with the material movement. Inventory tracking systems plus inventory audit results will provide two metrics: record on hand (ROH), which is the amount the tracking

system indicates should be present, and the physical on hand (POH), which is the result of a physical count. When the POH is less than the ROH due to shrinkage, there will need to be an inventory record adjustment so that inventory replenishment systems are using correct data. Failures in this area could result in items being sold even though they or a necessary component for their manufacture to order is not actually available.

Financial Measures It is important to determine how supply chain financial information is reflected in overall financial reporting. Exhibit 4-39 explores how the plan, source, make, deliver, and return processes impact financial statement elements on the balance sheet (statement of financial position) and income statement. This information can be useful when showing how supply chain management activities create year-overyear financial improvements in specific areas. Exhibit 4-39: Financial Statement Elements Impacted by Each Supply Chain Process Process Plan

Balance Sheet Elements

Raw materials inventory Accounts payable Cash Debt

Income Statement Elements

Cost of goods sold

Process

Balance Sheet Elements

Income Statement Elements

Source

Property, plant, and equipment Accounts payable Cash Debt

Depreciation Taxes

Make

Raw materials and work-inprocess (WIP) inventory Accounts payable Accrued expenses Wages payable Cash

Cost of goods sold Wages Utilities

Deliver

Raw materials (for warehousing only), WIP, and finished goods inventory Accounts payable Accounts receivable (for order management only) Accrued expenses Warranty reserves (for order management only) Wages payable Commissions payable (for order management only) Cash

Net sales (for order management only) Cost of goods sold Marketing and selling expenses and commissions (for order management only) Wages Utilities (for warehousing only)

Process Return

Balance Sheet Elements

Accounts payable Accounts receivable Inventory reserves Warranty reserves Commissions payable Cash

Income Statement Elements

Net sales

The selected supply chain financial, operational, and customeroriented metrics should support and validate these end results, which could be useful for proving that the organization has an adequate system of internal measurements as is required in the U.S. by the Sarbanes-Oxley Act (SOX).

Topic 2: Continuous Improvement Here we define and describe the purpose of continuous improvement along with a foundational quality system called total quality management. After looking at why a supply chain manager needs to learn about these tools, we describe a continuous improvement process. Some broad continuous improvement tools such as root cause analysis and benchmarking are discussed, and benchmarking gets a deeper dive.

Continuous Improvement and Total Quality Road Map Continuous improvement (CI) , as defined in the APICS Dictionary, 16th edition, is the act of making incremental, regular improvements and upgrades to a process or product in the search for excellence. Note how CI can be applied to processes or products. When applied to processes, it is called continuous process improvement (CPI) , which the Dictionary defines as a “never-ending effort to expose and eliminate root causes of problems: small-step improvement as opposed to big-step improvement.” Improving people’s skills can be considered an important aspect of CPI. Continuous improvement, along with customer satisfaction and people involvement are foundational concepts in total quality management (TQM) . According to the Dictionary, TQM is a management approach to long-term success through customer satisfaction…based on the participation of all members of an organization in improving processes, goods, services, and the culture in which they work.

TQM thought leaders have included many famous names in quality —W. Edwards Deming, Philip Crosby, Kaoru Ishikawa, J. M. Juran, and Genichi Taguchi. Part of what distinguishes TQM from other approaches is that it is based on the premise that management will support the ongoing improvement of every process involved in the development and distribution of a product. This implies continuous improvement of all processes over time. TQM employs a variety of tools for both qualitative and quantitative analysis to enable these holistic improvements. Continuous improvement can serve as a driving force in every decision about supply chain design and operations. When designing or redesigning a supply chain, supply chain managers need to research and identify how each process in the supply chain can be optimized. As supply chains are implemented, CI can then be used to further enhance capabilities to meet changing needs.

CI and TQM Continuous improvement and total quality management efforts go hand in hand across most organizations. Note how quality , as defined by the Dictionary, has two major components: Quality of conformance: defined by the absence of defects

Quality of design: measured by the degree of customer satisfaction with a product’s characteristics and features This two-pronged definition underscores how critical it is for product design to be factored into both supply chain design and operations so that product traits and features will meet customer expectations. There are several key premises of TQM that create its foundation and impact the guiding principles of an organization that uses it for continuous improvement: Management must be committed participants in the quality initiative in the organization. They will be the role models others look to for direction. Since TQM is an ongoing process, it requires an ongoing commitment to action. It is understood by the entire workforce that the goal is not to point fingers but to strive for better processes that have fewer issues in the first place. When everyone embraces it, participates on teams, and sees the results, it creates enthusiasm. It focuses on the customers and puts their needs at the front of every discussion about improvement. Customers can be internal or external, such as coworkers, supply chain partners, or consumers. Will this change be better for all customers? How could it impact them negatively? How will we prevent that from happening?

Many categories of suppliers are considered partners, and the various levels of ongoing relationships should never be adversarial. There must be standard performance measures so that incremental improvements can be measured and tracked over time and across partners.

Purposes Common purposes of continuous process improvement are To continuously refine the processes of manufacturing or service, not simply to focus on the quality of the goods or services produced To incorporate improvement into the processes themselves, not merely to subject processes to periodic reviews and audits To define achievable goals and set quantitative measures to chart progress toward reaching those goals To train employees to identify waste (wasted resources, wasted motion, wasted time, etc.) and participate in eliminating the waste To empower workers by involving everyone in the assessment and improvement of the processes they oversee, manage, or carry out To increase productivity To improve worker satisfaction by improving workplace safety, eliminating unnecessarily strenuous or stressful work, making

performance assessments more rational, and enhancing the quality of jobs and career options

Reasons for Adopting CI Reasons for taking a continuous improvement approach to supply chain design follow. Supply chain management is process-oriented. The basic units of the supply chain are not products or services that emerge from the chain; they are the processes that flow along the supply chain among functions and partners. Supply chains are dynamic. A supply chain constantly expands, contracts, and incorporates new stakeholders and new products. A constantly changing system requires continuous reengineering and process improvement. Supply chains evolve. Supply chains have evolved from functional isolation, to cross-functional cooperation, to global networks linked by electronic communications and enterprise software. As supply chains evolve across new frontiers of organization, scope, and technological complexity, they are in constant need of process improvement and redesign.

Continuous improvement of the supply chain design can reduce the costs of poor quality. The APICS Dictionary, 16th edition, defines cost of poor quality as follows: The costs associated with performing a task incorrectly and/or generating unacceptable output. These costs would include the costs of nonconformities, inefficient processes, and lost opportunities. A related term is appraisal costs , defined in the Dictionary as follows: Those costs associated with the formal evaluation and audit of quality in the firm. Typical costs include inspection, quality audits, testing, calibration, and checking time.

Applying the CI Model The continuous improvement (CI) model can be used to analyze, assess, plan, and implement changes that will improve the supply chain and its people and processes. The CI model we’re using here, shown in Exhibit 4-40, builds upon other supply management concepts, such as benchmarking and change management.

Exhibit 4-40: Continuous Improvement Model

Stage 1: Process analysis. The initial step in continuous improvement requires taking a hard look at internal and external supply chain design to find locations where waste or non-valueadded activities could occur. Stage 2: Process assessment. This stage involves reviewing the various key performance indicators (KPIs) that are being or might be used to measure how the supply chain is performing. Benchmarks can be used to set a specific performance goal, such as reducing manufacturing time along the supply chain by a set percentage. Stage 3: Project planning. Next a realistic schedule for the design, development, and review of the proposed supply chain change is developed. Responsibilities and accountability are

assigned, needed resources are identified, and a budget and schedule are created and approved. Specific commitments from stakeholders should be gathered so that the design is understood and supported. Stage 4: Implementation and change management. Once the design is completed, it will need to be implemented. Implementation feedback should be used to improve the process prior to sharing it with other internal stakeholders or supply chain partners. Each supply chain entity needs to know how making this change will contribute to the supply chain’s overall success and its ability to meet customer satisfaction. The entities also need to know how to fulfill their roles and responsibilities in the new supply chain design.

Personnel Improvement Personnel improvement involves working to develop supply chain personnel’s knowledge, skills, and abilities over time. Knowledge is the information needed to perform a task correctly. Skills are behavior changes in how a person performs tasks. Abilities are a person’s current capacity to perform necessary job tasks and apply relevant knowledge and skills. This improvement normally happens informally as people gain experience doing their jobs, but a formal

system can help challenge individuals and allow organizations to measure progress. Investing in personnel improvement also directly helps improve supply chain effectiveness and efficiency, because it increases worker consistency and reduces learning curves. While poorly trained operators tend to be inconsistent in achieving standard work times, trained personnel tend to be able to meet or exceed standards. Workers who are used to training and re-training will have lower learning curves when learning new skills. Their output reaches desired levels more quickly. When designing training, it is important to understand that different individuals have different learning styles. Visual learners learn best when pictures or graphics are available and the purpose and method of the training are well laid out. Tactile learners desire “hands-on” training opportunities. Auditory learners have better results when they are told the information rather than just reading it. In addition, adult learners prefer self-directed learning and need to know why the learning is needed and beneficial. Effective adult motivators include presenting learning as a way of solving a problem and giving learners a chance to apply their experience. Finding ways to empower individuals and help them believe that they can succeed are powerful levers for any learner.

Another source of motivation is a formal system of employee goal setting and management review. Each supply chain manager will mutually set training or learning goals for a period of time with his or her superior and also review progress toward prior goals. It is important to involve the learner in goal setting to get buy-in. A career path laid out with the necessary knowledge, skills, and abilities clearly communicated as minimum requirements can be a strong motivator. Training can be internal or external, formal or informal. Some examples of training delivery methods are discussed next. This area concludes with a discussion of evaluating training effectiveness. Informal, On-the-Job, and Cross-Training Informal training involves regular interactions between individuals and other daily experiences. It is an effective and necessary way that people learn and comprises the majority of learning for individuals. On-the-job training and cross-training are ways to accelerate learning in the job environment. On-the-job training is an informal but planned activity conducted by a superior or peer, who shows other personnel how to perform a task or process. This is the most common form of planned training, because it can be done without taking personnel away from their

other duties. It should involve time for learners to practice what they have learned, and there needs to be a follow-up session to ensure that the new information is being applied on the job. Cross-training involves training people to do their own job and someone else’s job, which appeals to organizations because that person can cover someone else’s work or assume a new position. Formal or Informal Coaching or Mentoring Coaching involves superiors giving training and feedback to subordinates on a regular basis. It is a form of learning by doing. Coaching skills can be taught to managers. Informal coaching should occur organically as personnel need or request feedback, but formal coaching should involve planning what will be taught, accounting for learner styles, and so on. Mentoring is a process of pairing an individual with a person who is further along the same career path. It can be effective at teaching not only technical skills but also interpersonal skills. It is especially useful for helping less-experienced managers grow into better managers. The mentor also learns how to impart wisdom effectively. Internal or External Training Courses Training courses can be conducted in-house using employees or consultants, or personnel can be sent to off-site courses. External

training is often the most cost-effective for small or mid-size organizations who don’t have a large number of students needing the same training. Instructor-led training is a very popular mode of delivery. Using vendors and suppliers to provide training has increased in popularity in recent years, especially for software training. Training that results in a certification can be a significant motivator. Training offered at conventions or conferences can provide a number of classes in a short time away from the office. A good way to reinforce learning from training courses or independent study is to have the supply chain manager present a recap to a group of peers. Online Training Online training can take the form of on-demand training or virtual classroom training. On-demand training can be available on the organization’s intranet site and accessed at any time by large numbers of persons at a low cost. Many younger workers prefer this method of training. A drawback is that it may not result in high retention rates. Some subjects are better retained than others, so some skills are best taught using other methods. Tests, practice, visuals, and other methods help with reinforcement. Tests and assignments can be used as proof of training.

Virtual classroom training may involve a live instructor or an offline instructor who reviews assignments. The virtual space can be attended by people from all over the world. These can be internally developed classes, classes that use an outside instructor, or online college or university courses with access to lecture materials, chat rooms, and file exchange. These setups keep learners motivated at a lower cost than classroom training, but they are less good for networking and learning interpersonal skills. Evaluating Training It is important to continually improve training in any form in which it is provided. Training results should outweigh the costs of providing that training. Costs can be compared against measurements of employee retention of learning, improvements in customer service, numbers of work errors, or learning curve time for performing new processes. Benchmarking various methods can help organizations determine how to reallocate training budgets.

Process Analysis and Improvement Continuous improvement is directed from the top down and implemented from the bottom up. Selecting processes for improvement is a job for top management. They are accountable for the strategic direction of the company, and so it is they who decide the priority order of process improvement. Projects must be selected

in harmony with overall business strategies and with the collaboration of the executive team. Management must become the driving force that gives the continuous improvement its momentum and credibility. Given this direction, a team should form that includes employees, especially those who operate within the process itself. Implementation of quality initiatives is a companywide process (or a supply-chain-long process) and should involve employees at all levels. The members’ detailed knowledge is required to analyze weak points, suggest improvements, and implement solutions. A first step is to learn about the process in depth and define the “as is” state of the process. There’s a saying in quality movement, “Facts are your friend.” You need a lot of data to manage supply chains effectively, to select processes for improvement, to map a process accurately, and to measure the progress of your process improvement initiatives toward their goals. Given an understanding of the process as it is, the next step is to analyze the process to find the root causes of inferior performance—the fundamental reasons it isn’t contributing to achieving supply chain goals. The result will be a “to be” version of the process that can be submitted for review and approval prior to being planned in detail and implemented.

Teams will be directed by top management toward a prioritized set of initiatives. A continuous improvement team may want to do preliminary research to determine which issues or areas will be relatively fast fixes or “low-hanging fruit.” Success in small-scale improvement projects will help build momentum. Team members can analyze other improvement opportunities based on the perspectives of key stakeholders such as customers, suppliers, employees, etc. As teams build expertise and confidence in themselves, they will become more proficient at using continuous improvement philosophies and tools and will be better prepared to take on more extensive and complex supply chain processes. Here are some common CI initiatives for supply chains: Customer responsiveness Perfect customer orders Performance improvement (by supply chain, function, teams, supplier groups, etc.) Increased productivity Strategic and financial alignment Asset management System infrastructure Demand planning Logistics Professional development of employees

Continuous Improvement Tools Continuous improvement teams use a number of techniques and methods for continuously improving supply chain processes: Pattern identification—pinpoints a pattern of variability within a process Defect measurement—identifies the number of defects that represent product or service failures Root cause analysis—identifies the root cause (versus the symptoms) of a problem with an unacceptable rate of defects Benchmarking—sets goals at specific levels by reference to an outside performance standard A description of one of these methods—benchmarking—follows as an example.

Benchmarking Benchmarking is a way of setting goals at specific levels by reference to an outside performance standard, such as best practices or the performance of another department or enterprise. For example, a benchmark might be best-in-class cycle time for any enterprise in an industry or a competitor with the lowest cycle time on a particular process. The Supply Chain Council conducts benchmarking surveys that are available to its members, allowing them to judge their own performance against that of other

organizations using SCOR metrics. Another method is to benchmark against a checklist of world-class processes (rather than specific performance measures). There are several broad approaches to benchmarking: competitive, best-in-class, and process. Each approach has its merits. Competitive benchmarking. In competitive benchmarking, an enterprise compares its performance to that of a competitor in its own industry. For example, assume that manufacturing lead time is a key performance indicator for an enterprise. Benchmarking would begin with determining average lead time and variability over a number of production cycles. These numbers could be compared with the performance of a competitor, an enterprise with similar challenges in the same industry. Perhaps that competitor has a 25 percent shorter lead time and less variability but is able to produce at the same level of quality. The process improvement team can use this competitor’s lead time as the goal for improvement. It is quantifiable, measurable, and realistic, since the competitor is already achieving it. Therefore, it is an acceptable benchmark. There’s an obvious payoff to competitive benchmarking as a method of setting a performance goal. Reaching the benchmark, or surpassing it, means the enterprise has improved its

competitive position. Ford Motor Company used competitive benchmarking to make a breakthrough in improving their accounts payable process. Their first restructuring of accounts payable, without a benchmarked goal, yielded a 20 percent reduction in personnel. For a second pass at improving the process, Ford benchmarked its performance against Mazda and was able to cut personnel from 500 to 75. Best-in-class benchmarking. With the best-in-class benchmarking strategy, a company looks to the best anywhere to develop a goal for improvement. Widening the search for a benchmark makes it possible to find even more dramatic and inspiring possibilities. Accounts payable doesn’t differ radically from industry to industry; Ford might have been able to find an even more efficient model for the process by looking outside the car industry. Even in areas where at first the dissimilarities seem an overwhelming barrier, a best-in-class approach may still help develop the most inspiring goals. A major health-care provider in Minnesota revamped the procedures in its endoscopy clinic by borrowing from Toyota’s lean production system. While receiving some criticism for borrowing assembly-line methods to improve delivery of a service, in fact the provider not only enabled doctors

to reduce the backlog of patients waiting for exams but it allowed the doctors to have at least as much time with each patient. The improvements also saved substantial money. The decision to process patients with the same efficiency Toyota achieves in its manufacturing plants turned out to be good for the doctors, the patients, and the clinic. The health-care provider benefited from getting outside its own industry—not only for a benchmark but for innovative process improvement techniques. Process benchmarking. Another approach to improving a process is to benchmark it against a checklist of world-class process descriptions. Rather than focusing on measurable aspects of process performance such as cycle time duration, a process checklist draws attention to the features of the process, to its qualitative aspects. The Oliver Wight group of business excellence consultants provides such a checklist for use in all industries. The process descriptions reflect the consultants’ global experience, and they include considerations such as Use of strategy to drive supply chain planning and execution Optimization of capacity, inventory, and other supply chain elements Use of monthly reviews for monitoring capability and flexibility Presence of data-sharing processes, financial integration, and teams including suppliers and customers.

In sum, benchmarking your goals against the best in your industry or the best in class provides an effective way to choose realistic yet inspiring goals. It’s only natural to have more faith in your ability to reach a goal if you know someone else has been there before. Not long after British athlete Roger Bannister reset the long-held benchmark for running a mile at slightly less than four minutes in 1954, other runners not only broke four minutes but ran past Bannister’s own mark. It’s worth noting that Bannister himself did not use another runner’s performance as his benchmark. He reached beyond any other current or historical mile runners for a pioneering goal. Sometimes, even the best-in-class mark may be too limited a goal for a company to follow. Someone—or some enterprise—has to be first. But even a pioneer like Bannister followed a strategy of continuous improvement to reach his goal. He got there through years of training, continuously shaving small amounts of time off his previous performances until he surpassed the speed that some believed was physiologically impossible. He reached his goal, quite literally, one step at a time.

Topic 3: Quality Tools

The seven basic tools of quality and the seven new tools of quality are described here.

Seven Basic Tools of Quality The seven basic tools of quality are a set of tools that help organizations understand their processes in order to improve them. These tools (also known as B7) include process mapping, control chart analysis, the Pareto chart, the cause-and-effect diagram, the histogram, the check sheet, and the scatter chart.

Process Map The APICS Dictionary, 16th edition, defines a process map (or flowchart) as follows: A diagram of the flow of a production process or service process through the production system. Standardized symbols are used to designate processing, flow directions, branching decisions, input/output, and other aspects of the process. Process maps can be used to map all types of processes— manufacturing flow, information flow, the stages of a financial transaction, and so on. Mapping the process helps members of an improvement team identify significant aspects of an inefficient or ineffective process and then locate the problem areas. In addition to

illustrating each step in a process, the chart or map can include other useful information such as the duration of each step, required resources, responsible positions, and financial impact. Process maps can be produced with pencil and paper, but they can also be put into various types of software. Exhibit 4-41 shows a typical process map in the form of a flowchart, depicting the order fulfillment process.

Exhibit 4-41: Process Map of the Order Fulfillment Process

One way to carry out process mapping is to schedule it as a brainstorming session for the improvement team. Using Post-it® Notes, each team member individually lists every task he or she can identify in the process, one per note. After a half hour (or other appropriate time), team members stick the notes with the task

listings on the chalkboard, one person at a time, while others continue thinking and writing. When all tasks have been posted, individuals or teams attempt to group the tasks by themes and put the groups in the order of performance. Next the group selects names for the themes, and a volunteer writes a final list of tasks, by theme, on a flip chart. At the end of the session, the entire process should be mapped, with all essential tasks in order and associated with the names of performers and the time each takes.

Control Chart The control chart , according to the Dictionary, provides “a graphic comparison of process performance data with predetermined computed control limits.” Control charts are useful graphical tools to differentiate special cause variation and common cause variation in a given process. This activity is called statistical process control (or statistical quality control) and is defined in the Dictionary as “the application of statistical techniques to monitor and adjust an operation.” Exhibit 4-42 illustrates a control chart with a center line representing the mean value and upper and lower control limits (UCL and LCL) representing plus or minus 3 sigmas from the center line respectively. In general, if the data readings taken fall within the

control limits, the process variation is considered to be in control. In this chart all the opportunities fall within the acceptable range.

Exhibit 4-42: A Control Chart

In addition to control limits, which are set using statistics, a process used to produce a product or service can also have specification limits, which are set by the customer. Like the control limits, there is an upper and lower specification limit (USL and LSL). If the process commonly has results outside these limits, there will be many rejected units and the process would need to be reviewed to make failures far less common.

Pareto Chart Pareto analysis, which shows the frequency of items in a data set, is based on Pareto’s law , defined in the Dictionary as “a concept developed by Vilfredo Pareto, an Italian economist, that states that a small percentage of a group accounts for the largest fraction of the

impact, value, and so on.” Closely associated with Pareto’s law is the 80-20 rule , which “suggests that most effects come from relatively few causes; that is, 80 percent of the effects (or sales or costs) come from 20 percent of the possible causes (or items)” (Dictionary). The Dictionary defines a Pareto chart (or diagram) as “a bar graph that displays the results of a Pareto analysis...[it] show[s] a distinct variation from the few compared to the many.” By identifying the significant few and separating them from the trivial many, a team will be better prepared to focus its resources efficiently and effectively to achieve the biggest gains. Pareto charts can be applied to any measurable data, including currency units, time, defects, suppliers, etc. Exhibit 4-43 illustrates the basic shape of a Pareto chart. After determining the categories for the bars, the bars are always ranked from highest to lowest. The set of bars that make about 80 percent of the causes would be the vital few causes to study. Here the largest bar is 80 percent on its own and is the major cause of the particular occurrence.

Exhibit 4-43: Pareto Chart

Cause-and-Effect Diagram A cause-and-effect diagram links an effect with the possible causes of the effect. It is a method of organizing factors (causes) and subcauses that affect a problem or process being investigated (effect). This type of diagram may also be called an Ishikawa diagram, after the person who first developed it, or a fishbone diagram, as the elements of the diagram resemble the skeleton of a fish. The goal of a cause-and-effect diagram is to identify all of the possible causes of an effect and then select the most likely ones for further investigation. The idea is to find the root cause of the effect in order to correct and solve the problem for the long term. Exhibit 4-44 illustrates a cause-and-effect diagram showing commonly cited categories of causes (environment, people, materials, measurement, methods, and equipment). For every cause, there are usually several potential underlying subcauses

(such as equipment failure or no maintenance performed). The development of a cause-and-effect diagram is a repetitive process that requires going back and forth to identify causes and effects.

Exhibit 4-44: Cause-and-Effect Diagram

Eliminating the underlying root cause of a defect can bring a process into conformance, while attacking a secondary symptom or the wrong cause may do little or nothing to eliminate the customer complaints. For example, sometimes training to improve employee skills will be suggested as a solution for a problem, when in fact employee skill or

understanding is not the real source of the difficulty. If a system is broken, no amount of employee training will fix it. Let’s say a financial service provider is receiving a high rate of complaints from customers who can’t understand their account reports, and the company responds by training sales assistants to give better explanations of the reports when customers call in to complain. The documents are the root cause of the problem, and the training is not the most efficient way to invest to provide what customers need. The Japanese have a method of approaching root cause analysis called the “Five Whys,” because it is based on the theory that answering a question about causation five times will lead you through the false causes or symptoms to the real cause. Whether or not five is the magic number is less important than the underlying concept. Finding root causes may take considerable digging through layers of superficial symptoms or secondary problems. An automotive company, as an example, conducted customer interviews to determine why they were receiving complaints that the seats in their cars were too low. Since that complaint was factually inaccurate, the researchers probed more deeply and discovered that the problem could be resolved by setting the side window ledges lower in the

doors. The answer “low seats” was superficial. The root cause of the complaint was really about the relative placement of the windows.

Histogram A histogram is a bar graph that displays the frequency distribution of measurement data, such as dimensions, temperature, or weight, for a process. It shows the amount of variation and the range of variation within a process. The frequency is shown on the y (vertical) axis. The x axis shows the range of variation. The goal is to identify whether There are surprises like unnatural distributions. (A bell-shaped distribution demonstrates that the largest number of measured units is in the center, with about half that number falling on either side. Twin peaks may indicate that data are coming from two or more sources that have variation, like different shifts or production equipment.) The variation of the bar graphs falls within or outside of specifications, indicating the amount of variability or number of failures. The top portion of the bell curve is in the middle or at either end, indicating that the data are skewed. (For example, if a pizza company studies the amount of toppings added to an average

pizza, a person who always adds more than the recommended amounts would have results that skew toward the high end.) At first glance it may seem that the Pareto tool is a histogram, but it is a different type of bar chart. The Pareto chart illustrates only the categories of an issue, such as type of defects, rather than showing a continuous range of data, as a histogram does. Exhibit 4-45 shows an example of a histogram.

Exhibit 4-45: Histogram Example

Check Sheet A check sheet is a simple and easy-to-use tool for summarizing a tally count of event occurrences such as the frequency of certain defects in a product in a specified period of time. In Exhibit 4-46, for instance, a manufacturer of fabric hearts uses a hash mark (or slash

mark) to record every time an item is either too pink, too red, lacks fragrance, or is the wrong size in the first four days of production runs in February. This is often the starting point in continuous improvement projects that can then be further explored using other CI tools. It’s important that the data gathered are from a single entity, such as the same piece of equipment or a particular production line employee. In addition, it is critical to ensure that the observations recorded are representative and that the team members who create the check sheets have sufficient time to do it accurately.

Exhibit 4-46: Check Sheet

Scatter Chart A scatter chart—also known as a cross plot, scatter diagram, or scatterplot—is a tool for showing the relationship of two variables in terms of whether they are interdependent and to what extent. The diagram has a horizontal x axis and vertical y axis that represent the

two variables being tested. The y axis is typically for the dependent variable, that is, the one that changes in relation to variable x, which is called the independent variable. The direction of the scattered points and their closeness to each other and an overall trend line indicate the type and strength of the correlation. Exhibit 4-47 shows a scatter chart.

Exhibit 4-47: Scatter Diagram Showing Positive Correlation between Training and Job Performance

As seen in the exhibit, if you were to draw a diagonal line from the interior corner of the graph to the points in the upper right portion, it would be easy to see that the points are fairly close together and that they trend upward and to the right. This shows a positive correlation between the two variables, such as training and job performance, which means that an increase in y may be dependent upon an

increase in x and therefore, if x can be controlled, there might also be a chance of influencing y. In other words, an increase in task competency could be linked to an increase in the number of hours of task training received by an employee in the supply chain. (If the points were more scattered but formed the same shape, there would be less positive correlation.) In another example, a scatter chart can be used for associative forecasting (such as regression analysis), in which case the independent variable is used to predict how the dependent variable should behave in the future.

Seven New Tools In the mid-1970s, a consortium of Japanese engineers and scientists discussed the need to augment the seven basic tools of quality with an additional set that could enable them to express important production-related information, support innovation, and facilitate the planning of major projects. They wanted to be able to communicate important information that could be put into action. With those goals in mind, they developed seven management and planning tools: Affinity diagram Tree diagram Matrix diagram

Process decision program chart Relationship diagram Matrix data analysis chart Activity network diagram

Affinity Diagram An affinity diagram is a tool for organizing a large number of brainstormed ideas by employees striving to solve a particular issue. Participants in the brainstorming session provide anonymous ideas and suggestions and, based on the number of them that relate to each topic, the group can get a sense as to the seriousness of the issue. It begins with a discussion leader presenting the topic or problem, which the employees then brainstorm about, recording each idea on a slip of paper or an index card. The ideas are then posted in one place, and the group determines how to group them by category or theme. As seen in Exhibit 4-48, each group of ideas is then given a descriptive title that encompasses the ideas below it. In this case, the challenge was trying to identify causes of product recall for a manufacturer. The group generated causes that fell into these six broad categories: inspection, customer feedback, product materials, frequency, costs, and return processes.

Exhibit 4-48: Affinity Diagram

This tool tends to provide new and more comprehensive insights into an issue that can become an official continuous improvement project. Then other tools can be used to further investigate each category.

Tree Diagram A tree diagram is a tool that lists tasks and activities in increasingly finer detail in order to meet a specific goal. As seen in Exhibit 4-49, the goal is on the left-hand side and the main branches of the tree “bloom” off of that. Each branch helps to clarify another aspect of the issue. The tree diagram can be used in conjunction with the affinity diagram and the relationship diagram.

Exhibit 4-49: Tree Diagram

Matrix Diagram The matrix diagram (matrix chart) is a useful tool for showing the relationships between two or more groups of information, the strengths of those relationships, and how those variables interact and respond to each other. Matrix diagrams can be in a variety of shapes: L, T, Y, C, X, and roof-shaped. The most commonly used is the L-shaped matrix, which illustrates how two groups of items relate to each other or one group to itself. As illustrated in Exhibit 4-50, this matrix shows how specifications for a product vary from one customer to the next. Exhibit 4-50: Matrix Diagram of Customer Specifications for Component #4572 Specification

Customer A

Customer B

Customer C

Specification

Customer A

Customer B

Customer C

Width

≤0.789 cm

≤0.790 cm

≤0.785 cm

Length

≤1.11 cm

≤1.20 cm

≤1.01 cm

Thickness

≤0.55 cm

≤0.575 cm

≤0.545 cm

Color (Pantone)

#127

#130

#129

Process Decision Program Chart The process decision program chart visually captures things that might possibly go wrong in a plan being developed. In Exhibit 4-51, the decision to increase shelf space was mapped out to determine all the related points that could influence a sequence of decisions as to how to reach the goal of achieving a good allotment of space.

Exhibit 4-51: Process Decision Program Chart

This tool can be used in two different manners: to identify measures that should be taken in order to avoid undesirable, intermediate consequences as progress is made toward the final desired result, and to design a plan to predict future foreseeable problems that can be resolved and ultimately result in achievement of the goal.

Relationship Diagram The relationship diagram, also called an interrelationship diagram, illustrates cause-and-effect relationships and is particularly useful for evaluating the links between different aspects of a complicated issue. As seen in Exhibit 4-52, the ideas that a team generates are placed in their own respective circles and clustered according to how they may relate to each other. Solid-line arrows are then drawn from each idea that strongly influences another idea. A dashed arrow implies that there is some influence but it is not strong.

Exhibit 4-52: Relationship Diagram

The goal is to identify the following: The major cause, that is, the one that has the greatest number of arrows emanating from it The most interrelated cause, that is, the one with the most arrows in and out In this instance, the diagram began with an increase in customer complaints, which had previously been at a minimum level. The team wanted to identify what could be the possible direct and indirect causes of that increase. They concluded that there are four factors that were about equally responsible for the issue. The team decided they would need to do additional analysis of those factors, after which they would be better able to stratify the complaints.

Matrix Data Analysis Chart The matrix data analysis chart is another tool that can be used to show the relationship between groups of information. As seen in Exhibit 4-53, the two variables (or features) against which the product lines are being measured are opacity and insulating properties. The closer the product line point is to the positive end of each variable, the stronger the feature is for that line, and vice versa. For instance, the wood louvers (product line B) of this manufacturer have significantly higher ratings on opacity and insulating capabilities compared to product lines C and D in the lower left quadrant. This tool can be useful when trying to differentiate marketing messages and compare seemingly similar products.

Exhibit 4-53: Matrix Data Analysis Chart

Activity Network Diagram The activity network diagram, also sometimes referred to as the arrow diagram or critical path method chart, is particularly helpful when an improvement team wants to identify the required order of tasks within a manufacturing process or project. Its primary benefit is to convey dependencies and simultaneous activities via a simple visual. This chart is critical for project management.

Using the Tools As you contemplate the 14 quality tools (the seven basic tools and the seven new tools) from which you can select for any continuous

improvement project, it will be useful to think about them in the following categories and select the one tool or combination of tools that matches what you are trying to capture: Nonquantitative tools: process flow chart or mapping, cause-andeffect diagram, affinity diagram, tree diagram, process decision program chart, relationship diagram, activity network diagram Combination tools: matrix diagram (if using points on the diagram that reflect measured data) Quantitative tools: scatter diagram, Pareto chart, run chart, histogram, control chart What’s important to remember is that if you have used a tool that did not result in actionable information, you may need to try another for the same task. However, if you think of your tools in these three categories it will be easier to determine which is the most appropriate. It may be appropriate to use a few tools on the same issue to drill down to the details needed.

Topic 4: Continuous Improvement Methods A number of continuous improvement philosophies such as lean, Just-in-Time (JIT), six sigma, and the theory of constraints are discussed here to show how continuous improvement can be

embraced systematically. First there is an introduction to these methods.

Continuous Improvement Methods Road Map Several well-tested approaches to continuous process improvement evolved during the last half of the 20th century. Many are related to total quality management to one degree or another, emphasizing the reduction of defects or elimination of waste in the use of time and materials. These various approaches are complementary and may have the most impact when combined under a continuous improvement umbrella. In brief, here are some well-accepted continuous improvement approaches: Lean strives to include quality in the product and processes using empowered teams, and it emphasizes elimination of waste. It grew from the same principles included in Just-in-Time (JIT), which focuses on reducing inventories to zero so that products always appear when they are needed, not before. When a lean system is running on “takt” time (releasing supply based on the rate of demand), JIT delivery of supplies is virtually a necessity to honor

the commitment to zero accumulation of inventory in production queues. Six sigma focuses on enhancing the customer experience by reducing the number of defects in a process until they approach statistical insignificance. Six sigma keeps the focus on achieving high-quality processes, not just fast ones. Errors inevitably introduce waste into a process. The theory of constraints (TOC) provides a systematic method of increasing a system’s throughput by identifying the slowest element in the system (the constraint) and focusing initial improvement efforts on that element. As one constraint is eliminated, another appears; hence, TOC is inherently a continuous improvement strategy. Part of that effort involves maintaining buffers at the constraints, which may seem to be incompatible with lean, but as the buffers are added only just before the current constraint and their level is carefully controlled, the other parts of the system could have reduced buffers. These approaches to continuous improvement can be used successfully together. For example, when TOC has a system running at the speed necessary to satisfy customer demand, lean tactics can be used to reduce waste and optimize delivery timing while six sigma controls smooth out system variability.

Waste is common to both lean and JIT and so is addressed here

Waste JIT and lean emphasize the elimination of waste (non-value-added activities). Waste is given a broad definition by the APICS Dictionary, 16th edition: (1) Any activity that does not add value to the good or service in the eyes of the consumer (2) A by-product of a process or task with unique characteristics requiring special management control The definition further explains that waste production can usually be planned and somewhat controlled. Scrap is typically not planned and may result from the same production run as waste. For instance, the first production run of the day may result in start-up waste because the product coloration doesn’t meet specifications since the colorants haven’t been used since the last run hours ago. Toyota pioneered JIT and lean and is well known for identifying and tracking wastes in its Toyota Production System.

Exhibit 4-54 shows the types of waste. Exhibit 4-54: Types of Waste Type

Description

Process

Taking unneeded steps to produce work; inefficiencies

Movement (transportation)

Moving products unnecessarily

Methods (motion)

Wasted time or efforts by operators

Product defects

Products and services that do not meet specifications

Waiting time

Queuing delays

Overproduction

Making more product than required

Excess inventory

Holding stock not required to fulfill customer orders

Unused people skills

Waste of knowledge or capabilities

Toyota’s Taiichi Ohno originally defined the first seven “deadly” wastes in the Toyota Production System. The eighth waste (unused people skills) was defined by James P. Womack and Daniel T. Jones in Lean Thinking. Overproduction is considered the most serious of the eight wastes. While JIT and lean concepts have their most familiar applications in manufacturing, they also have wider application in supply chain management. A smooth-running production process often can be achieved only when it is part of a smooth-running supply chain.

Lean Lean improvement initiatives focus on reduction or elimination of waste in all areas. The APICS Dictionary, 16th edition, identifies “lean” and “lean manufacturing” as synonyms for lean production , which it defines as follows: A philosophy of production that emphasizes the minimization of the amount of all the resources (including time) used in the various activities of the enterprise. It involves identifying and eliminating non-value-adding activities in design, production, supply chain management, and dealing with customers. Lean producers employ teams of multiskilled workers at all levels of the organization and use highly flexible, increasingly automated machines to produce volumes of products in potentially enormous variety. It contains a set of principles and practices to reduce cost through the relentless removal of waste and through the simplification of all manufacturing and support processes. Most lean resources credit Henry Ford as the first person to truly integrate an entire production process when he created what he called “flow production” in 1913. Ford’s techniques, however, lacked flexibility; they were intended to produce only black Model T automobiles. During the 1930s, Toyota revised Ford’s concepts to provide both continuity in process flow and a wide variety in product

offerings. This became known as the Toyota Production System (TPS). We will examine key aspects of the Toyota system throughout this discussion of lean. Lean thinking has applications all along the supply chain—from eliminating unnecessary steps in product design to aligning suppliers’ processes with the delivery schedules required for lean manufacturing. Waste, in the world of lean thinking, is anything that fails to add value in the eyes of the customer. Waste can therefore mean product features or entire products that customers feel are unnecessary. Waste can also refer to unnecessary materials, equipment, processes, plant, personnel, time—any operational element that can be eliminated without reducing the value provided to the customer. Reducing non-value-added costs and times passed to customers not only makes customers happier; it also tends to lower the organization’s costs or increases profits. For example, checking in and selecting seats online are two examples of ways that airlines have reduced their costs while reducing non-value-added wait time for their customers. This is a definite win-win for the supply chain and for the customer. Likewise, a supplier of retail goods to a major retailer can “lean” its supply chain by using point-of-sale data from its customers to create

replenishment orders to ship the right amount of product directly to each store. This helps minimize the bullwhip effect and keep inventory levels lower than if they were using only forecasting methods to drive their processes. Lean initiatives are fueled by a specific set of tools and techniques. For example, lean production is also compatible with six sigma. Exhibit 4-55 outlines the main features of lean production.

Exhibit 4-55: Lean Production

Lean Objectives Lean supply chains strive to achieve the following objectives. Eliminate waste in business value streams. Lean supply chains eliminate all processes that add cost without adding customer value, including materials handling, inspection (perfect products don’t require inspection), inventory, and rework (get it right the first time). The perfect lean system would also reduce distances that parts and employees have to travel to avoid wasted time and wasted steps. Meet customer demand. Organizations adopt lean and encourage their suppliers to do so to strengthen the supply chain. Lean systems aim to produce only products and services that customers want and only at the rate that customers want to buy them. Increase velocity. Velocity refers to the time it takes to provide value to the customer. Velocity in supply chain management is defined in the APICS Dictionary, 16th edition, as “the relative speed of all transactions, collectively, within a supply chain community.” The definition goes on to state that “a maximum velocity is most desirable because it indicates higher asset turnover for stockholders and faster order-to-delivery response for customers.” Through the use of JIT and lean techniques, velocity

produces products and services only as fast as customers want them. Reduce need for working capital. Working capital (the cash available for the day-to-day operations of a company) is increased because of reduced inventory and improved productivity. Increase inventory turns. Inventory turnover, or inventory turns, is the number of times that an inventory cycles, or turns over, during the year. Shortening lead times and assembling to order are ways to increase inventory turns. Gain market share. Quality, low cost, short lead times, and other lean principles help organizations and supply chains gain competitive advantage. Increase profitability. Increased profitability results when nonvalue-added activities are reduced and volume is added without adding resources. Develop the workforce. Lean reinforces the occupational development of employees though improved job design, training opportunities, more challenging work, more responsibility, participation at all employee levels, and more teamwork. Job titles are typically reduced and worker flexibility is increased.

Produce products and services with perfect quality. When all is functioning according to plan, lean systems allow employees to produce perfect results. In lean supply chains, organizations find suppliers whose methods will synchronize with lean requirements and develop long-term relationships with them. (Developing relationships with partners rather than seeking low bids for every project is a fundamental lean principle.) Organizations seek or develop suppliers who understand and are willing to play a role in creating value for customers by streamlining processes and developing the organizational capabilities to deliver just in time.

Lean Principles Lean Thinking by Womack and Jones identifies five principles that epitomize lean. These core lean principles are summarized in Exhibit 4-56. General implications for supply chain management are included. Exhibit 4-56: Lean Principles Principle Create value for the customer.

Implications for Supply Chain Management Only a customer can define what constitutes value in terms of a product or service. When a supply chain creates value for customers, it recognizes what creates value from the customer’s perspective and answers the question “What will the customer pay for?”

Principle

Implications for Supply Chain Management

Identify all steps across a value stream.

As noted in the APICS Dictionary, 16th edition, a value stream encompasses all “the processes of creating, producing, and delivering a good or service to the market.” All of the activities (both value-added and nonvalue-added and the highly visible and more subtle ones) that are performed to process raw material to finished product, from order to cash and from product concept to product launch, are included. Identifying steps across the entire value stream often exposes waste.

Create value flow.

What are the actions that create value flow? One-piece or continuous, smooth flow is the ultimate objective. When striving for smooth flow, problems that must be dealt with become visible.

Pull products based upon customer demand.

Pull scheduling replaces what is used and drives actions toward a make-to-order environment (versus push production scheduling). In pull, each successive step in an overall process signals the preceding step that it needs more material/product to work on and triggers the predecessor to produce the needed material/product. In a pull environment, no one upstream function or department should produce a product or service until the next customer downstream asks for it.

Strive for perfection by continually removing successive layers of waste.

Relentless continuous improvement removes successive layers of waste. Continuous improvement results are maximized when the first four lean principles are in place.

House of Toyota The House of Toyota, also called a house of lean, is a framework commonly used to explain the entire scope of lean. The House of Toyota graphic was created by Taiichi Ohno and Eiji Toyoda of

Toyota to help explain the Toyota Production System to employees and suppliers. Exhibit 4-57 we see a typical representation of the House of Toyota.

Exhibit 4-57: House of Toyota

Source: APICS Lean Enterprise Workshop Series.

Although Toyota has had its issues such as recalls, the company is still a good example of lean production. These quality issues reaffirm the critical importance of a company aligning its long-term quality strategy and value proposition with its shorter-term growth strategy, thereby ensuring that value will continue to exist.

Foundation The metaphor of a house was used to convey stability. Operational stability (the house foundation) implies stable demand and processes through leveling, standardized work, and processes improved through kaizen. Let’s look more closely at these three terms. The APICS Dictionary, 16th edition, tells us that load leveling (also referred to as capacity smoothing or level loading) is defined as follows. Spreading orders out in time or rescheduling operations so that the amount of work to be done in sequential time periods tends to be distributed evenly and is achievable. Although both material and labor are ideally level loaded, specific businesses and industries may load to one or the other exclusively (e.g., service industries). In the Toyota Production System, heijunka is the Japanese term akin to leveling. The Dictionary defines it as part of the Just-inTime philosophy and as “an approach to level production throughout the supply chain to match the planned rate of end product sales.” Standardized work (or standard work) has been compared to the steps in a dance; it defines tasks (such as content, sequence, and

timing) to achieve an optimum process in the time available. The Dictionary defines kaizen as follows: Continuing improvement involving everyone—managers and workers. In manufacturing, kaizen relates to finding and eliminating waste in machinery, labor, or production methods. Roof The House of Toyota roof contains the primary goals of the Toyota Production System achieved by eliminating waste. The primary goal is to have a customer focus, which is addressed in detail elsewhere since this is basically customer relationship management. Other goals include the following: Best quality. One-piece or continuous flow improves quality because the next (downstream) process uses the piece shortly after it has been produced at the previous (upstream) process. Unless there is batch processing, there will be very few pieces produced with a defect because a defective item should be found soon after it is made. (If there is batch processing, a quality problem could potentially be replicated in the entire batch before it is found in a downstream process.)

Lowest cost. A premise of lean is that the least amount of waste will result in the lowest costs. It should be noted, however, that if standard cost accounting is used for lean projects, the results will actually make it appear as though many lean efforts are having a seemingly negative financial effect on the organization. Here is why: When management accounting methods came into being in the early 1900s, they were designed to support manufacturers that produced large batches of products with long lead times. These manufacturers were also intent on having significant inventory for their customers. Thus, traditional management accounting measurements focused on planned versus actual direct costs and overhead (e.g., machine utilization, cost variance, budget adherence). Lean accounting instead focuses on delivery to the customer (e.g., through cycle time and inventory turns). Lean accounting also necessitates different types of financial, behavioral, and core process performance metrics. A lean metric is one “that permits a balanced evaluation and response—quality without sacrificing quantity objectives” (Dictionary). Thus management accounting does not capture or reflect significant productivity gains due to lean practices. It also tends to make profits appear lower than they actually are, even though cash flow has improved due to lean processes.

Shortest (delivery) lead time. With lean’s emphasis on activities such as one-piece flow and pull systems, queue times (wait times for a product awaiting the next step in a process) often shrink significantly. The result is typically a short lead time to the customer. Two Pillars Jidoka and Just-in-Time are two important lean concepts. They are shown as the outer pillars in the House of Toyota. The house will not stand without both pillars. Jidoka . Jidoka is a Japanese term that can be loosely translated as “automation with a human touch.” In the House of Toyota, jidoka is facilitated by line stoppage, the separation of operator and machine activities, mistake-proofing, and in-station (visual) control. Jidoka is sometimes referred to as “intelligent automation” or “autonomation.” It is the ability to stop production lines, by human or machine, in the event of problems such as equipment malfunction, quality issues, or late work. Specially equipped machines can stop a process immediately when a problem occurs and signal for help. Operators stop work and correct the problem. Sometimes managers or supervisors are involved, depending upon the magnitude of the problem. Whether the stoppage is

manual or automated, jidoka prevents defective products from being produced. It helps identify and correct problem areas using localization and isolation. Poka-yoke is a tool used to support jidoka. Often referred to as mistake-proofing or error-proofing, the term comes from “poka,” which means “error,” and “yokeru,” which means “to avoid.” Pokayoke is a failure mode control—a method or device to detect abnormal conditions and stop the process. An example of pokayoke is a component with a flange that allows it to be installed in one way only rather than being able to be installed backward by accident. In-station control (also referred to as visual control or problem visualization) describes the sequence when a problem arises. Since the equipment stops when an abnormality is detected, a single operator can visually monitor and efficiently control many machines. A problem display board (usually electronic) called “andon” allows an operator to identify problems in the production line at a glance. The problem is corrected, and improvements are incorporated into the standard workflow. Just-in-Time. JIT allows delivery of the right items at the right time to the right place in the right amounts. Takt time, one-piece flow,

and pull systems facilitate JIT. One-piece flow and pull systems are described elsewhere; takt time needs further explanation. When a lean system is ticking along at the perfect rate, its production of finished goods is exactly synchronized with the rate of customer demand. This reduces inventories to a minimum, eliminating all but work-in-process and in-transit inventories. The heartbeat of such a synchronized system is called takt time. Derived from the German word for musical meter, takt time uses this ratio:

For example, say that customer demand for walking chronometers is running at 1,000 units per day and available capacity is rated at 700 minutes per day; takt time would be 0.7 minutes per unit (700 minutes divided by 1,000 watches). The production system would then have to be designed to produce a unit every 42 seconds (0.7 x 60 seconds), or capacity would have to be increased. The end result of JIT is that each process produces only what is needed by the next process in continuous flow. A Just-in-Time system functions properly when all of the parts that are made and supplied meet predetermined quality standards.

Jidoka supports this through the detection of errors or defects during production. Center of House The center of the House of Toyota promotes the following core lean principles. Culture of continuous improvement. In order for lean to be successful, organizational leadership must relinquish hierarchical authority and create a culture of learning and experimentation to support continuous improvement. The continuous improvement mindset starts at the top, and everyone in the organization is involved. Employee involvement plays an important role in lean manufacturing in terms of both continuous improvement and quality control efforts. Employees are rewarded for successful initiatives. Respect for people. “People” means customers as well as people in the local communities and employees. How is respect for people achieved? Safety is ensured, the wider community is served, and employee morale is boosted. Organizations give back and protect the wider community through green practices and other environmental initiatives. Employees are empowered and take ownership for their work. Teams facilitate creativity, effectiveness, and efficiencies.

Additional Lean Considerations Let’s consider some additional concepts commonly applied in lean initiatives. Value Stream Mapping Value stream mapping is a paper-and-pencil tool that helps you to see and understand the flow of material and information as a product or service makes its way through the value stream. While it is similar to process mapping in six sigma, it tends to display a broader range of supply chain processes, stretching all the way from receiving raw material to delivering finished goods. Not only does a value stream map sketch all the steps in a production or service delivery process; it also includes the management and information systems that accompany the process. The basic procedure of value stream mapping is to begin by drawing the process. Then overlay a map of the information flows that support the process. This provides a picture of the current state of the supply chain, complete with value-adding and non-value-adding activities. (The bottom of the chart clearly differentiates value-added time from non-value-added time, such as waiting for production, and sums them separately.) After completing the value stream map of the current state with input and approval from all stakeholders, the next step is to draw a future state map that eliminates as many wasteful

activities as possible. Organizations that successfully convert a shop floor into a lean production area through value stream mapping will sometimes apply the same technique to mapping and improving other areas, such as incoming supply, outgoing distribution, the design process, or administrative procedures. Value stream mapping is a powerful yet simple tool that does not require advanced technology. Nevertheless, it provides a way to link metrics/reporting requirements and stakeholders from multiple functions (including managers and staff) to sustain a lean initiative across the entire supply chain. It gives managers and employees the same tool and language to use to communicate. Kaizen Event/Kaizen Blitz Kaizen is the Japanese word for continuous improvement, and it signifies a carefully designed, evolutionary process. A kaizen event is defined in the 16th edition of the APICS Dictionary as follows: A time-boxed set of activities carried out by the cell team during the week of cell implementation. The kaizen event is an implementation arm of a lean manufacturing program. A kaizen event is a regularly scheduled event that is designed to be started and completed in a limited time frame, such as a week. Therefore, it is used for continuous improvements that can be

identified and enacted without significant disruption to processes or staff. Note that this needs to be a regular process because one or two successes from kaizen events may lead to complacency rather than commitment to long-term reform. Therefore the change leaders in the organization (often assisted by consultants) should embed the kaizen event in a carefully developed long-term plan that is communicated clearly to all stakeholders. A related term for a more intense version of the process that could make many improvements but keeps the focus area narrow is a kaizen blitz . It is defined by the Dictionary as follows: A rapid improvement of a limited process area, for example, a production cell. Part of the improvement team consists of workers in that area. The objectives are to use innovative thinking to eliminate non-value-added work and to immediately implement the changes within a week or less. Ownership of the improvement by the area work team and the development of the team’s problem-solving skills are additional benefits. In general the kaizen blitz includes basic training, analysis (usually a flowchart of the process to be redesigned), and the design itself. The blitz is something of an anomaly, therefore, and is not without its dangers. For one thing, the quick turnaround time allows for only superficial training in analysis and design methods without attention

to the subtleties or tradeoffs. A kaizen blitz can be most useful at the beginning of a lean or TQM initiative to provide a quick demonstration of the possibilities of reform and thus convince skeptics that change can be beneficial. Lean techniques, such as the kaizen event, may have seen their first applications in Toyota and other Japanese companies, but they can be just as usefully applied in service settings as on shop floors. For example, a Minnesota health-care organization adapted Toyota’s Rapid Process Improvement Workshop (RPIW)—essentially a kaizen blitz—to their endoscopy service to reduce the annoyingly long wait for appointments. With the improvements that resulted, they doubled the number of patient visits per day without reducing the time spent with a physician. After that initial success, the medical center conducted dozens more RPIWs, which resulted in a savings of US$7.5 million in the first year. In this instance, the initial blitz was the first step in what became an organization-wide, lean revamping of the service supply chain. It is important to emphasize that TQM, lean, six sigma, and JIT all take years to achieve their objectives and many small improvements (and some large reengineering efforts) are needed in many places to increase the maturity of the system as a whole. Five Ss

The five Ss refers to a workplace organization method expressed in Japanese: seiri, seiton, seiso, seiketsu, and shitsuke. Collectively they describe how to organize a work space to optimize efficiency and effectiveness. Since order and organization are important concepts in lean, these five Ss (often referred to as 5S) have been adopted and translated into English as “sort, simplify, scrub, standardize, and sustain.” The purpose of the five Ss is to make everything about the workplace orderly and clean and keep it so. describes the five Ss. Exhibit 4-58: The Five Ss Term

Description

Sort

Sort means to separate needed items from unneeded ones and remove the latter. Sorting and organizing the work area, leaving only the essential paperwork, tools, and other materials necessary to perform daily activities, improves communication between workers and increases product quality and productivity.

Simplify (set in order)

Simplify means to neatly arrange items for use. The orderly arrangement of needed items makes them easy to use and accessible for anyone to find or put away and eliminates waste in activities.

Scrub (shine) Scrub means clean up the work area. Sweeping, systematic cleaning, and shining keeps everything in top condition so that when someone needs to use something, it is ready to be used; mess prevention also helps to maintain a safer work area.

Term

Description

Standardize

Standardize means to develop standard work processes. Creating a consistent approach for carrying out tasks and procedures helps clarify what is the “normal” condition and how to correct “abnormal” conditions.

Sustain

Sustain means to always follow the first four Ss. Maintaining and reviewing materials sustains the discipline and commitment of all other stages.

Source: Adapted from Five Pillars of the Visual Workplace by Hiroyuki Hirano.

The five Ss create a workplace suitable for lean production. They convey the message that quality starts with the people in the organization. The five Ss provide a framework for a workplace that is clean, uncluttered, safe, and organized, where people become empowered and engaged. Setup Time Reduction Setup time reduction has a major impact on production costs and product variety. This practice aims to reduce waste (time and material) in the setup process. It encompasses improved processes as well as having employees being responsible for their own setups. The Dictionary defines setup time as the time required for a specific machine, resource, work center, process, or line to convert from the production of the last good piece of item A to the first good piece of item B.

Reducing setup time increases an operation’s velocity and throughput. There are five steps to reduce setup time. 1. Classify internal and external changeover tasks. Internal tasks must be performed while a machine is stopped (idle time); external or preparation tasks can be performed while the machine is still running. 2. Convert internal setup tasks to external tasks. For example, organize tools and materials for setup while the machine is still running a batch. 3. Streamline internal setup. For example, find ways to reduce the time it takes to fasten equipment in place. 4. Eliminate adjustments. Documenting the proper adjustments for different materials helps eliminate wasteful trial and error, as adjustments are repeated until the machine produces an “in spec” product. 5. Minimize external (preparation) time, since small batch processes may not provide enough time to prepare for the changeover. Remember that reducing changeover time is a part of an overall strategy, and it impacts and is impacted by other areas such as lot size and lead time. Make sure that your setup time reduction accomplishes your strategic goals. Do you aim to reduce time, cost, human resources, maintenance, or a combination? Does quality

need to be improved? Although all of the above are often desired, generally not all are possible. Total Productive Maintenance Total productive maintenance (TPM) seeks to engage all levels and functions in an organization to maximize the overall effectiveness of production equipment. The APICS Dictionary, 16th edition, defines TPM as follows. Preventive maintenance plus continuing efforts to adapt, modify, and refine equipment to increase flexibility, reduce material handling, and promote continuous flows. It is operator-oriented maintenance with the involvement of all qualified employees in all maintenance activities. TPM aims to reduce mistakes and accidents. Where maintenance departments are traditionally responsible for preventive maintenance programs, TPM seeks to involve workers in all departments and levels, from the plant floor to senior executives, to ensure effective equipment operation. Three Major Areas of Waste As lean strives to eliminate waste, there are three broad types of waste it focuses on: muda, mura, and muri, according to Taiichi Ohno.

Muda is synonymous with waste—any activity that consumes resources but creates no value. Recall that value is what the customer is willing to pay for. Mura is a general Japanese term for unevenness or inconsistency. Mura occurs in the demand for production and in processes. In lean, mura creates muri. Muri is an overburdened situation—the overburdening of employees or processes. For many organizations, mura and muri are the root causes of muda. It is management’s responsibility to examine the muda in the processes and eliminate the deeper root causes of the waste by considering the connections to mura and muri. A typical example of the interplay of muda, mura, and muri is an organization playing catch-up and trying to make forecasted numbers as the end of a fiscal reporting period approaches. Demand is raised, increasing mura. This causes production to try to squeeze extra capacity from the process. Routines and standards are modified or stretched, leading to muri. Ultimately, this results in downtime, mistakes, backflows, and waiting. Muda is the waiting and corrections that result. Lean takes a problem-solving approach rather than a tools-based approach to eliminating waste. In lean, tools serve specific purposes and support focused improvement efforts.

lists tools that are used to combat muda, mura, and muri. Exhibit 4-59: Tools to Combat Major Areas of Lean Waste Muda 5Ss, TPM, setup reduction, flow, pull, kaizen, six sigma Mura Takt time, heijunka, flow, pull, six sigma Muri

Takt time, standard work, flow, pull

As lean strives to identify waste from the customer’s perspective and determine how to eliminate that waste, these tools help to make processes more standardized, effective, and efficient. For example, a pull system minimizes inventory waste by pulling inventory through the supply chain based on actual demand signals rather than pushing inventory out based on forecasts that could be inaccurate. In complex supply chains, especially global ones, implementing lean and responding to demand events from downstream operations poses challenges. But when system wastes are eliminated, lean’s benefits will include reduced inventories, lower labor and material costs, energy efficiencies, increased customer value, improved customer satisfaction, coordinated continuous improvement efforts across the supply chain, and competitive advantage and leadership in the global marketplace.

Just-in-Time (JIT)

Just-in-Time is a major component in lean’s House of Toyota. However, some organizations may practice JIT without embracing the entire lean philosophy, so it is important to understand JIT as a stand-alone philosophy as well. The APICS Dictionary, 16th edition, defines Just-in-Time as follows: A philosophy of manufacturing based on planned elimination of all waste and on continuous improvement of productivity. It encompasses the successful execution of all manufacturing activities required to produce a final product, from design engineering to delivery, and includes all stages of conversion from raw material onward. The primary elements of Just-in-Time are to have only the required inventory when needed; to improve quality to zero defects; to reduce lead times by reducing setup times, queue lengths, and lot sizes; to incrementally revise the operations themselves; and to accomplish these activities at minimum cost. In the broad sense, it applies to all forms of manufacturing—job shop, process, and repetitive—and to many service industries as well. JIT places a primary emphasis on eliminating time in queues at work centers by having the right materials arrive at the right places at the right times. This implies more than mere speed or timing; it implies quality as well, so JIT uses total quality management principles. Any lack of quality can prevent the rapid flow of goods to their appointed stations and create queues of stalled inventory. Any worker in a JIT

facility has the power, the responsibility, and the means to halt production to pull a defective product. Exhibit 4-60 illustrates the principal features of JIT.

Exhibit 4-60: Features of Just-in-Time Production

Three JIT Basics Three JIT focuses include waste reduction, variability reduction, and pulling materials into a work center rather than pushing them in from the preceding center. Waste Reduction Storage, inspections, queues at work centers, and defects all fail to add value while costing money and slowing down production.

Through continuous improvement, JIT targets each of these conditions for step-by-step elimination. Variability Reduction Continuous improvement includes elimination of variability discovered in the system no matter what the source, internal or external. The source might be inaccurate engineering drawings, equipment that fails to perform up to standards, or going into production without understanding customer requirements. Pulling Materials into Production In traditional systems, materials and parts move from place to place by being “pushed” from behind. Raw materials are extracted and sent to manufacturing. Materials and components move away from workstations when the operation there has been completed. Manufacturing ships goods out when they are in finished form. All of this activity takes place in accordance with schedules determined in advance on the basis of forecasts. JIT takes the opposite approach and “pulls” items through the system when they are demanded, not according to preset schedules. In a pull system, materials don’t move from supplier to plant until requested. Similarly, work-in-process (WIP) doesn’t move from one work center to another until a signal indicates that the time is right.

Lots sizes are kept small, and orders are entered more frequently. This reduces or eliminates any inventory waiting to be processed. This brings quality problems to light more quickly. Defects in materials can be hidden when there are inventory buffers; a defective component can be discarded and another taken from the safety stock. But in JIT there is no buffer, so there are no quick substitutions possible when a defective component comes on line. Therefore, a defect causes a slowdown and signals the need for process improvement.

Elements of JIT for Continuous Improvement Here are some of the elements of the supply chain that are subject to continuous improvement according to JIT principles. Suppliers Some supply chains have always included a JIT component. Fine restaurant supply chains are an example. Perishable items for consumption must be delivered on time with minimal variability and waste if they are to be served fresh to high-paying customers. JIT extends that model into manufacturing supply chains by building long-term relationships with a limited number of suppliers who are willing to incorporate JIT principles into their own businesses. A JIT supplier delivers on time, ships only quality goods that require no inspection, and reduces inventory in warehouses and in transit.

Sometimes suppliers actually move their warehouses into the plant to ensure that supplies are always available with almost no transport time or other delays. Not all suppliers are willing to be JIT partners. They may not want to be tied up in a long-term contract or to move at the pace of JIT, which can necessitate frequent, rapid engineering changes. The demand for zero defects and small, frequent shipments may also run counter to supplier preferences. JIT Layout Another way to reduce waste is to lay out the production facility in such a way as to minimize distances and maximize flexibility. Employees may be arranged in “work cells” that focus on one family of products manufactured with similar processes. This minimizes the distance the products travel through production and, ideally, allows production of one unit at a time in response to an order. Equipment is designed to be movable, with nothing bolted to the floor, so cells can be easily re-formed to accommodate new product families. Workers, too, are made more flexible by cross-training. Inventory Reduction “Inventory is evil,” in the words of Japanese JIT guru Shigeo Shingo. Shingo’s strong statement captures the spirit of JIT, though it might

be more proper to say that inventory not in motion is the real problem. Operations managers may begin instituting JIT by reducing inventory to the bare minimum necessary for efficient operation. With no “safety stock,” everything in the system has to work almost perfectly to avoid breakdowns. Continuous improvement finds ways to eliminate variability and defects so the system will work without inventory buffers. Lot sizes must be kept small to avoid accumulation of inventory, and that brings down costs of holding and handling items in storage or in queues. However, as holding costs go down, ordering and setup costs tend to rise. Small, frequent lots mean more orders placed for materials and more setups. Reducing order cost and setup time are JIT improvement projects. Order expense is often eliminated using backflushing, which replaces replenishment purchase orders with an automated order based on actual use in production and the bill of materials (which must be accurate). Various ways to reduce setup time are discussed next. Changeovers, Lead Time, and Lot Sizes Quick changeovers can provide immediate benefit in the form of lead time reduction. Reducing lead time using JIT or even by improving lead time in conventional systems can provide a number of benefits. The first benefit is a direct and immediate reduction in product cost, because setup time is a direct cost. It can also eventually reduce lot sizes—and thus order quantities—because setup time will not be as

large a component in the tradeoff analysis between the cost of setups and other costs. Reducing lot sizes will also eventually improve quality because defects will have less chance to be replicated across as many units. Another benefit of reducing lot sizes is that WIP inventory and queues (orders awaiting production at a work center) will be reduced because the total amount of inventory in process or waiting to be run at individual work centers is partly a factor of the order size. A side benefit of smaller orders, less WIP inventory, and smaller queues is that when less inventory is held between work centers, it will be easier to establish cellular layouts because the work centers can be physically nearer to each other. Scheduling Good communication is essential for efficient scheduling. In JIT, schedules are widely communicated within organizations and along the supply chain, improving suppliers’ ability to be responsive to orders. A finalized production schedule based on actual demand for components and materials is essential to putting JIT into action. However, schedules for JIT differ from traditional make-to-stock schedules. These schedules determine material requirements by focusing on the finished goods being demanded. Two particular types of schedules are favored in JIT: level and kanban.

A level schedule involves small batches of constantly changing items, so that production for each day exactly meets demand for the day. (Production and demand are level.) This can produce as many units as a large-batch system, but it requires reduction of setup time to do so. The kanban system originated in Japan, where display cards are generally used to signal that a work site is ready for a new batch of materials. (In Japanese, “kanban,” loosely translated, means card, billboard, or sign.) Kanban works (like JIT in general) in fast-paced mass production environments where one station is close enough to the next that a visual signal will suffice to trigger a delivery. Cards, a light, an empty parts bin, colored golf balls, or even an empty space on the floor can signal readiness for materials. Continuous Job Improvement JIT includes continuous employee and job improvement as well as continuous process improvement. In JIT organizations, responsibility for process improvement rests upon the workers closest to the process, so those employees take on supervisory responsibilities. The emphasis is on training and cross-training to boost employees’ skills and knowledge to keep up with their growing responsibilities. Jobs, too, are expanded and enriched to increase the challenge to

employees and to enhance their commitment to continuous improvement of every aspect of the workplace.

Six Sigma The APICS Dictionary, 16th edition, defines six sigma as follows: A methodology that furnishes tools for the improvement of business processes. The intent is to decrease process variation and improve product quality. Six sigma aims to achieve near-perfect products and services. The specific objective in a six-sigma organization is to get as close as possible to “zero defects,” with an outer limit of 3.4 defects per million “opportunities.” In six-sigma language, a defect is anything that does not conform to customer expectations, and an opportunity is any chance for nonconformance. If a company produces a million light bulbs, no more than 3.4 should fail to meet customer expectations. If a bank sets up ATMs, their customers should experience disappointment during no more than 3.4 times in a million opportunities—which may not be the same thing as one million visits to an ATM. Customers may have more than one expectation; for example, they may expect the machine to be online, the instructions to be easy to understand, the wait for their turn to be short, and, of course, the operation to succeed in delivering or depositing the

correct amount. That would be four opportunities for a defect per visit. One potential challenge to using the six-sigma approach arises from the difficulty of determining what constitutes a defect. Another challenge comes from setting a meaningful limit on variability. For instance, there is probably a range of wait times at the ATM that most customers will generally find acceptable. Is it 30 seconds, a minute, or two minutes? The project team leader, or the executive sponsoring the project, may be tempted to set the limits of variability as wide as possible to achieve a six-sigma level of defects. Also, not all opportunities are as significant as others. While some wait time is likely to be acceptable to customers, failure to record a deposit correctly or deliver the requested amount of cash may be completely unacceptable. (Defect, disappointment, and customer expectations are open to definition by focus group or other research methods.) Exhibit 4-61 illustrates the aim of six sigma to reduce defects to near zero. Assume that one million opportunities for a defect will result in the familiar bell curve with the target value in the center. If the process is in control from a six sigma perspective, about 99.9997 percent of those opportunities will fall within six sigmas (or standard deviations) from the target value. That will leave only 3.4 opportunities (just over 0.0003 percent) that result in defects.

Exhibit 4-61: Six-Sigma Control

By contrast, traditional quality goals often set the level at three sigmas to either side of the mean. (The mean is the target in the exhibit.) Three sigmas corresponds to 99.74 percent of products with no defects. At that rate, there would be 66,807 defects per million opportunities. When Motorola developed the six sigma concept, they chose six sigmas as an appropriate goal for the types of products they were producing. Some industries might need to set their goals at a different number of sigmas based on what customers find acceptable and what is feasible. Even so, setting ambitious goals and following six sigma improvement processes can result in significant improvements for any organization.

Elements of Six Sigma

Six sigma offers a set of tools for developing repeatable high quality under the guidance of a six-sigma-certified employee or consultant. Attaining six-sigma quality requires attention to three elements: the customer, the process, and the employee. Customer. The definition of quality—that is, the acceptable rate of defects—is in the mind of the customer. Customer expectations might include outstanding performance, reliability, competitive price, on-time delivery, excellent service, and so on. All these areas provide opportunities for defects that may drive a customer to a competitor. Process. Process mapping or flowcharting are techniques used to identify the unique steps in a process. When assessing a process, the company has to adopt the customer’s mindset—an “outside-in” view of the company’s performance. The goal is not only a low number of errors but also consistent performance. That is, the performance should remain very close to that number of errors and not show a great deal of variability in either direction. For instance, an air-freight carrier with on-time performance that stays right around an acceptable level may create more customer satisfaction than a carrier that has the same average on-time rate but is erratic and unpredictable, with late arrivals counterbalanced

by early arrivals. This may produce enough disgruntled customers to erode market share. Employee. Full employee participation has been a principle of quality systems since the early work of W. Edwards Deming. When it comes to customer satisfaction, there are no irrelevant employees (or processes). Bank tellers, receptionists, and file clerks (or data entry specialists) may occupy low rungs on the corporate ladder, but their “defects” tend to be highly annoying and visible to the customer. A company fully committed to the sixsigma approach will offer training at all levels. Six-sigma initiatives typically are directed from the top but implemented “from below,” by employee teams. Training in six-sigma tools and techniques takes place at different levels, with the possibility of certification at the level of green belt, black belt, and master black belt. People with any of the three “belts” have sufficient knowledge of quality standards, design and development procedures, and statistical analysis that they can lead process design or process improvement projects. Black belts and master black belts operate as full-time employees; master black belts primarily engage in teaching. Green belts may be consultants or employees with other responsibilities.

Six Sigma Process and Tools

The six-sigma process for conducting a continuous improvement initiative takes place in five phases, known by the initials of the phases as DMAIC: Define, Measure, Analyze, Improve, Control (as described in the APICS Dictionary, 16th edition). Phase 1: [Define] Determine the nature of the problem. Phase 2: Measure existing performance and commence recording data and facts that provide information about the underlying causes of the problem. Phase 3: [Analyze] Study the information to determine the root causes of the problem. Phase 4: Improve the process by effecting solutions to the problem. Phase 5: [Control] Monitor the process until the solutions become ingrained. Six sigma has developed a similar model to guide the creation of new processes (as opposed to conducting an improvement initiative): Define, Measure, Analyze, Design, Verify (DMADV). Because of its statistical basis, six-sigma analysis depends heavily upon thorough, reliable, measurable data. Without that level of visibility, there can be no determination of the rate of defects. Sixsigma techniques for defining, measuring, and analyzing a process

include quality control tools such as process mapping, control charts, and Pareto diagrams.

Six Sigma Case Study: Single-Source Contracting by U.S. Government In 2005, the U.S. Navy initiated a process improvement project with a kaizen event that demonstrates the compatibility of the techniques described in this section. The process that needed improving was the “J&A,” Navy-speak for “Justification and Approval to Limit Competition.” The J&A is used to justify sole-source contracting. It affects every contract specialist in the Navy’s air force (NAVAIR), yet studies found that the policy was confusing to new personnel even after training and was subject to divergent interpretation. The result was variability and poor quality in sourcing. The prescription for change was lean six sigma with a focus on reduction of variability and waste. With the assistance of a black belt lean six-sigma consultant, NAVAIR conducted a kaizen event. Participants sketched out a value stream map of the current J&A process, including a detailed list of “touch times” (six-sigma opportunities for error), waiting times, reviews, and “re-do loops” to document total cycle time. It turned out that the J&A process had 26 steps and 17 rework loops, for a cycle time that varied from 27.75 to 129 days. The next step was to create

a future value stream map eliminating wasteful steps and reducing errors, if possible to zero. The result of their efforts was a template to eliminate the “re-do loops” and to make the process so easy to understand that no prior training would be necessary for perfect completion of a J&A. One link in the template, for instance, provided complete guidance on conducting a market survey—a requirement of the process for which there was previously no instruction or explanation. The new template reduced the number of steps from 26 to 13 and the number of rework loops from 17 to zero. Total cycle time dropped 50 percent, to a maximum of 40.5 days and a minimum of 16. The benchmark for the new J&A process was set to no stops and no “re-dos.”

Theory of Constraints (TOC) The theory of constraints (TOC), developed by Eliyahu M. Goldratt, applies to any human organization, not only to businesses. Its central premise is that any system, such as a supply chain or a production process, contains at least one element that limits its maximum output. The APICS Dictionary, 16th edition, follows the theory in defining a constraint as “any element or factor that prevents a system from achieving a higher level of performance with respect to its goal.” An element can be any part of a system,

including people, a piece of equipment, a process, a facility, or even a way of thinking, among other possibilities. Because the constraint determines the maximum output of a system, TOC maintains that it should be the focus of improvement efforts. Why? For the system as a whole to produce maximum throughput, the constraint must be operating at its maximum speed. Furthermore, there is no benefit to be gained from speeding up the processes before or after the constraint. Imagine an assembly line with the constraint being one workstation that can complete its operation no more than 60 times per hour. Speeding up the process prior to the constraint to deliver 65 units will result in a steady buildup of inventory ahead of the constraint. It will not speed up the final output of the line. Maximum throughput at the constraint will remain at 60 units per hour. Increasing the capacity of the workstation immediately after the constraint to handle more than 60 units per hour will only result in downtime as the station completes its work and waits for the constraint to catch up.

Five-Step TOC Process Applying TOC as a method of continuous improvement requires five repeatable steps:

1. Identify the constraint. A typical indicator of a constraint is an excessive amount of work in a queue. The queue might contain any type of product, from airplanes waiting for a part to be installed to documents accumulating at a copier station. The delay might be the result of various causes, such as inadequately trained employees, a poorly conceived process, or an unreliable piece of equipment. 2. Exploit the constraint. Before investing heavily in process improvement, “exploit” the constraint by ensuring that the process is achieving the maximum output possible without major changes. Since the constraint determines the system’s overall output, it should never operate below its peak capacity. 3. Subordinate other processes to the constraint. Once the constraining element is operating at maximum efficiency, subordinate processes may have to be adjusted to operate at the new speed. This generally applies to processes preceding the constraint. Because the constraint determines the system’s maximum output, it must never be idle. Therefore, the processes that feed work to the constraint must be adjusted to ensure that they deliver work as needed. TOC recommends maintaining buffers ahead of the constraint so that it can keep functioning even if production slows down or halts ahead of it. 4. Elevate the constraint. If exploiting the constraint and adjusting subordinate processes result in satisfactory output, then

improvement efforts can proceed to Step 5. If output is still inadequate to meet customer demand, then the organization will have to invest in more significant improvements, such as purchasing new equipment, retraining or hiring new staff, or revamping the process itself. 5. Repeat the cycle. After completing the first four steps, an organization may start the process over by identifying the new constraint. There is always at least one constraint in a system.

Drum/Buffer/Rope Explanations of TOC sometimes refer to pace set for the constraint as a drum, because it determines the system’s speed as a drummer’s beat regulates the pace of a marching band. It is based on the maximum rate of that constraint (but not to exceed takt time [the rate of customer demand]). The Dictionary defines a buffer as 1) A quantity of materials awaiting further processing. It can refer to raw materials, semifinished stores or hold points, or a work backlog that is purposely maintained behind a work center. 2) In the theory of constraints, buffers can be time or material and support throughput and/or due date performance. Buffers can be maintained at the constraint, convergent points (with a constraint part), divergent points, and shipping points.

The “rope” is the scheduler that pulls orders through the system and schedules the portions of the process that occur before the constraint to ensure that the overall flow conforms to the drum beat of the constraint. One cannot push a rope, only pull it. Like other quality initiatives, TOC emphasizes the importance of pulling orders through the system to meet customer demand rather than pushing inventory through the system without due regard to demand.

Index A ABC analysis [1] ABC classification [1] Abilities [1] See also: Knowledge, Skills Acquisition costs [1] Activity network diagrams [1] Affinity diagrams [1] Aggregate inventory management [1] Anticipation inventory [1] Appraisal costs [1] Assets [1] ATP [1] Available time [1] See also: Availability, Rated capacity Available-to-promise (ATP) [1] See also: Capable-to-promise (CTP) Average inventory [1]

B B7 [1] , [2]

Backorders [1] Balance sheet [1] , [2] Basic seven tools of quality [1] , [2] Benchmarking Best-in-class benchmarking [1] Competitive benchmarking [1] Process benchmarking [1] Best-in-class benchmarking [1] Bills of capacity [1] Bills of material (BOMs) [1] Bills of resources [1] BOMs [1] Bottlenecks [1] Bucketless systems [1] Buffer inventory [1] Buffers Inventory buffers [1]

C Calculated capacity [1] Capacity Demonstrated capacity [1] Rated capacity [1] Capacity control [1] , [4]

See also: Capacity management, Capacity planning Capacity management [1] See also: Capacity control, Capacity planning Capacity planning [1] , [4] See also: Capacity control, Capacity management Capacity requirements [1] See also: Capacity requirements planning (CRP) Capacity smoothing [1] , [2] Capacity strategies Lag capacity strategy [1] Lead capacity strategy [1] Capacity variance costs [1] Capital costs [1] Carrying costs [1] Cash flows [1] See also: Statement of cash flows Cause-and-effect diagrams [1] Centralized inventory control [1] Chain of custody [1] Changeovers [1] Check sheets [1] CI [1] , [2] , [3] , [4] , [5] , [6] Closed-loop material requirements planning [1] Closed-loop MRP [1]

See also: Enterprise resources planning (ERP), Manufacturing resources planning (MRP II), Material requirements planning (MRP) Coaching [1] COGS [1] Commitment decision points [1] Competitive benchmarking [1] Configuration management [1] Configuration management system [1] Constraints [1] Continuous improvement [1] , [2] , [3] , [4] , [5] , [6] Control charts [1] See also: Statistical process control (SPC) Cost of goods sold (COGS) [1] Cost of poor quality [1] Costs Inventory costs [1] Cross-functional training [1] Cross plots [1] Cross-training [1] Cumulative lead time [1] Customer orders [1] Cycle counting [1] Cycle stock [1]

D DBR [1] DCs [1] DDMRP systems [1] Decentralized inventory control [1] , [2] Decoupling [1] Define, Measure, Analyze, Improve, Control [1] Demand Dependent demand [1] Independent demand [1] Interplant demand [1] Demand-driven material requirements planning systems [1] Demand-driven MRP systems [1] Demand pull [1] Demand time fence (DTF) [1] Demonstrated capacity [1] Dependent demand [1] Disposition [1] Distribution centers (DCs) [1] Distribution inventory [1] DMAIC [1] See also: Six sigma Drum-buffer-rope (DBR) [1]

DTF [1]

E Echelons [1] Economic order quantity (EOQ) [1] Efficiency [1] See also: Effectiveness Employee improvement [1] End-of-life management [1] See also: Product life cycle management (PLM) EOQ [1] Exception reports [1]

F Feedback loops [1] See also: Feedback Financial metrics [1] See also: Financial ratios Financial reporting [1] See also: Generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS) Financial statements Balance sheet [1] , [2] Income statement [1] , [2]

Statement of cash flows [1] Finished goods inventory [1] Firm planned orders (FPOs) [1] Fishbone diagrams [1] Five Ss [1] Fixed order quantity (FOQ) Economic order quantity (EOQ) [1] Flowcharts [1] Flow process charts [1] Fluctuation inventory [1] FOQ [1] , [2] Forecasts [1] FPOs [1] Frozen zones [1] Funds flow statements [1]

H Hedge inventory [1] Heijunka [1] Histograms [1] Holding costs [1] House of Lean [1] House of Toyota [1]

I Income statement [1] , [2] Independent demand [1] Interplant demand [1] In-transit inventory [1] Inventory Anticipation inventory [1] Average inventory [1] Cycle stock [1] Fluctuation inventory [1] Hedge inventory [1] In-transit inventory [1] Lot-size inventory [1] Physical inventory [1] Pipeline inventory [1] Safety stock [1] , [2] Work-in-process inventory [1] Inventory accuracy [1] Inventory adjustment [1] Inventory audits Cycle counting [1] Inventory buffers [1] Inventory control [1]

See also: Inventory management Inventory costs Acquisition costs [1] Capacity variance costs [1] Capital costs [1] Carrying costs [1] Landed costs [1] Ordering costs [1] Risk costs [1] Storage costs [1] Inventory levels [1] Inventory management Aggregate inventory management [1] Item inventory management [1] Inventory ordering systems Demand-driven MRP systems [1] Fixed order quantity (FOQ) [1] , [2] Lot-for-lot (L4L) [1] , [2] Min-max systems [1] Order point systems [1] , [2] Periodic review systems [1] Time-phased order point (TPOP) [1] Inventory planning [1] Inventory policies [1]

Inventory status data [1] Inventory tracking [1] Inventory valuation [1] Inventory visibility [1] Ishikawa diagrams [1] Item inventory management [1]

J Jidoka [1] JIT [1] , [2] , [3] , [4] Joint replenishment [1] Just-in-time (JIT) [1] , [2] , [3] , [4]

K Kaizen [1] Kaizen blitzes [1] Kaizen events [1] Kanban [1] Key performance indicators (KPIs) [1] , [2] Knowledge [1] See also: Abilities, Skills KPIs [1] , [2]

L

L4L [1] , [2] Lag capacity strategy [1] Landed costs [1] Lead capacity strategy [1] Lead time Cumulative lead time [1] Manufacturing lead time [1] Safety lead time [1] Lean [1] , [2] , [3] Lean continuous improvement [1] Lean manufacturing [1] , [2] , [3] Lean metrics [1] Lean production [1] , [2] , [3] Level loading [1] , [2] Life cycle analysis [1] Liquid zones [1] Load leveling [1] , [2] Loads [1] , [2] Lost customers [1] Lost sales [1] Lot-for-lot (L4L) [1] , [2] Lot-size inventory [1] Lot sizes [1] Lot sizing [1] , [2]

M Manufacturing lead time [1] Master production schedule (MPS) [1] , [2] , [3] Master schedule items [1] Master scheduling [1] Master scheduling grids [1] Matrix data analysis charts [1] Matrix diagrams [1] Measures Performance measures [1] Mentoring [1] Metrics Financial metrics [1] Lean metrics [1] Minimum order quantities [1] Min-max systems [1] Mistake-proof [1] MPS [1] , [2] , [3] Muda [1] Mura [1] Muri [1]

O Obsolescence [1]

Offsetting [1] Open orders [1] , [2] Ordering costs [1] Order point systems [1] , [2] Order promising [1] Order quantities [1] Order quantity systems [1] , [2] Order releases Planned order releases [1] , [2] Orders Customer orders [1] Open orders [1] , [2] Planned orders [1] Scheduled receipts [1]

P Parent items [1] Pareto's law [1] , [3] See also: 80-20 rule, Pareto charts Pareto charts [1] See also: Pareto's law Pegging [1] Performance measures [1] Periodic counting [1]

Periodic review systems [1] Personnel improvement [1] Physical inventory [1] Pipeline inventory [1] Pipeline stock [1] Planned order receipts [1] Planned order releases [1] , [2] Planned orders Firm planned orders (FPOs) [1] Planned receipts [1] Planning horizons [1] , [2] Planning time fence [1] Poka-yoke [1] Process benchmarking [1] Process charts [1] Process control charts [1] Process decision program charts [1] Process flow diagrams [1] Process improvement tools Benchmarking [1] Process maps [1] Production lead time [1] Productivity [1] Product traceability [1]

Pull systems [1] , [3] See also: Push systems Purchase prices [1] Push systems [1] See also: Pull systems

Q Quality [1] Quality costs Appraisal costs [1] Cost of poor quality [1] Quality tools Activity network diagrams [1] Affinity diagrams [1] Cause-and-effect diagrams [1] Check sheets [1] Control charts [1] Flowcharts [1] Histograms [1] Matrix data analysis charts [1] Matrix diagrams [1] Pareto charts [1] Process decision program charts [1] Relationship diagrams [1]

Scatter charts [1] Tree diagrams [1] Quantitative forecasting methods Life cycle analysis [1]

R Rated capacity [1] See also: Available time Raw materials inventory [1] Relationship diagrams [1] Released orders [1] , [2] Replenishment Joint replenishment [1] Resource allocation [1] Resource bills [1] Resource management [1] Resource planning [1] Resource profiles [1] Resource requirements planning [1] Returns [1] See also: Reverse supply chains Risk costs [1] Routing [1] Routing files [1] , [2]

S Safety lead time [1] Safety stock [1] , [2] Scatter charts [1] Scatter diagrams [1] Scatterplots [1] Scheduled receipts [1] Scheduling Drum-buffer-rope (DBR) [1] Setup time [1] Shrinkage [1] Six sigma [1] , [3] See also: DMAIC Skills [1] See also: Abilities, Knowledge SKUs [1] Slushy zones [1] Standard hours [1] Standardized work [1] Standard time [1] Statement of cash flows [1] See also: Cash flows Stockkeeping units (SKUs) [1]

Storage costs [1] Suppliers [1] Supply chain cost Cost of goods sold (COGS) [1] System nervousness [1]

T Takt time [1] Theory of constraints (TOC) [1] , [2] , [3] Three Vs Variability [1] Velocity [1] Throughput time [1] Time fences Demand time fence (DTF) [1] Planning time fence (PTF) [1] Time-phased master schedule grids [1] Time-phased order point (TPOP) [1] Time zones Frozen zones [1] Liquid zones [1] Slushy zones [1] TOC [1] , [2] , [3] Total quality management (TQM) [1]

TPOP [1] TQM [1] Traceability Product traceability [1] Training Cross-functional training [1] Tree diagrams [1]

U Utilization [1]

V Valuation Inventory valuation [1] Value stream mapping [1] Value streams [1] Variability [1] Velocity [1] Visibility Inventory visibility [1]

W Warehouses Distribution centers (DCs) [1]

Waste Muda [1] Mura [1] Muri [1] WIP inventory [1] Work center files [1] Work in process [1] Work-in-process inventory Finished goods inventory [1] Raw materials inventory [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

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Module 5: Forward and Reverse Logistics Forward and reverse logistics are at the core of supply chain management. We start this module with a discussion of managing supply chain logistics, including distribution networks and related distribution services. This includes warehousing and transportation strategies as well as materials-handling services such as picking, packing, and put-away. Value-added services such as postponement can also be done at warehouses. Trade considerations are also addressed, including import/export regulations and related standards such as Incoterms® trade terms or the Harmonized Tariff Schedule. Reverse logistics includes handling returns as well as repairs, remanufacturing, and disposition of waste. How to determine reverse logistics requirements and how to design a reverse network that is cost-effective and then implement it are addressed. The waste hierarchy, hazardous waste, and waste exchanges are covered.

Section A: Logistics and Distribution This section is designed to Define logistics and explain its relationship to supply chain strategy Identify the functions within logistics Explain the objectives of logistics Describe the tactics used to create an effective logistics strategy Differentiate between 3PLs and 4PLs and describe their appropriate use Enumerate warehousing objectives Identify warehousing considerations of ownership, number, location, configuration, and support systems Discuss how storage locations can be organized to maximize velocity and cube utilization Describe several stock location methods for grouping inventory in storage locations Discuss how to forecast warehouse capacity Explain the mechanized and automated systems in warehousing along with their advantages and drawbacks

Describe materials-handling options in warehouses in terms of space use, labor, equipment, and automation Describe the dual objectives of transportation Discuss how to forecast transportation capacity Discuss how to assess capacity constraint factors when evaluating bids from carriers Enumerate advantages and disadvantages of transportation modes Discuss selection of the appropriate mode of transportation given various factors. The supply chain is about “moving”—or “transforming”—raw materials and ideas into products or services and getting them to customers. Logistics, one of the most critical functions in supply chain management, is about moving materials or goods from one place to another. It is, in that sense, a service provider to design, production, and marketing that can bring added value by being quick and effective.

Topic 1: Logistics Here we start with the big picture of logistics, including a discussion of its scope, components, and value proposition. Then logistics

objectives and enabling tactics are addressed. Using 3PLs and 4PLs and their pros and cons are discussed after that.

Logistics Road Map The APICS Dictionary, 16th edition, defines logistics as follows: 1) In a supply chain management context, it is the subset of supply chain management that controls the forward and reverse movement, handling, and storage of goods between origin and distribution points. 2) In an industrial context, the art and science of obtaining, producing, and distributing material and product in the proper place and in proper quantities. Note that the SCOR model refers to “...obtaining, producing, and distributing material...” as sourcing, making, and delivering. At a basic level, logistics includes the various tasks required to get the right product to the right customers at the right time. More comprehensively, it also means getting the right quantity of product in the right condition to the right place at the right price. Logistics is part of supply chain management. As Douglas Long writes, “Supply chain management is logistics taken to a higher level of sophistication.” Where one ends and the other begins is subject to debate.

In Supply Chain Logistics Management, authors Bowersox, Closs, Cooper, and Bowersox include several functions that are treated in their own areas of this course, such as forecasting and inventory management. Whether these functions are or are not within the scope of logistics, all agree that inventory and forecasting must be considered when designing and managing an effective, efficient logistics system. Logistics has a slightly different definition in different regions of the world as well. For example, in Europe, logistics goes from raw materials to the final delivery to the customer, thus including manufacturing, while in the U.S., manufacturing is not usually under the purview of logistics. Exhibit 5-1 illustrates how the scope of logistics may or may not include various parts of the supply chain.

Exhibit 5-1: Logistics in the Supply Chain

Exhibit 5-2 provides an overview of what is typically included in logistics.

Exhibit 5-2: Functions of Logistics

Warehousing and transportation are essential functions of logistics that are inextricably linked. The type and number of warehouses have a large impact on transportation costs. Note that import/export, packaging, inventory management, and logistics information systems (including transportation and warehouse management systems) and their management are addressed elsewhere in these materials. Logistics enabling technologies are also addressed elsewhere; these include various methods of data exchange, application programming interfaces, bar codes, RFID, the Internet of Things (IoT), sensors, telematics, and other automatic identification and data capture (AIDC) technologies. AIDC and integrated logistics information

systems provide faster information visibility and increased transaction accuracy. Logistics technology enables automated tracking of the movement of goods across the supply chain, leaving employees to handle just the physical movement of goods. Logistics is the only function in the supply chain that is required to operate 24/7/365; there are no days off. That is why customers often take it for granted; they’ve come to expect that product delivery will be performed as promised. However, excellent customer service can be expensive and takes expertise, especially since logistics is now a globally integrated endeavor. For example, during the global pandemic of 2020, there was an initial slowdown of demand followed by a large spike in demand that resulted in large trade imbalances (more imports than exports in many countries), which in turn triggered a massive shortage of containers and a spike in container prices. According to the United Nations Conference on Trade and Development, by early 2021, due to this container shortage, freight rates from China to South America had increased by 443 percent while rates from China to North America increased by 63 percent. Importers on longer routes or routes with more stops were hardest hit. Supply chain partners must efficiently and effectively carry out logistical tasks to achieve competitive advantage. In a global market,

this may require mastery of languages, currencies, divergent regulations, and various business climates and customs.

Logistics Value Proposition The right configuration of transportation modes, warehouses, and other logistics assets and functions is needed to meet each customer’s expectations and requirements. How will you know when you’ve got the right balance? If you keep in mind that logistics must be managed as an integrated effort to achieve customer satisfaction at the lowest total cost, then it makes sense that cost minimization and service are the key elements in this value proposition. Service Logistics customer service implies that customer orders are complete, undamaged, delivered on time, and consistently correct over time. Any level of logistical service can be achieved if a company is willing and able to pay for it. Technology isn’t the limiting factor for logistics for most companies—it’s the economics. For instance, what does it cost to keep the service level high if a company keeps a fleet of trucks in a constant state of delivery readiness or it keeps dedicated inventory for a high-volume customer? How do you decide if it’s money well spent? The key is to determine how to outperform competitors in a cost-effective manner.

In most situations, the benefit-cost impact of a logistical failure is directly related to the importance of the service to the customer. When a logistical failure will have a significant impact on a customer’s business, error-free logistics service should receive higher priority. For instance, a missing part that causes a plant shutdown might justify flying the parts to the destination, while a late delivery that requires dipping into safety stock will be negligible. The customer that never has expensive delays and very few lost sales will have higher customer satisfaction and loyalty. Cost Minimization The second element of the value proposition, cost minimization, should be interpreted as the total cost of logistics. The APICS Dictionary, 16th edition, describes the total cost concept of logistics as the idea that all logistical decisions that provide equal service levels should favor the option that minimizes the total of all logistical costs and not be used on cost reductions in one area alone, such as lower transportation charges. For many decades, the accounting and financial departments in organizations sought the lowest possible cost for each individual logistical function, with little or no attention paid to integrated total

cost tradeoffs. Instead, today’s leading supply chain companies develop functional cost analyses and activity-based costing activities that measure the total cost of logistics. The goal now is for logistics to be cost-effective as determined by a benefit-cost analysis, taking into account how a logistical service failure would impact a customer’s business.

Logistics Trends Today the bulk of the logistics budget goes toward transportation costs. According to the 31st annual “State of Logistics Report” by the Council of Supply Chain Management Professionals, United States companies spent US$1.63 trillion performing logistical services in 2019, a 0.6 percent increase over the prior year. Of this amount, over US$680 billion was for motor carrier transportation and over US$378 billion was spent on all other forms of transport, which together constituted about 65 percent of total logistics costs. According to the “State of Logistics Report,” in 2019 Inventory storage costs rose by 6.6 percent over the prior year due to limited warehouse capacity. Costs for transportation modes were as follows (in billions): Truck: US$680.4 Rail: US$83.9

Parcel: US$114.4 Water: US$47.9 Air: US$75.2 Pipeline: US$57.4 U.S.-China trade tensions and the start of the global pandemic promoted a push toward making supply chains more resilient by increasing sourcing diversification and backup capacity. The report warned against going too far with a single-sourcing, Just-in-Time cost focus.

Logistics Objectives and Tactics At the highest level, logistics shares the objective of supply chain management: to meet customer requirements. Other objectives include Responding rapidly to changes in the market or customer orders Minimizing variances in logistics service Minimizing inventory to reduce costs Consolidating product movement by grouping shipments Maintaining high quality and engaging in continuous improvement Supporting the entire product life cycle, including reverse logistics. An effective logistics strategy depends upon the following tactics: Coordinating functions

Integrating the supply chain Substituting information for inventory Regulating supply chain partner numbers to ensure that each purchasing category has an optimum number of suppliers (not too many, not too few) Pooling risks We’ll analyze each of these tactics.

Coordinating Functions Logistics has interlocking, interdependent parts. Before the advent of modern logistics management, however, each area had its own separate management and pursued its own strategies and tactics. Rather, a cross-functional approach is needed in logistics, just as in supply chain management. Teams that cross functions are also very likely to cross company or national boundaries to accommodate international supply chains. Logistics has tradeoffs. An improvement in one area may very well have negative consequences in another unless decisions are coordinated. For example, locating warehouses in the countryside may save considerable money (Walmart does this), but it makes it harder to provide same-day delivery (which is why Amazon has warehouses in key urban areas). Different packaging will almost

certainly affect shipping and storage. The desired level of customer service still must be profitable. The overall goal of logistics management is more value in the supply network as measured by customer satisfaction, return to shareholders, etc. There is no point, for instance, in raising the cost of shipping—thus, the price to the customer—to deliver faster than the customer demands. Fast delivery, in other words, is not an end in itself, and the same is true of any aspect of logistics or supply chain management.

Integrating the Supply Chain Integrating the supply chain requires taking a series of steps when constructing the logistics network. In a dynamic system, the following steps may be taken out of order and retaken continuously. 1. Locate in the right countries. Map all countries in the forward and reverse supply chains. Analyze the forward and reverse chains to see if selecting different geographic locations could make the logistics function more efficient and effective. (Countries differ by infrastructure, labor, stability, regulations, and taxes.) 2. Develop an effective import-export strategy.

Determine the volume of freight and the number of SKUs (stock keeping units) to move. Decide where to place inventory for strategic advantage. This may involve deciding which borders to cross and which to avoid as well as determining where goods should be stored in relation to customers. (Some shipping companies now add a “war risk surcharge” if transport is near a nation with civil unrest or war.) Both geographic location and distance from the suppliers and/or customer can affect total costs and delivery lead times. 3. Select warehouse locations. Determine the optimal number of warehouses. Calculate the optimal distance from markets. Establish the most effective placement of warehouses globally. 4. Select transportation modes and carriers. Determine the mix of transportation modes that will most efficiently connect suppliers, producers, warehouses, distributors, and customers. Select specific carriers. 5. Select the right number of partners.

Select the optimum number of companies—freight forwarders, third- or fourth-party logistics providers—to manage forward and reverse logistics. In selecting logistics partners, consider their local market and regulatory knowledge. 6. Develop state-of-the-art information systems. Reduce inventory costs by more accurately and rapidly tracking demand information and the location of goods. Developing stateof-the-art information systems may be difficult in some regions. Such situations make defining the processes and information flows vital.

Information in Place of Inventory Physical inventory can be replaced by information in the following ways: Improve communications. Talk with suppliers regularly about plans and trends. Use continuous improvement tools. Collaborate with suppliers. Implement the right interfaces and develop the needed relationships to share data. Use Just-in-Time methods to coordinate deliveries from suppliers. Remove obsolete inventory. Track inventory precisely. Track the exact location of inventory using bar codes and/or RFID (radio frequency identification) with

GPS (Global Positioning System). Keep inventory in transit. Keeping inventory in transit can reduce inventory costs. One method of doing this is cross-docking. A payload area can be considered a mobile warehouse. Rolling inventory should be closely tracked by GPS to reduce risk of loss and facilitate rapid adjustments if a customer changes an order at the last minute. Use postponement centers. Avoid filling warehouses with the wrong mix of finished goods by setting up postponement centers to delay product assembly until an actual order has been received. Mix shipments to match customer needs. Match deliveries more precisely to customer needs by mixing different SKUs on the same pallet and by mixing pallets from different suppliers. Speed up customs. Reduce customs time by preclearing freight. Make more products or components on demand. In addition to make- or assemble-to-order manufacturing methods, another example is using a 3D printer to generate replacement parts on demand rather than stocking items with highly variable demand.

Regulating Number of Supply Chain Partners Having fewer logistics partners generally increases efficiency but could create tradeoffs in other logistics objectives, so it is best to have just the right number of partners. One way to optimize for efficiency and customer service is to look for an entire echelon (tier)

you can do without—such as all the wholesale warehouses or factory warehouses. See Exhibit 5-3.

Exhibit 5-3: Costs of Multiple Echelons

Having too many partners is more often the problem than having too few. The more partners there are in the supply chain, the more difficult and expensive the supply chain is to manage. Handoffs among partners cost money and time. Having many partners means carrying more inventory. Reducing the number of partners can reduce operating costs, cycle time, and inventory holding costs. There is, however, a lower limit below which you create more risks and problems than you solve, which is why this is an optimization process rather than a minimization process.

Pooling Risks The APICS Dictionary, 16th edition, defines risk pooling as

a method often associated with the management of inventory risk. Manufacturers and retailers that experience high variability in demand for their products can pool together common inventory components associated with a broad family of products to buffer the overall burden of having to deploy inventory for each discrete product. In regard to inventory management, pooling risks is a method of reducing stockouts by consolidating stock in centralized warehouses. The risk of stockouts increases as supply chains reduce the safety stock or component parts inventories held at each node and move toward Just-in-Time ordering procedures. With every entity attempting to keep inventory costs down in this manner, the risk of stockouts rises. Statistically speaking, when inventory is placed in a central warehouse instead of in several smaller warehouses, the total inventory necessary to maintain a level of service drops without increasing the risk of stockouts. This is because aggregating customer requirements reduces variation in demand. An unexpectedly large order from any one customer will still be small in relation to the total supply. There are tradeoffs to consider. Because the central warehouse may be further away from some production facilities than the smaller warehouses would be, lead times and transportation costs are likely

to go up. Again, logistics has to be managed from the point of view of improving the value of the overall system, not just one part of it.

Logistics Service Providers Since the 1980s, there has been a trend toward using outside companies to handle warehousing, shipping, and other logistics responsibilities. This outsourcing of some or all logistics operations is especially common among larger companies, such as 3M. The most compelling reason to let another party take over logistics functions is the decision to focus on core competencies. There are many logistics ownership models. In a 1PL, the organization is not outsourcing logistics; the organization owns and operates its own fleets. In a 2PL, the organization does all of the route planning itself but outsources vehicle ownership, operation, and maintenance to a third party. The two types of outside logistics companies we’ll look at here in more detail are third-party logistics providers (3PLs) and fourth-party logistics providers (4PLs). According to the APICS Dictionary, 16th edition, in a third-party logistics arrangement a buyer and supplier team with a third party that provides product delivery services. This third party may provide

added supply chain expertise. Fourth-party logistics is described in the Dictionary as follows: Fourth-party logistics differs from third-party logistics in the following ways: (1) the 4PL organization is often a separate entity formed by a joint venture or other long-term contract between a client and one or more partners; (2) the 4PL organization is an interface between the client and multiple logistics services providers; (3) ideally, all aspects of the client’s supply chain are managed by the 4PL organization; and, (4) it is possible for a major 3PL organization to form a 4PL organization within its existing structure. Early versions of logistics outsourcing involved transactional relationships with third parties offering single services—trucking from Ryder, shipping from the United States Post Office (USPS) or UPS, overnight air from FedEx. (One traditional type of outsourcing has been the use of the government postal services to deliver business mail and small parcels.) The recent trend in 3PL arrangements, however, is toward long-term contractual relationships with providers of integrated services, such as transportation plus storage. The 4PL setup extends that trend by removing all logistics functions from the client company and putting them under integrated management by a general contractor.

How 3PLs and 4PLs Are Related References to logistics outsourcing commonly use the term “3PL” to cover all types. Technically, there is a distinction: In a 3PL arrangement, the third party takes over some or all logistics functions and performs them itself. A 3PL may be a specialized provider that focuses, for instance, on air or over-theroad transport or warehousing. It may also be a multipurpose logistics provider capable of taking over the entire logistics function. In a 4PL arrangement, a logistics specialist takes over the entire logistics operation and subcontracts some or all specific functions. In the role of general contractor, the fourth-party provider hires out the various logistics services and coordinates the efforts of the subcontractors on the client’s behalf. Sometimes this is still called third-party logistics, but the presence of subcontractors makes this in reality a fourth-party setup. Typically, the 4PL charges a fee for its service, not a markup.

Advantages/Disadvantages of 3PLs and 4PLs Using third-party contractors to carry out some or all logistics functions can provide the following benefits:

Improved business focus. Outsourcing logistics functions allows both the company and its contractor to focus on what they do best. More current logistics technology. Contract logistics providers are generally able to stay current with technology. Contractors may be quicker to incorporate new software and better able to upgrade to the hardware necessary to run it well. The client company, on the other hand, may have to spread its software and hardware budgets over several functional units in addition to logistics. Greater technological flexibility. The third-party logistics provider is better positioned to adapt to different technologies used by the company’s clients. This potentially expands the company’s customer base at a reduced cost. More efficient warehousing for rapid replenishment. Rapid replenishment may require more warehouses in regions that are closer to clients. Using the 3PL’s warehouses is cheaper than building or acquiring the company’s own, specifically because in a 3PL warehouse, there is only a cost for the space occupied by your product. The 3PL, if it uses warehouses for multiple clients, can generate economies of scale.

Improved service to customers. Third-party providers may be better able to offer a variety of services to the company’s customers. More workforce and resource flexibility. It’s quicker and simpler to hire a contract specialist for a new function—or to drop a contractor when business shifts to a new market—than to hire and lay off internal workers. Benefits of the 4PL arrangement include the following: Improved business focus. Contracting out the entire logistics function frees up the company to focus on its core business. Higher-quality logistics operations (or reduced costs, or both). The 4PL’s special competence in managing logistics should result in lower-cost, higher-quality service with less damage and fewer delays. As a logistics specialist, the 4PL can find the best subcontractors for each function and can design an efficient overall process. Greater business flexibility. Having a highly competent provider in charge of logistics gives a company the ability to adapt its warehousing, transportation, and packaging needs more rapidly to new market strategies or new products. The provider can renegotiate with current subcontractors or replace them with

providers that have the capacities, skills, locations, or other features appropriate for the new venture. Realizing the benefits of third-party logistics may create some risks: Loss of control. It may be more difficult to develop a comprehensive logistics strategy when the company has given control of some aspect of the system to a contractor. Potential for inefficiency. A 3PL that takes over logistics functions for which the company was doing a good job may actually perform worse in that area. Turning over logistics to a 4PL involves the following risks: Loss of direct control over the logistics process and all specific functions Potential for less effective or more costly operations if the 4PL writes biased contracts rather than seeking out the most efficient suppliers Logistics outsourcing may put the contractor into direct communication with the company’s customers, and this entails risks. The 3PL employee (or 4PL subcontractor) becomes a representative of the client company, which may be judged by the contractor’s behavior. A 3PL may contract with a client’s competitors, raising the

risk that confidential information may pass through the contractor to the competitor.

Outsourcing Considerations Before outsourcing logistics to a third- or fourth-party provider, a company should ask itself the following questions: What are our current costs? When evaluating bids from potential third- or fourth-party logistics providers, a company needs to know what the functions in question currently cost. It also needs to take into account potential savings in time plus improved quality of service to customers. There’s no point in paying more than current costs unless the arrangement will provide other benefits. And there’s no point in saving money on logistics if the contractor increases delivery errors or otherwise alienates your customers. What customer skills does the contractor possess? Has the bidder researched your needs and company culture? If not, how likely is it to do the background work necessary to provide highquality service to you and to your customers? Is the company reliable? What do its other customers have to say about it? (Be sure to use credible references.) What are the contractor’s special strengths? Many contractors began as providers in one area, such as trucking, mail delivery, or

warehousing, and added other logistics competencies as they grew. UPS, for instance, is now a fully integrated transportation company and a logistics consultant, but in the beginning it was a single-purpose company. The shipper needs to evaluate the match between its needs and the contractor’s competencies. Will the contractor hire the most-qualified partners (if necessary)? Especially when considering a 4PL, a company should evaluate the contractor’s ability to subcontract effectively. Some contractors are biased toward their own divisions (or favored subcontractors), even if those aren’t the best-qualified options.

Contract Considerations Once a 3PL or 4PL has been selected, it is important to develop a mutually beneficial contract to ensure that the relationship can be successful. Achieving long-term benefits for both parties requires both parties to identify what the end result will look like as well as how the parties will get there. Many 3PL or 4PL relationships have poor initial start-up periods that can cause the relationship to fail or falter and thus harm the long-term relationship, so an important contract consideration is to specify what each party will do to ensure that the first six to 12 months of the relationship go smoothly. This

difficult period will require commitments of time and energy from both parties as well as formal specification of shared risks and rewards. On the communications front, contracts can promote regular communications in both directions, for example, forwarding customer feedback to the 3PL. From a monitoring and controlling standpoint, it is important to carefully select the performance metrics to be used to assess the success of the relationship. These metrics need to address strategic priorities such as level of customer service. Specific rules that should be included in contracts include confidentiality clauses, subcontractor clauses, clauses for remedies, and escape clauses. Since 3PLs or 4PLs are working so closely with your suppliers and customers and likely have direct access to organizational data, confidentiality clauses need to be robust. Subcontractor clauses help set subcontractor quality and other selection criteria, which is especially important when working with 4PLs since you are ceding control. From a remedy standpoint, a specific process for correcting variances from performance targets needs to be laid out in advance and agreed to by both parties. These clauses need to specify the use of arbitration to avoid costly court settlements. Escape clauses provide both parties with the specific allowed reasons for and methods of ending the relationship.

Topic 2: Warehousing and MaterialsHandling Strategy Warehousing is a key logistics activity that helps ensure that products are close enough to their demand locations to enable their distribution within the needed lead time. Materials handling encompasses activities that take place within a warehouse or on its grounds. Proper design of warehouses and the selection of mechanized and/or automated materials-handling equipment can keep warehousing costs acceptable while providing the needed level of customer service.

Warehousing Strategy Warehousing involves “the activities related to receiving, storing, and shipping materials to and from production or distribution locations” (APICS Dictionary, 16th edition). Warehousing can contribute to logistical goals in a number of ways: Respond rapidly to changes in the market or customer orders. To enable rapid responses, organizations use demand planning data such as forecasts and market analysis to anticipate changes in the market or customer needs. Changes may include the number and placement of warehouses relative to markets,

management of inventory levels, efficient product movement through the facility, and technology to track products. The transportation and warehousing interface is critical. Minimize variances in logistics service. In today’s times of rapid change, efficient tracking and handling of inventory in the warehouse is critical to achieving predictable service. Loading, unloading, packaging, and order picking each have a role in minimizing variability in service. Minimize inventory to reduce costs. The more efficiently warehouses are managed and the more strategically they are placed in relationship to markets and transportation, the less inventory will build up in the system. Consolidate product movement by grouping shipments. The tactic of aggregating smaller shipments into larger ones for more cost-effective transportation depends upon the efficient placement and management of warehouses. Expeditious unloading, tracking, repackaging, and reloading are all crucial to effective consolidation of movement. Maintain high quality and engage in continuous improvement. Every aspect of warehouse operations should be subject to continuous improvement, with the goal of eliminating errors.

Support the entire product life cycle and reverse logistics. The number, placement, and efficiency of warehouses must take into account the early life cycle phases and the end of the product life cycle—returns (repair, replace, or recycle). Based on these goals, the following considerations must be taken into account regarding warehouses: Determining mix of private, public, or contract warehouses Determining the optimum number of facilities necessary to aid in reduction of inventory while reducing stockouts Selecting the right location for each warehouse to ensure costefficient access to supply, markets, and transportation Designing each facility to be the right size and configuration for its products and processes Developing management systems that employ space, labor, equipment, and information technology to minimize delays, product damage, and product loss Together, these factors can increase the overall value of the supply chain and improve its competitiveness. The first three of these considerations are addressed next.

Owned Versus Leased Warehouses

Warehouse ownership takes three forms: private, public, and contract. Private Warehouses Private warehouses are owned by the company. The benefits of ownership are straightforward. Control. Private warehouses can be built or, to a lesser extent, remodeled to suit the company’s type and size of inventory, its staff, its operations, and its location preferences. Deciding whether to build or remodel can involve some serious calculation and guesswork. Building provides the greatest flexibility to suit the current product mix and operations. Before deciding to build, the company may want to forecast and decide how long the current size and configuration will work before the facility needs renovation. Remodeling may or may not be less expensive than building. No markup. A company can avoid paying a markup by owning its own warehouse. Market presence. A company may be able to reinforce its presence in a local market by placing a warehouse near its customers. Proximity can facilitate faster and more personal service.

The downside of private ownership is a loss of budgetary flexibility. A warehouse is a depreciating asset. The fixed costs of ownership also persist even if business turns down and the warehouse capacity isn’t used. Selling a specialized facility—especially in the midst of a general downturn in business—can be time-consuming and hard on the bottom line. Companies have been known to walk away from useless real estate. Public Warehouses Public warehouses are independent businesses offering various services for a fee. Independently owned warehouses are available in a variety of configurations—refrigerated, bonded, general merchandise, household goods, other specialties, for example. And they may offer benefits that more than compensate for the loss of control and market presence provided by ownership. Flexibility. By hiring warehouse services, a company gains the flexibility to increase or decrease its warehousing costs to match market fluctuations. Potential cost reduction. Despite the markup charged by the owner, a public facility may offer lower overall costs than a private facility by providing economies of scale and lower labor costs. The public warehouse may serve more than one client, thereby making

more efficient use of its capacity than is possible in a privately owned, single-use facility. Contract Warehousing Contract warehousing has evolved from public warehousing, and it offers a combination of the benefits of public and private facilities. It involves contracting for the service over fixed period of time, but the contract can provide a guaranteed amount of space and include service level agreements for value-added services that are normally not available in public warehouses. Potential cost reductions. Compared to private warehousing, a contract warehouse may be able to provide equal or better service and do so cost-effectively. When comparing costs, the logistics manager can measure the relative merits of each on performance indicators such as fill rates, units shipped per hour, and rate of ontime deliveries. The contract warehouse may gain a pricing edge on the private warehouse in several ways. First, because the contractor is a specialist, its warehouses may be run more efficiently than warehouses owned and managed by the manufacturer. This may result from the contractor’s ability to hold down wages and benefits and to provide economies of scale in transportation. The profit motive prompts a contractor to keep operating costs down to win business.

Tailored services. In return for the stability of a longer-term relationship, the contract warehouse can tailor its services to the needs of a particular client more than a public facility can afford to do. Flexibility. While a contract locks in the company for a longer time period than a hiring arrangement, it provides more flexibility than private warehousing can offer. Using a short-term contract arrangement, a company can also gain the flexibility of testing new markets without investing capital in new facilities. Expanded geographic market. A third-party provider may own and operate a widely dispersed network of warehouses that can expand a client company’s access to new geographic markets. Mixing Ownership Types Mixing and matching the three ownership types works well for many companies. For instance, a company may use private facilities to handle its year-round business and hire or contract for extra warehouse space during seasonal peaks.

Determining Right Number of Warehouses Once, it was easy to decide the number of warehouses: one per market. This was often due to an organization’s marketing strategy rather than logistics decisions. Management was mainly concerned

with locating distribution centers within easy reach of each market and with storing plenty of inventory in each one to avoid shortages. As logistics matured, however, warehousing became much more strategic. Now deciding on the number of warehouses requires systems thinking. Every decision about the structure of a system requires a series of follow-up decisions to deal with the impact of the first one. Decisions about warehousing, for instance, may affect transportation, lead times coming into and going out of the warehouse, available labor, packaging, locations, taxes, tariffs (in global supply chains), etc. Selecting an appropriate number of warehouses for the logistics system is all about tradeoffs. As you add warehouses to the system, some costs will tend to increase and some will decrease. An increased number of warehouses in a system can affect the following: Customer service. The main reason to increase the number of warehouses is to place goods closer to more customers, thereby improving customer service. Today, however, the general trend is to optimize the number of warehouses and to optimize logistics

operations so that high customer service levels are maintained and total costs are minimized. Transportation costs. Adding warehouses can be an effective way to reduce transportation costs by shortening the distances between the warehouses and the points of origin and delivery. There are other considerations, however. A centralized system of warehouses will likely facilitate more rapid inventory turnover. It will also benefit from economies of scale, realized by consolidating outbound shipments into full loads that qualify for lower rates. Transportation costs also reflect the efficiency of service, which may decline with the addition of warehouses. On the other hand, with additional warehouses, inbound transportation costs could increase if there are deliveries by partly full payloads. Inventory. As you add warehouses, you tend to increase the amount of total floor space in relation to the space available for storage, due to redundancies. While more facilities mean less safety stock per site because of shorter lead times, aggregate safety stocks go up. Setup and overhead costs. More warehouses require more expenditures on construction or renovation, setup, and maintenance. Overhead increases include duplication of equipment (one for each place) and labor. As you increase the

total number of warehouses, you also increase the probability of adding relatively inefficient facilities to the system. To reduce the number of warehouses, one can start by eliminating the inefficient locations. Exhibit 5-4 provides a rough picture of the tradeoffs in costs that occur with the increase in the number of warehouses in a logistics chain. Note that in this example, two main components of inventory carrying cost are shown separately: the cost of the inventory itself and warehousing overhead costs.

Exhibit 5-4: Cost Effects of Increasing Number of Warehouses

As the exhibit shows, the overall costs in the system tend to decline as the number of warehouses increases, but only up to a point. After that point, the total cost of warehousing rises per warehouse added. That happens because increasing costs in many areas eventually overwhelm savings in other areas. The relative rates of the increases

and declines will differ by logistics system; these are general observations. Despite the potential savings resulting from a strategic consolidation of warehousing to serve the same customer base, a logistics chain may benefit from adding warehouses in the following instances: Local customers want rapid delivery, and it is an order qualifier because competitors offer it. Transportation can’t provide the required service without adding warehouses. Small-scale customers require fast, frequent shipments that are better accommodated by a decentralized system of warehouses.

Determining Right Locations for Warehouses Deciding upon the location of warehouses is closely linked with decisions about the number of warehouses. Logically, the decision about numbers comes first, because it depends upon the size of the customer base, the volume and timing of demand, and customer service targets. After deciding how much storage space is required for meeting these targets, the location decision comes next. However, some location decisions will be made independently of these warehouse number estimates. If, for example, a supply chain serves markets in several nations, it may be necessary to locate distribution centers in each country, regardless of market size, due to

economic considerations and product differences. Availability of transportation also influences choice of location. Below are the significant factors to be considered when locating warehouses: Available services. The most important feature of a potential warehouse location is the availability of required services. These may include rail lines or access for trucks, electricity, water, and other municipal services, including adequate police services. Absence of a required service can be a deal breaker. Neighborhood. Warehouses can be located anywhere zoning allows them. Warehouses may also be located in central shopping areas, such as downtowns; in any commercial zone; or in sparsely settled areas. If the warehouse will be new construction, the area has to meet certain requirements such as available space. Costs. The costs of procuring and setting up a warehouse are related to available services and to location. Such costs can vary significantly. Insurance costs exist within a wide range depending upon local social and environmental conditions. Cost of land varies with location; in general, the closer to urban centers, the more the land costs. Warehouse design should take into account the efficient use of space, especially on expensive property. There

may be a tradeoff in cost of transportation and cost of land, since cheaper land may be more distant from the market to be served. Community inducements. An area eager to attract business may offer tax incentives that impact the location decision. An available, appropriate workforce is also a requirement, though workers are mobile enough to influence only the general area, not the neighborhood in which the warehouse locates. Regulatory concerns. Environmental impact statements can slow down construction and run up costs. The factors influencing warehouse locations are interdependent and impact the rest of the system. Consequently, they require careful analysis. Many of the decisions discussed so far are intensified in a global supply chain, especially decisions related to available services, insurance costs, and the workforce. For example, Toyota decided to locate a plant in Canada rather than in a previously favored region of the southern United States. They based that decision on an assessment of the relative quality of the workforce in each region and the difference in health insurance costs, which are paid for by the employer in the United States and by the government in Canada. Such factors are also of concern in locating storage facilities.

Internal Warehouse Design and Capacity Forecasting Internal warehouse design starts with the end in mind by determining requirements related to warehouse activities and desired inventory flows. Advances in information technology and warehouse equipment have made intelligent, efficient storage and retrieval much easier, and warehouse designs also take the desired level of investment in such capabilities into account. A requirement might be for the fastest-moving products or parts to be the most easily accessible, while the slow movers can be parked out of the way. In terms of inventory flows, some organizations will want to store different goods for different periods of time while others want to keep inventory in motion such as by using cross-docking. Storage locations themselves are designed to maximize efficiency and the effective use of space. Warehouse space involves a large capital investment for an organization, so it must be arranged to maximize the amount of storage while leaving sufficient space for equipment movement and other warehouse activities such as receiving, cross-docking, order picking, assembly, packaging, and staging.

Warehouse Layout

Exhibit 5-5 shows the basic layout of a warehouse.

Exhibit 5-5: Basic Warehouse Layout

Warehouses are generally designed as one-floor systems. Rack storage maximizes the cubic space of the warehouse—called cube utilization—by storing items on vertical racks. The maximum height is determined by the equipment used to place and pick pallets or other inventory or by existing warehouse height limitations. Filling an entire warehouse with single selective racks (multi-story racks that are one pallet-width deep on each side of an aisle) might maximize the amount of this type of inventory that can be stored, but the workflow areas will be congested and overall throughput could be abysmal. A velocity analysis can be performed to optimize warehouse flow. The ideal system has 100 percent accessibility,

meaning that all inventory can be accessed without having to first move some other inventory. Note how cross-docking involves moving freight directly from receiving to outgoing shipping in the graphic. Deliveries often need to be reconfigured in the staging area to new assortments, such as each retail store being sent a variety of goods from various manufacturers. Also, while cross-docking could be one service a warehouse offers, other facilities do cross-docking exclusively. The design maximizes dock space and minimizes internal material movement distances. Once a layout that optimizes velocity and cube utilization is determined, the next concern is to organize stock locations.

Stock Location To perform the inbound receiving process, warehouse personnel need to know what the inventory is and where best to take it (rack storage, bulk storage, outgoing dock, break-bulk, sorting, packaging, and so forth), even if the organization has millions of SKUs (stock keeping units), as is the case for many large businesses. For the order picking and filling process, warehouse personnel need to know exactly where the required items are stored, in which order to pick the items, and the route to take.

Stock location involves deciding where to store specific inventory in a warehouse. The idea is to optimize storage based on the organization’s prioritization of speed of access or cube utilization. Here are some stock location methods: Using random-location storage . As defined in the APICS Dictionary, 16th edition, random-location storage is a storage technique in which parts are placed in any space that is empty when they arrive at the storeroom. Although this random method requires the use of a locator file to identify part locations, it often requires less storage space than a fixed-location storage method. Random-location storage is also called floating inventory location. This method maximizes cube utilization and can be rapid if the organization uses warehouse automation systems such as directed pick and put-away. Using fixed-location storage . Fixed-location storage is defined in the Dictionary as a method of storage in which a relatively permanent location is assigned for the storage of each item in a storeroom or warehouse. Although more space is needed to store parts than in a random-location storage

system, fixed locations become familiar, and therefore a locator file may not be needed. This method may be acceptable for warehouses that do not need dense cube utilization because space is not at a premium, throughput is low, or there are not many SKUs. It is also often used for relatively slow-moving items like spare parts or for situations where order pickers do not get a picking list (e.g., there are relatively few items in inventory). Using ABC classification. Inventory can be grouped by its ABC classification and could use secure or fast-moving storage areas. Grouping functionally related items together. Items can be grouped by their use, for example, all modular components for the same product family, all kitchen appliances, or all hardware. A related storage type is called point-of-use storage, which has special assembly staging areas and nearby inventory storage. Grouping high-velocity items together. Items that arrive and leave quickly, but not quickly enough for cross-docking, can be placed in locations near the outbound staging area. Grouping items by similar physical characteristics. Hazardous materials need to be stored in an area with strict security measures. Frozen or refrigerated items are stored together. Bulky

or odd-shaped items, such as couches, can also be stored together. Grouping reserve stock separately. Reserve stock can include bulk storage of items when working stock is considered a partial pallet for picking, or it can refer to defective or obsolete items and returns. Reserve stock can be stored out of the way. The working stock can be replenished from the reserve stock.

Warehouse Capacity Forecasting and Planning Warehouse capacity forecasting and planning is a must before building or leasing warehouse space, because the warehouse will need sufficient capacity for the next three to five years. Changes to warehouse capacity in a shorter time frame tend not to be costeffective due to building and/or setup expenses, lease negotiations, and so on. Capacity forecasting is a function of inventory levels in the aggregate. Individual inventories will vary between a minimum (equal to safety stock) and maximum level. We are looking for the most common inventory level—an average, called the mode. The mode (most common level) will be approximately halfway between the safety stock level and the maximum level. For the rest of the discussion in this area, interpret “average” as meaning the mode.

While calculating warehouse size using forecasted average inventory may not seem to leave enough room for maximum inventory, when random-location assignment is used, the inventory that is currently at a maximum level will balance inventory that is currently at a minimum level. If, instead, fixed warehouse locations are assigned to specific items, the size of the warehouse would need to be the sum of all maximum space per item. The warehouse will frequently have a large amount of unused space. Warehouse capacity is therefore typically forecasted as this average inventory level. A few items need to be considered before calculating the forecasted average inventory level: Averages must first be calculated for each type of unit. Various units can be aggregated based on their storage requirements; items of like size can be aggregated because it is the total cubic meters or feet used that needs to be calculated. Some average warehouse space requirements may need to be calculated. Often, the number of items that fit on a pallet within a storage bay (including a calculation of how high the pallet can be stacked) could be estimated; the pallet size could be used for its cubic volume requirement. In practice, this analysis is often simplified from cubic meter/feet requirements to the number of

pallet storage bays needed to house the forecasted average aggregate inventory. Many organizations and industries standardize their pallet size to allow all pallets to fit in any storage bay. For our calculations, each pallet would then be one unit. Some compensation is often added for pallets that are used for individual items rather than shipped as whole pallets. A pallet that can store 18 boxes but holds only one box at present still takes up an entire storage bay. Any bulk storage capacity requirements would be calculated separately. For each year of the three- to five-year warehouse space requirements, a forecast must be calculated. The year with the highest capacity requirement will indicate the overall warehouse capacity requirement—expressed in cubic meters or feet or in storage bays. As an example, let’s say that the sum of all forecasted average inventories for an organization takes up 18,000 cubic meters (m3) in the highest forecasted year of a five-year plan. All inventory fits on a standard-size pallet that, when full, is 1.2 meters deep × 1.0 meters wide × 1.5 meters tall = 1.8 m3. Calculating the need for storage bays divides the space requirement by the standard pallet cubic

space: 18,000 m3/1.8 m3 = 10,000 storage bays. The organization multiplies this by a factor of 1.1 to account for partially filled pallets. This factor is based on historical analysis of existing warehouse usage. Then 10,000 × 1.1 = 11,000 storage bays needed. After determining the requirements for the inventory, the calculation is adjusted to account for other space requirements. When storage bays are used, the process might work as follows: Determine the raw space footprint. Multiply the number of needed bays by the square meters used per pallet. (Vertical storage and thus cubic space utilization is accounted for in a later step.) This results in a square meter (m2) space requirement for just the inventory. Finding the square meters or feet requirement is useful because real estate is sold or leased using this unit of measure. To continue the prior example, 11,000 storage bays × 1.2 m2 of floor space (1.2 meters deep × 1.0 meters wide) = 13,200 m2 of floor space needed just for inventory. Factor in space for all inventory movements. Multiply this result by a factor that is greater than one to account for space around inventory in each storage bay, aisle space, handling equipment space, and space for picking, sorting, consolidating, and so on. This is typically at least a multiplier of three. Organizations can analyze existing warehouses that use the same types of

warehouse equipment to determine the right factor to use. In this example, the factor is 3, so the calculation is 13,200 m2 × 3 = 39,600 m2. Account for vertical space utilization. Determine how many levels of vertical storage will exist for pallet storage bays. For example, if there will be four levels of vertical storage for all bays, then the raw space footprint could be divided by four (e.g., ground storage plus pallet racks that are three levels high). In this example, there are four levels, so the calculation is 39,600 m2/4 = 9,900 m2. Add space for expansion or excess capacity. Divide by a factor for the target utilization of the warehouse. This is a way of building in excess capacity. For example, if the target utilization rate is 80 percent, then the warehouse floor space would be divided by this percentage to find the total necessary space. In essence, this warehouse would be only 80 percent full under the current forecasts. This utilization rate would be set by organizational policy based on strategic and risk analyses. Since the rate here is 80 percent, the calculation is 9,900 m2/0.8 = 12,375 m2. This much land could be leased or purchased to build a new warehouse, or an existing warehouse of this size (and sufficient vertical height for the racks) could be leased or purchased.

Note that there are many ways of determining warehouse space capacity requirements. Organizations that use fixed-location storage, for example, may use maximum inventory requirements rather than average inventory requirements so as not to run out of space when orders arrive. Additionally, the space requirement could be divided among several distribution centers. If this is the case, the volume of goods to be stored in each warehouse would be divided first, and then the remaining adjustments would proceed separately. This would result in a larger total space requirement, because each warehouse would need its own functional areas for goods handling.

Materials-Handling Strategy The APICS Dictionary, 16th edition, defines materials handling as follows: Movement and storage of goods inside the distribution center. This represents a capital cost and is balanced against the operating costs of the facility. The goal of materials handling is to contribute value to the supply chain by making effective and efficient use of warehouse space, human labor, materials-handling equipment/automation, and related information technology. When all of these considerations are combined effectively, materials handling and distances traveled are

minimized, time spent in stock locations is minimized, space utilization is optimized, and order put-away or picking is logical and efficient. While all warehouse tasks used to be accomplished by manual labor, mechanical or automated assistance can make most tasks easier, faster, safer, and more efficient. When selecting the best combination of equipment and human labor for the products, space, and type of operations, the supply chain manager will most likely need the assistance of warehouse equipment experts who have access to optimization software. Note that poor selection of equipment or automation may add to expense without increasing value if it can’t be used effectively in the available space. A wise selection will be justified by future cost savings. Therefore, it is important to determine an overall strategy for the mechanized and automated materials-handling options the warehouse will use. This strategy needs to be consistent with the skill levels of the workforce. Training or talent acquisition may be needed. Exhibit 5-6 provides an overview of the various materialshandling options an organization might consider. It is divided into mechanized systems and automated systems. Exhibit 5-6: Materials-Handling Options Type

Features and Uses

Benefits

Limitations

Type

Features and Uses

Benefits

Limitations

Mechanized Systems Forklift trucks

Load and unload vehicles

Flexible uses

Expense to buy,

Lift pallets or slipsheets

Can lift and retrieve in

train, and

Available in numerous

high shelf areas

maintain

configurations

Automation available

Inventory damage Safety requirements

Conveyors

Store and retrieve goods

Inexpensive operation

May block access

Load, unload some types

Reduced labor costs

to aisles and/or

of vehicles

Efficient use of space

shelves

Four-wheeled container

Efficient use of space

Expensive to

towed by dragline (floor or

Can improve inventory

automate, use in

overhead mount)

identification and

complex systems

Used in order selection

accuracy

Rapid

Motorized/nonmotorized Scanners for fast, accurate information Towlines

obsolescence

Automated models can switch lines Scanners available Tow tractors with trailers

Like towlines, used mainly

More flexible than

More expensive

for order selection

towlines

than towlines (driver)

Can tow multiple trailers Driver required Bridge and wagon cranes

For heavy lifting

Can lift heavier objects

Very expensive

Bridge cranes: overhead

than forklift or conveyor

Single bay linear

on movable girder

Efficient use of space

travel only

Wagon cranes: on floor

Automation, remote

(like forklifts)

operation available (bridge)

Type Carousels

Features and Uses

Benefits

Limitations

Series of multilevel bins

Reduces order selection

Item size

on oval track

labor

Item weight

Rotates

Reduces storage

Moves inventory to a

requirements

stationary order selector

Eliminates paperwork given computergenerated pick lists and rotation

Type

Features and Uses

Benefits

Limitations

Automated Systems Automated guided vehicle systems

Move on floor on tape or

Programmable for

High acquisition

wire

flexibility without need for

cost

Similar in use to forklift

operator

and tow tractors

Maximum use of space;

Riderless with

fit in narrow aisles, reach

programmed stops

high shelves

Can have tines or platforms Automated sorting systems

Usually used with

Reduced human time

High acquisition

conveyors

and labor for retrieval

cost

Automate direction of

and storage

items into shipments

Speeds of up to one

Most devices

package per second

programmable for different speeds to fit shipment specifications

Type Robotics

Features and Uses

Benefits

Used to build and break

Used in difficult or

down unit loads

dangerous environments

Programmed to

Can integrate program

recognize product

logic

stacking patterns and

Increases speed,

place products in a

dependability, and

predetermined position

accuracy

Limitations High cost

on conveyor belt Live racks

Contains roller

Reduces need for lift

Little access to

conveyors

trucks to transfer unit

stock in middle

Designed to be loaded

loads

from the rear, where it is

Offers potential for

elevated, using gravity to

automatic rotation of

move product to front of

product

rack Automated storage and retrieval systems

Automate storage and

Maximum storage

retrieval

allowed per square foot

Use very high storage

of floor space

racks

High storage and

Machine moves both

retrieval speed with few

horizontally and vertically

errors

Programmed at end-of-

Reduced labor cost and

aisle station

human errors

High cost

Mechanized Systems Mechanized systems include a wide range of types of materialshandling equipment, including forklift trucks, conveyors, towlines, tow tractors with trailers, bridge and wagon cranes, and carousels.

Forklift Trucks

Type of fuel/battery, amount of lifting power, size and shape (some models are adapted especially to narrow aisles), and other features can be mixed and matched. Forklifts can drive directly into semi trailers or in other vehicle payload areas. Forklifts allow pallets to be raised up or down from the tops of high stacks, and some can also reach both high and deep. Some models are adapted to lifting slipsheets instead of pallets. (A slipsheet is a thin, pallet-sized sheet of plastic, laminated paperboard, or corrugated fiberboard that slides underneath a load.) Automation is available in a computer-controlled, driverless model.

Conveyors Conveyors, as seen in Exhibit 5-7, move goods into or out of some types of vehicles and storage spaces. The basic decision when selecting a conveyor is whether or not to have a motor. The roller conveyor relies on gravity to move goods slowly down the line; the belt conveyor (or conveyor belt) is motorized to provide more speed or move goods uphill. Conveyors can be equipped with scanners to read bar codes on items traveling along them, thus speeding up inventory and reducing error rates.

Exhibit 5-7: Conveyor

Source: Photograph used with permission from Metzgar Conveyors, © 2011.

Conveyors offer several advantages: Inexpensive operating costs (especially with the roller type) Reduced labor costs (including costs for injuries and accidents) Efficient use of space (They fit into narrow aisles.) Ability of scanners to read bar codes or RFID Movement of far more inventory than trucks could move at far less cost (for example, moving coal from a mining area to a storage area) The tradeoff is that using conveyors can potentially block access to the area where loading takes place.

Towlines The towline, shown in Exhibit 5-8 and also called a towline conveyor, uses a four-wheeled container that is towed by a dragline, which can be mounted overhead or in the floor. Overhead lines are easier to install and move than in-floor lines. Some automated models can be uncoupled from one line and attached to another, giving them access to more than one dock. Overhead lines with automated decoupling provide more flexibility than standard belt or roller conveyors, but, on the whole, they are much less flexible than forklifts.

Exhibit 5-8: Towlines

Source: Photograph used with permission from Rhodes Systems International, Inc., © 2011.

Towlines may also be equipped with scanners to identify the goods being conveyed. Automated systems can be complex and very expensive. Towlines provide several advantages: Efficient use of space (They fit into narrow aisles.) Potential to improve inventory identification and accuracy Tradeoffs include the following: Requirement of heavy capital investment when automated Need to invest significant time and money to design complex systems Relatively rapid obsolescence, especially in elaborate systems

Tow Tractors with Trailers Tow tractors can pull several trailers conveying pallets. They are generally used, like towline conveyors, in order selection. Tow tractors are not automated, and, because they require a driver, they are more expensive to operate than towlines. However, they are also more flexible.

Bridge and Wagon Cranes For heavy lifting, warehouse managers may turn to cranes. The two basic types are bridge cranes (also called overhead cranes) and wagon cranes.

The “bridge” part of a bridge crane, shown in Exhibit 5-9, is a horizontal girder, or pair of girders, that rests at each end on a truck.

Exhibit 5-9: Bridge Crane

The trucks run along tracks, giving the crane the ability to move objects horizontally in the direction of the runway. They can also move objects perpendicular to the track, along the direction of the girder that runs between the tracks. Because they are suspended, bridge cranes leave the floor space below them free for other activities. Bridge cranes are best used in low- to medium-volume activities that require moving items that are large, heavy, or awkward to maneuver.

Wagon cranes, also called crane trucks or stacker cranes, offer the mobility that is provided by forklifts and is absent from conveyor systems. They can negotiate narrow aisles and use all three dimensions of warehouse space—height included. They are available in fully automated models that can lift objects in and out of storage without the assistance of a human operator. Though these cranes are generally used to lift and swing objects that are too heavy or oddly shaped to be moved by other types of equipment, they can also be used to move objects horizontally for short distances. Advantages of cranes include Easy access to most areas within the lifting bay (bridge crane) Extension to areas outside the building (bridge crane) Ability to lift heavy objects that can’t be handled with forklifts or conveyors (especially the bridge crane) Ability to negotiate narrow aisles and to use all dimensions of a warehouse, including its height (wagon crane) Overhead suspension that leaves all floor space free for other uses (bridge crane) Available with radio control for remote operation (bridge crane) or fully automated for driverless picking and storing of items.

The main drawback of either type of crane is capital expense. The logistics manager may have to justify the expense by documenting the crane’s appropriateness to the functions and space requirements of the warehouse.

Carousels A carousel consists of a series of bins mounted on an oval track with the option of multiple track levels. The entire carousel rotates, moving inventory to a stationary order selector rather than requiring that person to go to the inventory storage location. The advantages of using a carousel include the following: It reduces labor required for order selection by reducing walking length and time. It can significantly reduce storage requirements, especially when stackable or multitiered carousels are used. Paperwork can be eliminated when the system uses computergenerated pick lists and carousel rotation. A pick-to-light system uses a series of lights that indicate the right pick location and the number of items to remove from that bin in the carousel. In some pick-to-light systems, a computer generates the pick lists and operates the carousel. A similar system, pick-to-voice, uses computer-generated voice commands to guide picking.

Advantages include Efficient use of floor space Reduction of time and labor required to pick items from storage Available automation to further enhance productivity.

Automated Systems Mechanized handling methods are often supplemented by automated systems, which can include automated guided vehicle systems, automated sorting systems, robotics, live racks, and automated storage and retrieval systems. These systems involve a higher capital expense than less complex systems but often can eliminate some labor costs, meaning that the warehouse will have relatively higher fixed costs and relatively lower variable costs. This can result in higher profits when volumes are high enough to cover the fixed expense but also higher losses if volumes are too low.

Automated Guided Vehicle Systems Automated guided vehicle systems (AGVS) perform much the same type of work as pallet trucks or tow tractors with trailers, and they operate without a rider. Instead of running on tracks, they move along optical tape or a magnetic wire in the floor, and they can be programmed to stop at various stations along their paths. Models are available with tines for lifting pallets or with platforms; some models

are specially designed to move materials into high storage areas along narrow aisles. Advantages include Programmability to increase flexible use without the expense of a human operator Ability to maximize use of warehouse space by operating in narrow aisles and providing access to high shelves. The primary drawback is the high cost of acquisition.

Automated Sorting (Sortation) Systems Generally used with conveyors, automated sorting systems direct items on a conveyor into their proper locations in a shipment. The system receives the required sorting information from a code on the master cartons of the items to be shipped. Most automated sorters can be programmed to work at different speeds to fit the requirements of particular shipments. Advantages include Reduced labor costs Increased speed (up to one package per second).

Robotics

Robotics in warehousing is used to build and break down unit loads. To break down a load, the robot is programmed to recognize product stacking patterns and place products in a predetermined position on the conveyor belt. To build unit loads, that process is reversed. The following are advantages of using robotics: It can be used in situations that are difficult or dangerous for humans, such as high noise areas or areas with extreme temperatures (such as food freezers) or in working with hazardous materials. It has the capacity to integrate program logic and increase speed, dependability, and accuracy. The drawback of robotics can be the cost. For example, Amazon purchased warehouse robotics system manufacturer Kiva in 2012 to control the cost of these devices, which is still US$15 to US$20 million per warehouse after the purchase, according to an article by Ananya Bhattacharaya. Amazon also restricted these systems to its exclusive use. Since there were no similar competitors, it took the industry four years to develop viable alternatives, according to an article in Bloomberg News by Kim Bhasin and Patrick Clark. These robots pick up storage racks and move them to where they are needed, and since the robots require less space to operate, the warehouses that use them can hold 50 percent more inventory per

square foot, cutting operating costs by 20 percent, or close to US$22 million, per warehouse. They also reduce the “click-to-ship” cycle to 15 minutes from 60 to 75 minutes. If implemented in all warehouses, Deutsche Bank estimates this would be a one-time savings for Amazon of US$800 million net of robot installation costs. For the rest of the U.S. warehouse market, as of 2021, a number of competitors have emerged, many originating in Europe, to capture the 95 percent of U.S. warehouses that had yet to be fully automated (ten percent of these were already semi-automated), according to an article by Scallog Logistics, which cites research by DHL.

Live Racks The live rack contains roller conveyors and is designed to be loaded from the rear where it is elevated, thereby using gravity to move product to the front. When an item or carton is removed from the front, the items behind it slide forward. Using live racks provides these advantages: It reduces the need for lift trucks to transfer unit loads. It offers automatic rotation of product—the first product on the conveyor will be the first out (first-in, first-out, or FIFO). A drawback of using live racks is that access to the stock in the middle can be hampered.

Automated Storage and Retrieval Systems The most advanced automated systems are called automated storage and retrieval systems (AS/RS). In addition to automating both storage and retrieval, these systems feature very high storage racks that multiply the capacity of the warehouse. The storage and retrieval functions are handled by a programmable AS/RS machine that moves both horizontally and vertically. The storage racks themselves may rise 100 feet or more, towering over standard warehouse racks. Because of the design of the storage and retrieval machine, the racks can be arranged along very narrow aisles. The AS/RS machine is programmed at pickup and discharge stations located at the ends of aisles. Another handling device, such as a towline, conveys incoming items to the AS/RS, which is programmed with instructions for delivering the items to specific bins in a specific sequence. When an AS/RS is being sent into the racks to retrieve items for an outgoing shipment, software helps it find the required items in the most efficient way. The AS/RS machine moves through the racks at high speeds—300 to 400 feet per minute horizontally and 100 feet per minute vertically. Computers may be dedicated to the AS/RS station.

The advantages of AS/RS systems include Maximum storage density per square meter or foot of floor space Tight control of storage and retrieval for high speed and freedom from error and pilferage Fast throughput to enable things like same-day delivery order promising Reduction of labor costs (and human error). The obvious drawback is capital cost. AS/RS systems are complex, large, and very expensive. However, some systems are scalable in that one can upgrade part of a facility at a time, adding more aisles and picking shuttles as needed without affecting the existing AS/RS aisles. A single failure point might also take the entire system off line, though some systems avoid this issue by enabling individual picking units to be taken on or off line for maintenance independently. Other disadvantages may include added labor required to properly put away materials, dedicated space, loss of flexibility (it’s not easy to move such a system), and equipment failures.

Topic 3: Transportation Strategy We’ll begin our consideration of transportation by looking at two of its objectives: product movement and temporary storage. Next we’ll examine capacity constraints and capacity forecasting and planning.

Transportation Objectives Transportation and warehousing are key logistics functions that need to be in balance. Supply chain managers weigh the costs of warehousing to reduce lead times against the costs of transportation. The transportation market has long been deregulated, which places the power and responsibility of refining a supply chain’s transportation tactics in the hands of logistics and supply chain professionals. Success in transportation planning and administration will provide tangible benefits to the organization’s bottom line. The primary objective of transportation is product movement: carrying goods and materials between supply chain partners and customers. A secondary objective is providing temporary storage for in-transit inventory.

Product Movement Since the movement of materials around the supply network is both necessary and expensive, keeping down the costs in time, money, and environmental impact is of strategic importance. Efficient Use of Time Efficient use of time is a factor in developing a successful transportation strategy because inventory in transit isn’t available for use in production or for sale to customers. This puts a premium on

moving materials and goods as infrequently and as rapidly as possible. But the premium isn’t absolute. There are tradeoffs to consider, since faster transport modes are expensive. Transportation costs also trade off against inventory costs. Tactics such as Just-in-Time delivery emphasize reduction of inventory costs, and one method of keeping down inventory is to ship more frequently—thus possibly raising transportation costs. Efficient Use of Money Efficient use of money provides a complex set of challenges to the transportation planner. As always, it is advisable to consider all the factors that contribute to total cost. You want to become more costefficient in one area without raising costs by a greater amount in another area. Line-haul costs need to be determined. These are defined in the APICS Dictionary, 16th edition, as basic costs of carrier operation to move a container of freight, including driver’s wages and usage depreciation. These vary with the cost per mile, the distance shipped, and the weight moved. Line-haul costs include the following: Vehicle costs. A supply chain partner can choose between controlling its own fleet of vehicles, hiring transportation as

needed, or contracting with a carrier for a longer term. With a company fleet, the company incurs internal costs for financing, leasing, and depreciation. In a global supply chain, there are additional challenges that can make it extremely difficult to control your fleet worldwide. With commercial or public transportation, the company incurs external costs. Driver/operator costs. Unless the mode of transport is a pipeline, transportation includes the cost of labor required to operate the vehicle—drivers for trucks; pilots, copilots, and crew for air transport; engineers for rail; and so forth. Driver shortages can drive up costs due to higher market wages, difficulties with certification, lack of investment capital, and expanded regulation. Vehicle operating costs. Operating and maintaining a fleet of owned or leased vehicles requires expenditures for repairs, cleaning, parking, etc. As fuel prices rise, operating expenses increase for road, air, rail, and water transportation. One way in which steamship companies are minimizing their costs is by running their ships more slowly to consume less fuel, which increases delivery time. For example, Wärtsilä, a ship engine producer, has calculated that reducing cargo ship speed from 27 to 18 knots results in a 59 percent fuel savings at a cost of one extra week in transit between the Far East and Europe, or fuel

savings of more than US$2 million for a one-way trip. Other companies use semi trucks without sleeping cabs or extra wheels to reduce the overall weight. General and administrative costs. Funds must be allocated to management of the transportation function. Insurance and security costs. With a private fleet, a company pays insurance costs to cover a variety of security concerns. Products may be damaged, lost, or stolen in transit. Transporting hazardous materials requires extra expense for insurance coverage, for security, and to comply with regulations. Air, rail, and water transport must provide protection against terrorism as well as vandalism and theft. Minimal Harm to Environment Finally, transportation of all types makes demands on the environment, some of which show up as costs of doing business. Transportation constitutes a large portion of domestic petroleum consumption in the United States and a rapidly growing amount in other areas of the world, especially in emerging economies such as China and south Asia. As supply chains extend over increasing distances, fuel for commercial transport and the pollution that goes with it are bound to

become increasingly problematic. The costs of fuel and the associated pollution add to the reasons for managing transportation and information efficiently. However, some progress is being made on this issue both in the U.S. and the European Union. For the neighboring ports of Los Angeles and Long Beach, California, the Clean Truck Program was signed into law in 2008, requiring diesel-powered, short-haul drayage trucks to meet new environmental standards that will reduce their air pollution by 80 percent. (Drayage trucks transport shipping containers from docks to off-site warehouses.) Trucks that do not meet the standards currently pay a fine but will eventually be banned from Los Angeles and Long Beach. Since these ports handle nearly 45 percent of container goods entering the U.S., this is a significant step in reducing harmful pollutants in these areas. Also, by 2023, per the California Air Resources Board, almost all heavy trucks in California need to have a 2010 or newer engine model year. (A special retrofit filter is currently required for older models.) The U.S. EPA’s Clean Air Nonroad Diesel Rule (also known as Tier 4), affecting industrial equipment, generators, and transportation

infrastructure such as heavy forklifts and airport service equipment, was fully implemented in 2015, reducing allowed particulate matter and nitrogen oxides. Ultra-low-sulfur diesel was also fully implemented in 2014 for nonroad, locomotive, and marine engines. (It was fully phased in for trucks in 2011.) The European Union has established low emission zones (LEZs) in which high-polluting trucks are prohibited. Specifically, regulations prohibit higher-emission heavy-duty diesel trucks from entering certain EU cities. Vehicle emissions are classified into Euro standards for the vehicles they apply to; trucks are rated Euro VI, Euro V, Euro IV, etc., with the lower numbers having more restrictions due to their higher emissions or lack of particulate filter or catalytic converter. Before a truck enters into an LEZ, the driver must know the emissions standard for that particular vehicle. (For more information on emission standards, see the links in the online Resource Center.) The European Union also places restrictions on the movement of trucks, both to reduce traffic congestion and to encourage more efficient transport modes. For example, in Switzerland and Austria, for Alps crossings, there are truck bans during the night and during some days. Trucks are encouraged to use piggyback rail transport.

Note that transportation also affects the environment through water and noise pollution. Adopting fuel-efficient vehicles and developing new fuels that aren’t petroleum-based may slow the growth trend, but any declines resulting from fuel efficiency will be balanced against greater consumption of other resources as markets continue to develop around the world. Not all of these effects are reflected in the costs of doing business.

Temporary Storage Transportation vehicles are not designed for long-term storage and are generally not used for that purpose. Nevertheless, it can sometimes be more economical to “warehouse” inventory in a vehicle than to unload, store, and reload the carrier. However, that necessitates space to park the vehicle, and fees are charged for temporary parking of a trailer. Carrier charges and fees are also added when land or water vehicles are retained beyond a specified loading or unloading time. Those charges are called demurrage fees if they involve rail freight cars or ships and detention fees if they pertain to truck trailers. If the goods to be stored need to be kept at a certain temperature, refrigerated trailers may be kept running as long as temporary storage is needed, but this can be quite costly.

Three situations provide the most frequent examples of the use of vehicles for temporary storage: Short-term storage. Trailers and railcars sometimes park at a facility without being unloaded if the contents need to be stored but are scheduled to move again in a few days. In the global arena, logistics parks (designated areas for storage and distribution built to complement industrial zones) are a growing option for efficient short-term storage. Some trucking companies have their trucks set up with two trailers so the driver can park one temporarily outside an urban area. After the first delivery, the driver retrieves the second trailer and delivers those goods. Logistics warehouses in China are classified as either bonded or nonbonded. Bonded logistics parks (BLPs) are often located near ports and serve as cost-effective holding areas where shipping orders can be consolidated from various locations before being exported. Nonbonded logistics parks, which have cheaper rental rates than BLPs, are increasingly being developed on the expanding road network (such as that connecting Shanghai to other cities in the Yangtze River delta). Crowded facility. If a warehouse is too full to accept the contents of an arriving truck or railcar, some of the contents of the warehouse may be loaded into another vehicle. That vehicle then

takes a slower and often cost-equivalent or cheaper route to its destination. In other cases, the limited shipping dock capacity at the outgoing facility may be the reason to ship something early but by a slower method. In some cases, the cost-equivalent but slower method will be intermodal. The tradeoff in extra transportation time and costs must be balanced against the enhanced storage capacity. Changed destination. With global positioning to track in-transit inventory, the destination could be changed mid route. (One generally needs to select a destination to release an order.) Reasons to divert a shipment of goods while in transit include to make the best use of available warehouse space or to accommodate changes in customer orders, such as last-minute cancellations or new orders. In the case of crude oil, in many cases the oil is traded on the market as soon as the tanker is under way toward a general destination like the U.S. West Coast, and the delivery time frame continually grows shorter as trading continues. The final owner chooses the specific destination based on the best available deal.

Transportation Capacity Forecasting and Planning

As with warehouse capacity, transportation capacity needs to be forecasted and planned in advance. Transportation capacity is easier to scale up quickly than warehouse capacity, since there are numerous options for increasing carrier capacity. Doing so efficiently and economically is the challenge. A number of constraints on transportation capacity need to be considered when forecasting and planning, so these are discussed first. After addressing forecasting and planning, the benefits of investing time in this area are covered.

Capacity Constraints When evaluating bids from carriers or forecasting transportation requirements, a logistics manager should understand the capacity constraints with which he or she is operating, including distance, volume, density, stowability, handling, liability, and conflicts of interest. The following discussion analyzes the impact of these factors. Economies of Distance and Scale Constraints in these categories include distance, volume, and density. Distance. The farther your shipment travels, the more it will cost you. It consumes more fuel, requires more labor, causes more

wear and tear, and, in general, increases variable costs. However, the principle of economies of distance—similar to economies of scale—decreases the impact of that upward trend. The reason is that all miles are not equally costly, and longer trips usually include a greater percentage of the less-expensive miles. graphs the relationship in a general way. For one thing, starting and stopping use more fuel and cause more stress on vehicles than cruising. Line hauls especially benefit from this phenomenon, because they generally include a large proportion of highway miles. Volume. As you pile more weight into a vehicle payload, economies of scale reduce the cost per pound or kilogram, as pictured in . Why? Because you’re spreading fixed costs over a larger number of units. Thus, a full load is more cost-effective to transport than a partial load, so consolidate your small loads into larger ones whenever possible. If you don’t do so, the carrier may do it for you by adding stops to take on cargo to fill the empty spaces. Someone has to pay for those side trips. Density. In shipping, low-density goods will cost much more per pound or kilogram to transport than denser goods like coal, the reason being that a truck filled with feathers is carrying far less weight than a truckload of dense coal. The variable costs for labor and fuel aren’t much affected by the weight of the load, and the

fixed costs are spread over the greater number of pounds or kilograms. Density can be increased by packaging as well. For example, items that require assembly after purchase are often configured this way to increase density. There is a limit to the positive effects of high-density shipping, however, because there is a cap on the amount of weight a truck can carry—legally or practically. Dense liquids, such as laundry detergent, will reach the weight limit long before filling up the volume of a truck. Setting aside that limiting case, graphs the general relationship of increasing density to decreasing cost per pound or kilogram of cargo.

Exhibit 5-10: Economies of Distance and Scale in Transportation

Stowability

Items with odd shapes that prevent them from efficiently sharing cargo space cost more to ship than items of similar density and weight that stow more efficiently. Redesigning awkwardly shaped products for efficient storage can greatly reduce the costs of transport and warehousing. For example, items shipped in bales are given a less expensive freight rate by shippers than the same items shipped in individual sale units, to account for the lower total number of items that can fit in a vehicle payload. Handling Challenges involved in handling the cargo during the loading and unloading of vehicles affect pricing. Some questions to consider include Is special equipment required to move the cargo? Are physical dangers involved? Have the materials been properly grouped and packaged for ease of handling and storage all along the logistics supply chain? How the freight is packaged and grouped before and during loading makes a considerable difference in ease of handling at all subsequent stages of the process. Consequently, packaging has significant cost implications. Different supply chain partners, with different concerns, will be affected by packaging and grouping—the shipper, the carrier, and the recipient (or recipients) who warehouse,

distribute, and, finally, unpack the goods for display and sale. At the end of the forward logistics supply chain, someone has to dispose of the packing materials—the pallets, boxes, wrappings, etc.—by reusing, returning, or recycling them. Consider, for example, automobiles and motorcycles. From the perspective of easy handling, both the shipper and the consignee— such as a dealership—might be happiest to ship assembled vehicles that could be driven up and down ramps into and out of the shipping vehicle. To improve logistics, however, both foreign and domestic manufacturers now often ship parts and assemble the vehicles in plants near markets. Handling is far more efficient for containers of parts. (This can also enable postponement, since parts can be assembled into different models.) Packaging also needs to take into account marketing needs without hindering logistics priorities of safe and efficient handling during shipping. The most productive, cost-effective packaging meets the following criteria: Efficiency of handling during loading, unloading, and storage Protection against damage to the cargo Communication (that is, packages should be labeled for ease of identification, tracking, customs, and handling) Low environmental impact

Liability The cost of transport is affected by the need to protect the cargo against various dangers. If carriers are required to insure the cargo or cover any claims on their own, they will pass along the costs. Examples of major liability concerns follow: Susceptibility to damage. Televisions, for instance, are more of a liability issue than paper products. Perishability. Fresh fish pose a series of problems. Any delays in shipment or refrigeration failures can be ruinous. Value per pound. Shipping precious metals or antiques exposes the carrier to liability risk. Susceptibility to theft. Some goods are more valuable than others to thieves. The likelihood of theft is also increased if the cargo will sit for part of the trip or will change hands frequently. Shipments awaiting customs clearance are susceptible. Conflicts of Interest Each party in the supply chain has different needs and goals. Suppliers typically want flexible delivery times, large yet stable volume demands, and consistent material mixes. Manufacturing organizations strive for high production output and low production costs. Logistics and warehousing management seek to minimize transportation costs by using quantity discounts and minimizing inventory levels. Finance wants to minimize order changes,

inventory, and product variety. Retailers need short order lead times and quick delivery. Customers demand variety and low prices. In short, conflicts of interest seem to be built into the supply chain. Because of the advances in technology, supply chain managers now have the information resources to make strategic decisions for optimal impact throughout the supply chain. While tradeoffs were more one-sided in the past, it may now be possible to come close to meeting the goals of all participants in the supply chain. Here are some key examples. Lot size versus inventory. Manufacturers often prefer large lot sizes because they improve process control and reduce per-unit setup costs. However, this creates high inventory and storage expenses. Advanced manufacturing processes seek to reduce inventories and improve system responsiveness. These processes make it possible to meet the needs of retailers and customers by enabling the manufacturer to respond more quickly to customer demand while retaining process control cost efficiencies. Information technology can reduce the lead times required by manufacturers to react to the needs of supply chain partners. Technology also allows retailers and distributors to track the status

of inventory throughout the process, enabling them to better manage customer expectations. The improved information flow also gives retailers and distributors a better idea of the process flow and the capabilities of manufacturers. The increased confidence level allows retailers and distributors to reduce the inventory held in anticipation of manufacturing problems. The result is better coordination of supply with demand. Inventory versus transportation costs. When a payload is full, the operating costs are distributed among more items, thereby reducing the per-item delivery cost. When payloads are only partially full, transportation costs are higher, as more deliveries— as well as more gas, salaries, and maintenance—are needed for the same amount of goods. However, when units are delivered by full loads, it takes longer for stock to be depleted, increasing storage costs. Information technology can minimize this conflict. Distribution control systems combine forecasting and delivery schedule information to allow a materials manager to transport goods from various warehouses together, minimizing deliveries and transportation costs. Retailers may also choose to combine shipments from different manufacturers by break-bulking. Decision

support systems enable the supply chain to find a suitable balance between transportation and delivery costs. Lead time versus transportation costs. Lead time consists of time committed to processing orders, procuring and manufacturing items, and transporting items. While transportation costs are lowest when high quantities are transported together, lead times are reduced when goods are transported as they are manufactured. So there is a tradeoff between holding items until there is enough build-up to reduce shipping costs and transporting them early to reduce lead time. Information can be used to reduce the impact of this tradeoff, such as by using forecasting and information systems to anticipate demand or by helping consolidate loads into full shipments. Product variety versus inventory. Organizations producing a variety of products incur higher manufacturing costs while their manufacturing efficiency decreases. In order to maintain lead times competitive with those of a manufacturer of fewer types of products, smaller amounts must be transported. The more different products a warehouse stores, the less space there is for any single product’s inventory. An additional challenge is forecasting the demand for each product since substitutes compete for the same customer. As a result, higher total inventory

levels must be maintained to ensure the same level of service. Product variety, therefore, increases both transportation and warehousing costs. One solution is delayed differentiation, which involves shipping generic products as far out as possible, allowing the variations or customization to be added later. An example would be from a clothing manufacturer whose main challenge is to predict which styles will have the most demand, since production begins months before the selling season. A shipment of blue jeans can have specific pant lengths be quickly finished at a distribution center before shipment. Delayed differentiation aggregates customer demand across all products. This produces a more accurate demand forecast with less variability, allowing reduced safety stocks and better matching of supply with demand.

Forecasting and Planning With an understanding of the constraints on transportation and the tradeoffs that are needed for the organization’s products, supply chain managers can forecast their transportation capacity requirements and thus develop plans for purchasing the right size and type of fleet or contracting with the right type of carrier and transportation mode. As with all capacity planning, the goal is to have sufficient capacity while avoiding the costs of excess capacity.

Getting capacity just right moves the organization away from the reactive and toward the proactive—in other words, from an emergency mentality to a graceful flow of logistics. The main problem with traditional transportation forecasting is that it is uses actual orders rather than demand forecasts, so the time available for planning is very short. Historical averages can be used, but these fail to account for critical forward-looking information such as an upcoming product promotion. Emerging transportation capacity forecasting tools, which may be part of a transportation management system, improve upon this system by linking to and incorporating the following types of information: Customer demand information from the organization’s demand forecasting process Marketing information so planned promotions can be reflected as an increase in transportation capacity requirements Manufacturing and product strategies and decisions Required carrier mode, type, protection class, and other transportation details related to specific product characteristics A good transportation forecast is broken down by transportation lanes such as various sea shipping lanes as well as by transportation mode.

Benefits of Transportation Capacity Forecasting and Planning The benefits of integrating information from other parts of the supply chain into transportation forecasting include the following: The spot market for transportation is rarely used. Several weeks of notice can be given to supply chain managers responsible for carrier procurement. Carrier procurement can be detached from order creation. (The carriers will be reserved but given their assignments later.) It is easier to arrange for intermodal shipments (e.g., rail to truck), which can lead to significant savings. Backhauls can be planned with sufficient time to reduce deadheading (empty vehicle return trips). Sufficient transportation capacity can allow warehouse staffing to be planned more accurately. For owned fleets, transportation staff and equipment will be more accurately planned. Transportation becomes not only less expensive but more responsive, because you will have time to raise or lower capacity. Arranging things in advance allows for more time for collaboration between transportation providers and supply chain partners on the receiving end of the shipments.

Section B: Distribution Services and Transportation Choices This section is designed to Explain how basic warehouse activities such as picking, packing, and put-away can add value when done efficiently Describe other value-added services that can be provided in a distribution network, such as postponement Describe various delivery patterns, which are the ways that customers choose to receive their goods (i.e., through various supply chain echelons) Understand the impact of changing delivery patterns Explain the tradeoffs between various transportation modes so the best mode can be selected for a given requirement Describe the value density versus packaging density relationship Describe each mode of transport (rail, motor, water, pipeline, air, and intermodal), including its background, capabilities, market conditions, and limitations Differentiate classifications of carriers, including common carriers, private carriers, contract carriers, and exempt carriers.

Distribution services are the services that various distribution intermediaries provide. Basic services include things like pick, pack, and put-away, but a wide range of value-added services are now available to be leveraged. Supply chains also need to consider which delivery patterns they will support, a decision that is based strongly on customer demand. These patterns are moving toward more and more e-commerce. Transportation requires knowing a lot about the various modes of transport so that the best mode can be selected for the product’s features and requirements. Each of the various modes is described along with its pros and cons. Once a mode is determined, then a specific carrier needs to be selected, and some general categories of these are presented.

Topic 1: Distribution Services and Delivery Patterns Distribution services include warehouse activities such as picking and value-added services such as consolidation. Delivery patterns are the methods that customers choose to acquire products, and this could include things like drop shipping or use of distributors and retailers.

Warehouse Activities The following activities may take place in a warehouse. (Some of these may be considered value-added, such as if they have been streamlined, but inspection during receiving is an example of something not considered value-added.) Receiving is defined in the APICS Dictionary, 16th edition, as encompassing the physical receipt of material, the inspection of the shipment for conformance with the purchase order (quantity and damage), the identification and delivery to destination, and the preparation of receiving reports.

Prepackaging refers to the situation in which products are received in bulk from a supplier and subsequently packaged in smaller quantities or combined with other products to form kits or assortments. Put-away , as defined in the Dictionary, involves removing the material from the dock (or other location of receipt), transporting the material to a storage area, placing that material in a staging area and then moving it to a specific location, and recording the movement and

identification of the location where the material has been placed.

Storing refers to putting items under warehouse control (in a storage point upstream of a workstation). Order picking is defined in the Dictionary as selecting or “picking” the required quantity of specific products for movement to a packaging area (usually in response to one or more shipping orders) and documenting that the material was moved from one location to shipping It is also known as order selection. Moving is “the physical transportation of inventory from one location to another within a facility” (Dictionary). Shipping is defined in the Dictionary as the function that performs tasks for the outgoing shipment of parts, components, and products. It includes packaging, marking, weighing, and loading for shipment. Packaging and packing and marking are related to this definition. Packaging is

the materials surrounding an item to protect it from damage during transportation; the type of packaging influences the danger of such damage. Packing and marking includes all the activities of packing for safe shipping and unitizing one or more items of an order, placing them into an appropriate container, and marking and labeling the container with the customer shipping destination data as well as other information that may be required.

Warehouse Functions and ValueAdded Services Warehouses today offer economic and service benefits that go well beyond simple housing of raw materials, parts, or finished goods. On the economic side, warehouse operations can reduce the overall cost of logistics by their efficiency and effectiveness in receiving goods and packaging or arranging them for reshipping. At the same time, warehouse operations may improve customer service by cutting lead times, packaging goods for easy handling and identification, and arranging shipments to fit the recipient’s unique requirements. Warehouses are places of constant activity as workers and machines unload, store, retrieve, repack, arrange, and reload inventory that they may also assemble-to-order.

Functions that add supply chain economic or service value include Consolidation of materials for shipping Break-bulk and cross-dock facilities Postponement Stockpiling seasonal inventory Spot-stocking advance shipments Assortment (similar to spot-stocking) Mixing (similar to break-bulk).

Consolidation Consolidation occurs when a warehouse receives materials from more than one plant and combines them into outgoing containerload (CL) or truckload (TL) shipments (shipments that fill up the entire cargo bay) to a specific customer. It reduces logistics costs through economies of scale, because the consolidated shipments qualify for CL and TL discounts. It also reduces congestion at the customer’s dock. However, the warehouse may have to add sorting and perhaps assembly capability. There will be training and possibly hiring costs —plus costs for remodeling if more space is required. Exhibit 5-11 provides a graphic view of consolidation as it functions for inbound shipments (a) and outbound traffic (b).

Exhibit 5-11: Consolidation

Break-Bulk and Cross-Dock Facilities Operations at break-bulk and cross-dock facilities are similar except for the way orders come into the warehouse. The APICS Dictionary, 16th edition, defines break-bulk as (1) Dividing truckloads, railcars, or containers of homogeneous items into smaller, more appropriate quantities for use. (2) A distribution center that specializes in break-bulk activities. A break-bulk facility can build new truckloads of assortments of goods all destined for a given location. The Dictionary defines cross-docking as the concept of packing products on the incoming shipments so they can be easily sorted at intermediate

warehouses or for outgoing shipments based on final destination. The items are carried from the incoming vehicle docking point to the outgoing vehicle docking point without being stored in inventory at the warehouse. Crossdocking reduces inventory investment and storage space requirements. An example of a break-bulk operation is food retailers. They receive full truckloads of combined customer orders from manufacturers. The break-bulk warehouse sorts or splits individual orders and ships them to the retail customers. Because the long distance transportation movement is a large shipment, transport costs are lower and there is less difficulty in tracking. For example, Walmart’s customers are its retail stores. If a supplier sends a bulk order of camping cots, the right number gets put in each truck bound for a different retail location as part of an assortment of goods for that store. That assortment may itself constitute a TL. Break-bulk and cross-dock facilities provide the benefits of consolidated, full-trailer shipment into the facility, out of the facility, or both. They also reduce handling costs because put-away and picking are avoided. Exhibit 5-12 depicts break-bulk and cross-dock operations.

Exhibit 5-12: Break-Bulk and Cross-Dock Operations

Postponement Goods enter a postponement center in component form for later final assembly. The goal is to enable both production efficiency and responsiveness. (Typically these are tradeoffs.) Final configuration of the finished product is postponed until an order arrives, allowing parts to be assembled to fit the specific order. For example, since Europe uses four different plugs for electricity, generic printers arrive at a European distribution center and, once orders are received, workers add the correct cable along with written materials and labels in the correct language. Components can generally be stored more efficiently than finished products. Also, forecasting is easier for the family of products that can be assembled from the parts than it would be for the separate end products. If the warehouse contained finished products, it would require safety stock for each item. There will, however, be costs for training or hiring staff with final production skills. Processing at the

warehouse may be more expensive than finishing the product at the plant would have been.

Anticipation (Stockpiling Inventories) Anticipation inventory, such as seasonal clothing, lawn furniture, or agricultural products, is stored at the warehouse in anticipation of future demand. Stockpiling enables more efficient use of production capacity by reducing the need to increase capacity for the seasonal demand. In the case of agricultural products, it’s the “production” that is seasonal rather than the demand. So the product is stored in larger amounts as it becomes available and then distributed as demand comes in. A disadvantage of stockpiling is that more warehouse capacity is required than would be necessary for a Just-in-Time delivery system.

Spot-Stocking Spot-stocking is focused on strategic markets. It is allocating inventory in advance of heavy demand in strategic markets rather than the inventory being stocked year-round or shipped as it’s being produced. Advance shipments from a plant are sent to key markets to be sure they are close to customers in season. Agricultural products are

spot-stocked during the harvest season to put them close to key markets and then are warehoused centrally for the rest of the year. Customers and producers benefit from spot-stocking of items in key markets to minimize the chance of a shortage during peak demand.

Assortment Warehousing Assortment warehousing is a technique that stores the goods close to the customer to ensure short customer lead times. Assortment benefits the customer by reducing the number of suppliers it has to deal with to acquire the assorted goods. It also reduces transport costs by allowing larger shipment quantities.

Mixing Mixing resembles break-bulk but involves shipments from more than one manufacturer. In a typical mixing setup, the warehouse receives full-vehicle shipments of different products from manufacturers in diverse locations, with each shipment receiving the full-load discount. (A full-load discount is a quantity rate discount offered for a CL or TL, e.g., usually set at 10,000 pounds (4,536 kilograms) for a truckload. A full load may occur when the cubic volume is full or when the weight limit is reached, whichever comes first.)

At the warehouse, shipments are broken down and assembled into the product mix desired by each customer or market. A particular outgoing shipment may contain goods that just arrived (as in breakbulk or cross-dock facilities), or it may combine the current shipment with products from storage. Mixing avoids multiple smaller shipments from each manufacturer along with the required separate handling, storage, and display. It also makes more efficient use of storage space in the warehouse. Exhibit 5-13 illustrates the process of mixing shipments.

Exhibit 5-13: Mixing

Delivery Patterns and Fulfillment Channels Delivery patterns, also called shipping patterns, refer to trends in how customers are buying goods and getting them to their place of business or home. Organizations can leverage some general order

fulfillment channels described here. Note that the direct-to-consumer model has radically shifted delivery patterns for many organizations and logistics specialists. The type of distribution network a supply chain adopts will have a huge impact on facility numbers and location decisions. Distribution channel strategy is determined during strategy formation; however, some tactical selections can be determined during network design. There are several types of fulfillment channels, each having different levels of service outputs (break-bulking, spatial convenience, waiting and delivery time, variety and assortment) and channel design intensity (i.e., the complexity of the network and number of options or locations for customers). Manufacturer storage with direct delivery. Exhibit 5-14 shows the type of network in which the manufacturer uses direct delivery. The manufacturer takes a customer order through any number of sales channels (direct, catalog, website, etc.) and directly ships the goods to the customer, with no intermediaries other than perhaps a carrier (unless the manufacturer owns a fleet).

Exhibit 5-14: Manufacturer Storage with Direct Delivery

This model is common in business-to-business (B2B) settings but can also be used for business-to consumer (B2C) sales. An example of its appropriate use in the B2B setting is for perishable goods that need to be on retail shelves as quickly as possible to maximize their useful lives. This could also be a supplier that produces large lot-size quantities. The primary benefit to the manufacturer is a direct relationship with its customers so it can directly interact with and market to them in the future. For B2C, it is used primarily for low variety, make-to-order goods that the customer is willing to wait for, since lead times can be long. Since there is only one echelon, the manufacturer has complete control over inventory and has low carrying costs. Shipments are typically in truckload (TL) or containerload (CL), but logistics costs can be high and intermediaries may be needed to reduce these costs. Manufacturer storage with drop ship. Exhibit 5-15 shows the drop ship model, in which a distributor or retailer (or direct sales or online merchant) takes orders from customers and the customers

receive the goods directly from the manufacturer. The distributor or retailer may have a floor model but no inventory. This model would probably use transload and cross-dock facilities. It would be best for high-value, sporadic demand items; these might be bulky items like refrigerators or be make-to-order, customized, or postponed items that can be finished when the order arrives. Shipments may be in small lots, and thus transportation costs can be higher and lead times longer, but the manufacturer can control delivery service reliability.

Exhibit 5-15: Manufacturer Storage with Drop Ship

In this model, the manufacturer doesn’t have direct contact with the customer, so customer knowledge is less than with the prior model. At the same time, the manufacturer does not need to maintain a sales force or other functions like credit approval. Manufacturer to distribution center to retailer. Exhibit 5-16 shows the traditional supply chain, a manufacturer working with

regional distributors. The distributors supply retail locations (in which customers buy goods) and handle the local delivery portion with their own vehicles. There can be one or more distribution centers (DCs) in this model, and a wholesaler echelon could also be added. The multiple echelons all need inventory, so this model is inventory-intensive. It is best for mass-produced, inexpensive goods with high competition. It produces strong product availability and high levels of customer service.

Exhibit 5-16: Manufacturer to Distribution Center to Retailer

The channel intermediaries and retailers are generally independent, but some DCs could be owned if this can be done for less than 3PLs can do it after all facility and inventory carrying costs are accounted for. Distributors provide break-bulk activities and minimize inventory by using fewer, more centralized warehouses. The retailers take over all customer-facing functions

and their associated costs. The organization may need to negotiate for preferred shelf space and may not have much control over promotions or access to customer information without forging information-sharing partnerships. Independent distributor with omni-channel network. Exhibit 5-17 shows a network where an independent distributor is the channel master, buying goods from multiple manufacturers (or other distributors) in bulk and aggregating them for a one-stop shop for retailers, local distributors, wholesalers, or direct customers. Having an omni-channel network means that the independent distributor maintains multiple customer contact methods, such as a sales force, a call center, a website/app (both mobile- and computer-accessible), and a series of wholesale and/or retail locations. Regardless of the method of customer contact, the customer experience should be seamless and consistent. Manufacturers join these independent distributors to gain another sales channel and access to a larger market. Retailers and distributors can often buy assortments in TL or CL shipments, and they gain economies of scale in pricing so they can sell at a competitive price for a profit.

Exhibit 5-17: Independent Distributor with Omni-Channel Network

The distributor needs to develop these local distributor and retail partnerships carefully to ensure that they build and maintain a large enough customer base. This will be accomplished, in part, by holding high inventory levels of fast-moving items. These organizations might negotiate exclusive contracts for markets, but competitors might do the same, and therefore they may not have full market access. These distributors need a thorough and efficient transportation network of owned or contracted carriers to provide high customer service while controlling relatively high transportation costs. They can provide value-added services like aggregate inventory storage and bulk shipping of assortments. If they want customer information or information on promotions, they will need to form information-sharing partnerships. They will also have a large number of suppliers they need to coordinate and partner with, when possible, to control prices, lead

times, quality, and availability. They might even negotiate costsharing contracts. Independent aggregator with e-business network. The model shown in Exhibit 5-18 is very similar to the previous model, but it depends more heavily on direct marketing to individuals through its own heavily branded website, which may sell all manner of goods. Alibaba and Amazon are examples. Direct shipment of goods to customers through parcel services is very common, but these organizations may also own a fleet or sell or ship through local distributors (which they may own). They move slow-moving goods directly from manufacturers through local distributors rather than carry this inventory themselves.

Exhibit 5-18: Independent Aggregator with e-Business Network

Other independent distributors will sell specialty goods to B2B or B2C niche markets using web sales. The independent distributor gains direct access to customers and can manage this customer

information and customize the customer’s web interactions. They often use loyalty programs that offer free shipping for an annual membership fee. To keep this customer loyalty, they need very high levels of customer service. The exhibit also shows that some independent distributors in this model still sell goods to local distributors, retailers, or even to other e-businesses. This allows the organization to offer omni-channel fulfillment such as buy online/pick up in store. (Usually the retailer would also be the distributor in this case.) The 2020 pandemic vastly increased the number of retailers who adopted some form of this model, selling both online and in retail stores. Each type of channel, by virtue of how it’s structured, will perform at different levels on the key dimensions that impact customers’ satisfaction levels, including customer service level, product assortment, product availability, delivery time, channel complexity, inventory cost, transportation costs, and channel facilities. There are always tradeoffs to be made between channel types and the exact service attributes that make customers happy. The ability of customers to track and trace on their own is a clear example of an order qualifier these days. The convenience and variety of the directto-consumer model has seen a trend of delivery patterns shifting in

this direction, so this model and its implications for logistics are discussed next.

Direct-to-Consumer Model Exhibit 5-19 summarizes some of the order fulfillment channels that relate to the direct-to-consumer model but also shows some other permutations, because a variety of tactics can be used to accomplish direct-to-consumer delivery patterns. Other order fulfillment channels can likewise be accomplished in more than one way.

Exhibit 5-19: Direct-to-Consumer Permutations

As online shopping continues to make strong inroads into more and more areas that were traditionally retail purchases, organizations are

facing strong changes in delivery patterns. In 2012, U.S. retail ecommerce sales were around 5 percent of total quarterly retail sales. This rate steadily increased each year, to about 10 percent by the beginning of 2020, but then spiked during the pandemic to almost 15 percent. As of the first quarter of 2021, the rate had fallen to 13.6 percent, according to the Census Bureau of the U.S. Department of Commerce. This represents almost $200 billion of commerce for that quarter. The retail delivery pattern involves shipments of goods or components from multiple suppliers, consolidation at distribution centers, and shipment from there to retailers. This pattern emphasizes multimodal transportation for efficiency and economies of scale. The direct-to-consumer delivery pattern, on the other hand, involves the same first steps of getting goods and consolidating them at distribution centers, but from there it becomes a series of small package deliveries directly to consumers. In some cases, the directto-consumer delivery pattern involves forwarding individual packages directly from suppliers to customers with no intermediaries. Even the direct-to-consumer delivery pattern has been shifting. While there has been a movement toward next-day delivery, for consumers who are working during the day, this has resulted in packages left outside doors or missed deliveries. One innovative

solution developed by Wehkamp, a large Dutch mail-order company, was to ask “When do you want your delivery?” to help make deliveries when customers are actually home. They even developed same-day delivery, in part by reducing their time from customer order to ready to ship to 30 minutes. Other European services have started making deliveries to small village grocery stores or gas stations for customer pickup. The magnitude of the shift in delivery patterns from large shipments to retailers to individual shipments to consumers is immense for the logistics industry. Third-party logistics providers who specialize in truckload and less-than-truckload (LTL) delivery networks are under pressure from the reduction in demand for their services. Mergers and acquisitions are occurring among traditional 3PLs as they seek to scale upward to be large enough to start offering services other than just TL and LTL. If this trend continues, there will be far fewer logistics providers in the market, and those that survive will need to be able to provide their traditional functions plus functions that are currently provided by the likes of UPS, FedEx, and USPS. For example, according to a Bloomberg article by Black and Day, to improve the reliability of their same-day and two-day deliveries, Amazon has been investing in a private fleet of airplanes, and in 2019 it abandoned its contract with FedEx for air cargo. Per an article by Katie Canales, Amazon was also working to double the

size of its private delivery fleet in 2021 by providing business start-up assistance to small trucking companies in exchange for exclusively working with Amazon. Part of its strategy to achieve same-day delivery is to open distribution centers in these urban areas rather than locating them in the countryside, as is the case with many retailers, including Walmart.

Topic 2: Transportation Mode and Carrier Selection Transportation modes include rail, motor, water, pipeline, air, and intermodal combinations. Some selection criteria are provided up front, followed by a discussion of each mode. Carriers are the individual organizations providing transportation services. Various types of carriers are discussed.

Transportation Mode Selection Criteria When it comes to the method of transporting goods, a logistics manager first decides which mode of transportation best fits with the overall logistics needs for the product and the marketing channel. Modes of transportation include rail, motor, water, pipeline, air, and intermodal combinations.

Exhibit 5-20 shows the weight of freight shipments broken down by mode in millions of tons for 2017 and the projected usage for 2028 in the United States. Exhibit 5-20: Weight of Freight Shipments by Mode in U.S. (millions of tons) Shipment Mode Truck Rail Rail intermodal Air Water Pipeline Total

2017 Totals

2028 Projected Totals

10,731

13,916

1,731

1,842

200

286

14

18

930

1,036

1,567

3,625

15,172

20,730

Source: Adapted from Bowersox et. al., Supply Chain Logistics Management, 5th edition, which cites the Freight Transportation Forecast, 2017-2028, American Trucking Association Inc., 2017.

A given mode will not necessarily be competitive for a given set of logistics requirements. Each mode has its own inherent advantages and disadvantages. The best mode to select will depend upon the product type, size, weight, value, delivery speed, and lane volume needed to meet customer requirements. Lane volume is the volume of traffic in a given shipping lane (an origin-destination pairing) and is a factor in both land and water carrier pricing. The higher the volume

in the lane, the lower the price for that transportation mode (and therefore the transportation mode needs to be highly efficient to compete). This is because low-volume lanes may not have available materials for backhaul, so carriers add fees due to the greater potential for empty vehicle return trips (deadheading) or stranded empty containers. Exhibit 5-21 shows that a reliable method to find the best mode of transportation for shipping a specific product type is to compare the product’s value density (the value of units being transported per cubic foot or meter) versus its packaging density (the amount that can be packed per cubic foot or meter).

Exhibit 5-21: Value Density versus Packaging Density

To help weigh the importance of shipping options with different costs and delivery speeds, keep this in mind: Items with a higher value density usually merit shipping by a faster method, and items with lower value density can usually be sent by a slower method and then held in inventory. On the other hand, the more units that are handled per cubic foot or cubic meter, the more the need for automated materials handling. Let’s look at an example. Postal offices or organizations do not own the letters they ship, so for them the value density is about zero. They collect letters from letterboxes and then bring them to a hub. Once there, the letters need to be sorted and sent forward to the next hub. At this second hub, the letters are re-sorted according to street address. The packaging density is very high (more than 10,000 letters per cubic meter), so the focus is on automatic materials handling. Bricks are an example of a product with low value density and low packaging density. The value per brick is very low, and bricks are sent to customers on pallets, so the packaging density is also low. The preferred way to treat this kind of low value/low density goods is to load the pallets at the manufacturing plant and directly transport them to the customer site using a low-cost transportation mode.

When looking at manufacturers of copy machines and digital cameras, you will discover that they use different modes of transportation. Copy machines have a low value density and are shipped in containers from the Far East to the U.S. and Europe. Cameras have a high value density, so the emphasis is more on how to recover the invested money quickly. These products will be transported by airplane.

Rail Transport Rail transport is very fuel-efficient. Based on data provided by the Association of American Railroads (AAR), in 2021 U.S. railroads averaged 480 ton-miles to the gallon (a railway fuel efficiency measurement that means an average train moved a ton of freight across 480 miles on a gallon of fuel), which makes it three to four times more fuel-efficient than truck transport. Transport by rail rather than truck reduces greenhouse gas emissions by 75 percent. Rail transport has increased its transportation volume by almost double from 1980 levels (2,222 tons per railcar in 1980; 3,817 in 2020) while reducing its overall fuel consumption by 104 percent from 1980 levels. (Fuel efficiency was only 235 ton-miles per gallon in 1980.)

Background

At one point, railroad transport accounted for more than half of the intercity freight in the United States. While deregulation stabilized rail’s percentage share of the intercity transport market, it resulted in an ongoing decline in the number of large carriers, miles of track, and total revenues as rail carriers abandoned unprofitable lines and cut rates to be competitive. The U.S. trucking industry was the major beneficiary of the decline in rail. Rail transport between countries of the European Union has never been especially efficient because of national differences in gauge widths and signaling systems and other differences in infrastructure and organization as well as politics. Moreover, the reliance on rail for commercial transport entered into serious decline in the latter part of the 20th century under competitive pressures from other modes of carriage. In 1995, rail hauled 20.2 percent of freight in the EU, but this declined over the years and in 2019 was at 17.6 percent. Over the same period, road transport increased its share of freight transport from 67.4 percent to 76.3 percent (as noted in the European Commission’s “EU Transport in Figures Statistical Pocketbook 2012” and updated with information from Eurostat). On the other hand, rail transportation has grown in importance in the national and international movement of goods in Asia. China has its New Silk Road initiative that seeks to finance rail and other logistics

infrastructure projects in multiple countries (but with strings attached). The following are reasons often cited for the increase of rail’s importance in Asia: Twelve of the 30 landlocked countries of the world are located on the Asian continent, with the nearest ports often several thousands of kilometers/miles away. The distances linking the origins and destinations (both domestically and internationally) justify the economics of rail transport. There is a reliance on ports to connect national economies to the world’s markets, especially in the context of growing containerization and intermodal transport. Several Asian countries are major exporters of mineral resources, and rail transport is crucial to their logistics. A steadily increasing volume of goods is being exchanged globally. Rail is recognized as environmentally friendly and safe. Beyond Asia, rail transport is a crucial aspect of many other country and regional transport networks. Growing international trade, the establishment of free trade areas, and requirements for increased efficiency and improved quality of transport services are all factors that should sustain and grow rail transport for future decades in

locales such as Australia, North Africa, the Middle East, and numerous other areas.

Capabilities What railroads do especially well is to carry heavy loads of low-value goods over long distances at relatively low rates. The rough ride over steel rails and the jarring impact of coupling tends to cause more damage to cargo than occurs with other modes of transportation (about 3 percent of tonnage)—hence, in part, the focus on low-value, durable freight. Also, the relatively low rate structure—about onetenth the cost per ton-mile of truck transport—makes rail transport attractive for low-value freight. As the value of the cargo declines, the cost of transportation consumes a greater portion of the selling price. Rail transport offers a clear advantage in carrying very heavy loads when compared to motor carriers and airplanes. Compared to water transport, which is also well adapted to heavy loads, rail carriers have the edge in accessibility to diverse destinations and points of origin. Trains have an advantage over other modes of travel in bad weather conditions, which disrupt their travel times very little. They also offer the logistics manager considerable safety, although in exchange for safety the logistics manager must budget more for expensive packaging.

Trains have the capability to carry virtually any product or material except very bulky items—the need to cross bridges and pass through tunnels restricts the size of the items carried—but in recent years they have narrowed their focus to concentrate on raw materials mined or harvested far from waterways. They have also broadened their appeal by developing specialized equipment, such as refrigerated cars, cushioned cars for appliances, and doublestacked containers. Unit trains carrying one product, such as grain or coal, are able to speed up delivery times by avoiding switching yards and traveling directly to one destination. In 2020, intermodal transport made up 25 percent of the revenue for major U.S. railroads, the largest single component. Half of this was for imports and exports. Much of the rest of the U.S. rail business comes from carrying coal, with smaller slices allotted to chemicals and other raw materials or commodities.

Market Conditions The transportation manager who is considering available options for U.S. rail transport will find few rail carriers available. Because of high fixed costs for equipment, buildings, and tracks, railroads tend to be very large, heavily capitalized businesses. If high fixed costs are the bad news for rail economics, low variable costs are the good news. Since deregulation, U.S. railroads have lowered their variable costs

even more by renegotiating labor agreements. Use of computers and technologies such as anti-idling devices in railyards has also increased the efficiency of train movement, lowering expenses for fuel and labor. When they were more tightly regulated, U.S. railroads were more numerous. Since deregulation, however, smaller lines have dropped out of business or consolidated into larger companies. About 560 companies have survived, but only a small number—big names such as Union Pacific and Burlington Northern—account for the majority of revenue. There is little room for expansion in the industry in most countries because of the overwhelming expense of laying new track and the difficulty of locating available land for right of way. The exception to this rule is China and elsewhere in Asia, and rail lines there are expanding. To compensate for limited ability to expand their service to new locations, railroads have heavily entered into intermodal transport of goods. In combination with trucks, ships, or planes, trains can deliver goods to domestic and overseas locations. Not only is trucking freight rail’s biggest competitor, it’s also its biggest customer. Some transportation experts say that truckers are losing their edge because of highway congestion, higher fuel costs, driver shortages,

and pending safety regulations. Meantime, railroads have made a huge bet on intermodal service, spending hundreds of millions of dollars on new facilities and upgraded tracks to handle the increasing traffic volume.

Issues/Challenges Though rail lines reach more destinations than are available to waterborne carriers, their access to multiple destinations pales in comparison to the reach of highways. There is no flexibility in railroad right of way. Both shipper and recipient must have facilities near the tracks; otherwise they will have to arrange with another type of carrier to get their goods to or from the terminal. This makes rail virtually useless for direct delivery to a retail location. Railroad transport is relatively slow. This can result from the necessity of stopping at numerous locations, from the slow procedures required to decouple and recouple cars in a switching yard, and from practical restrictions on speed related to current infrastructure. In the EU, the problems with speed have been especially great because of the different standards among nations. In addition to the generic constraints applying to all railroads, the EU’s rail carriers are hampered by the need to change crews and locomotives at border

crossings and by the requirement to give priority to passenger services. However, this last limitation has received EU regulatory attention. The European Rail Network for Competitive Freight (Regulation EU 913/2010) came into force in 2010 and requires better balance between freight and passenger service. In addition, the ERTMS (European Rail Traffic Management System) is a digital command and control system that has replaced national systems with a single European system that has standards for technical interoperabiliy. It includes voice communication between train drivers and signallers and also helps automatically regulate train safety. This change sped up trains and increased rail infrastructure capacity. As mentioned earlier, rail transport tends to cause more damage to fragile products than other modes of transport, and consequently it requires special care to be taken in packaging fragile products.

Motor Carriers As rail transport has dwindled, trucking has expanded. Motor carriers haul produce, raw materials, parts, cars, stage sets, hazardous materials, fish, flowers, and farm animals through Europe, Asia, Africa, Australia, and the Americas. There are approximately four million miles of highway in the United States alone. From the smallest pickup truck to the longest semi with two or three trailers

hitched to its cab, motor carriers have become absolutely essential to the world’s supply chains.

Capabilities The market for truck transport is the relatively small shipment of high-value items traveling a short distance. Accessibility is the strong suit of the motor carrier. There are virtually no locations that are off limits for trucks. They don’t require ports, vast switching yards, or large terminals. All trucks need is a road to the shipper’s and recipient’s docks or door. Assisted by the expansion of the road network, motor carriers in the United States have moved into parts of the market previously served by the railroads. Most freight arrives at retail stores via truck. Light and medium manufacturers also rely on trucking. When cargo travels by other modes, trucks often carry the freight to and from the port or rail yard. Motor carriers also offer speedier delivery than rail or water transport. Barges, of course, are slow. Trains generally have to stop at switching yards to add or remove cars. Trucks can be more direct.

Market Conditions Motor carriers benefit from relatively low fixed costs, associated with the vehicles themselves and terminal facilities. Unlike trains, trucks

ride on a surface built and maintained by taxpayers. The American Trucking Associations’ truck tonnage index (an index set relative to 2015 tonnage, with that year set to 100) showed a significant dip in tonnage in the beginning of 2020 from 110 to less than 105. By January 2021, this rate was still 2.1% below the January 2020 rate. Compared with other transport modes, over-the-road hauling provides relative ease of entry. Currently there are about 65,000 general freight trucking companies in the U.S. (The 50 largest companies account for 40 percent of revenue.) Indeed, the industry depends on those (sometimes highly) independent operators who get into the business by purchasing a cab, getting licensed, and offering their services to anyone with a trailer to haul. There are some regulatory limits placed on what a carrier can haul and where it can operate. For example, carriers may be limited to carrying only commodities, only explosives, only building materials, etc. The trucking industry comprises three segments: truckload (TL), less-than-truckload (LTL), and specialty. The TL segment includes many carriers who compete on their rates. A truckload shipment weighs over 15,000 pounds (6,818 kilograms). Because they are fully loaded, trucks in the TL segment generally travel straight from the loading dock to the

destination; they don’t have to stop and take on more pallets to fill up the trailer. In the LTL segment, trucks start with loads of less than 10,000 pounds (4,536 kilograms). Because they have space in the trailer, these trucks often have to stop at intermediate locations to take on more cargo. This, of course, extends their delivery time, uses more fuel, and raises labor costs for the drivers and dockworkers. The higher costs of doing business in this sector have led to more consolidation than in the TL sector. Specialty carriers include companies such as United Parcel Service (UPS) and Federal Express.

Issues/Challenges Although motor carriers benefit from low fixed costs (trucks being much cheaper than ships or planes), they do have to contend with high variable costs. Trucking companies are beset by rising costs for equipment, repairs, and the wages paid to drivers and the laborers who load and unload cargo. Trucking is more labor-intensive than its competition, so it is impacted more than other modes by rising labor rates. Ongoing truck driver shortages have also contributed to these rate increases. Truckers address these cost challenges by various means, including computerized billing, mechanization at terminals,

more efficient scheduling with fewer intermediate stops at terminals, and coordination with other modes of transport. Since deregulation in the U.S. in 1980, competition for customers has increased in the trucking industry. The result has been lower rates, which are a boon for the logistics manager but have caused many carrier bankruptcies. For high-value or less-durable goods, trucking may be less hazardous than rail or water transport. Air-filled tires provide a better cushion for cargo than steel wheels on steel rails. Vehicle suspensions, too, are better than they used to be. Riding long hours in the cab can still be hard on the operators.

Water Transport Water transportation forms an important part of domestic and international trade. It includes several categories: inland waterways, lakes, coastal and intercoastal ocean, and international deep sea. In international shipping, water is the dominant mode, and it is the most inexpensive method of shipping high-bulk, low-value commodities.

Capabilities Water carriers can handle huge loads, measured either in weight or size. A barge traveling slowly down the Rhine or some other

European waterway, for example, might be loaded down with 1,500 metric tons (or tonnes) of high-density cargo (approximately 1,654 U.S. tons), while a fully loaded semi-trailer truck traveling across a bridge above it carries only 7 metric tons (7.7 U.S. tons) and itself weighs approximately 36.3 metric tons (40 U.S. tons). In other words, the barge could hold the weight equivalent of more than 30 fully loaded double-trailer trucks. Rather like trains, however, barges and other floating carriers find their most fitting use in conveying low-value, high-density cargo over long distances, with loading and unloading accomplished mechanically. Probably the largest vessels on the water are the oil tankers. They are usually classified by function and size. There are two functional types of the vessels: the crude tankers, which carry unrefined crude oil from the field to refineries, and the product tankers, which carry petrochemicals from refineries to market areas. Sizes range from inland or coastal tankers to gigantic supertankers. Most newer tankers have a double hull, thereby creating extra “safety” space between the storage tanks and the hull. Each very large ship can transport two million barrels of oil. In light of recent serious oil spills in oceans, both the U.S. and the EU have passed laws regarding

pollution and double hull requirements that are in effect as of 2015 and 2010 respectively. The primary value that water transport provides the logistics manager is low cost. At less than a penny charged per ton-mile, shipping by water is even cheaper than using a train. Water carriers also make highly efficient use of fuel. According to their 2012 annual report, the American Waterway Operators found that one gallon of fuel moves one ton of cargo 616 miles by inland barge, 478 miles by train, and only 150 miles by truck. A 2017 study by the U.S. National Waterways Foundation upgraded the inland barge estimate to 647 miles for a ton of cargo on one gallon of fuel. Water transport can also relieve congestion on crowded highways—a significant consideration in the European Union and near urban centers generally. In the Asian region, more than one billion tons of freight moves by inland water carrier annually on waterways such as the Yangtze and the Ganges, and one-third or more of all cargo travels by water in Bangladesh, the Lao People’s Democratic Republic, and Myanmar. In some areas of Asia where there are few roads or railroads, waterways constitute the sole means of connecting remote rural communities to urban centers. Shipping containers play a big role in domestic and most international water shipments. In fact, it has been said that

containerization has transformed global trade in manufactured goods as dramatically as jet planes have changed the way we travel and the internet has changed the way we communicate. The shipper places cargo into a container at its facility. The container is then transported by rail or trucking carriage to a water port for loading onto a containership. After arrival at the port, the container is unloaded and loaded onto a rail or trucking carrier and delivered to the customer. Containers are typically 8 feet/2.44 meters high by 8 feet/2.44 meters wide and of various lengths, from 20 feet/6.1 meters to 53 feet/16.15 meters. Many new containerships are capable of carrying 18,000 20-foot equivalent units (TEUs) or the equivalent of that many 20-foot containers. (The largest vessel can carry 23,964 TEUs.) But the container is much more than a box and has become increasingly sophisticated. Depending upon the cargo, there are stringent container temperature and storage requirements.

Market Conditions In the United States, water transport has remained stable, in the range of 15 to 17 percent of total ton-miles, over the past five decades. During that time, however, the portion of that amount due to Great Lakes shipping (shipping on the five freshwater lakes of central North America between the United States and Canada,

connecting midwestern U.S. ports with the Atlantic Ocean via the St. Lawrence Seaway) has declined to a fraction of its peak in the 1950s, while river and canal transport have increased to make up the difference. The ships used on the Great Lakes are deep-water vessels, which can harbor only in deep-water ports such as those on the Lakes or the coasts. Canal and river transport relies on flatbottomed barges with more flexibility as to where they can travel. In the EU, freight moves on such major rivers as the Rhine, the Rhone, the Danube, and their many tributary canals. According to a 2020 article in PortNews, in 2019, China had 127,000 kilometers of inland waterways (first in the world) upon which were shipped 3.913 billion tonnes of freight that year. Of the 19,000 kilometers of high-level inland waterways planned to be ready by 2020 (i.e., suitable for larger barges), 13,400 miles had reached the desired standard by the end of 2019. The Yangtze, one of its major rivers for transporting coal and steel, had 2.39 billion tonnes of freight that year, also a first-place record. The network is continuing to grow in efficiency and profitability. The primary products transported on inland waterways include commodities such as cement, chemicals, and some agricultural products. U.S. Great Lakes vessels mostly carry ore, coal, and grain. The bulk of this trade qualifies for exemption from government

economic regulation. These exemptions, combined with low fixed costs (an amount somewhere between rail and road), mean that shippers can afford to transport goods in their own vessels rather than hiring a third-party carrier. Like trucks, and unlike trains, water carriers are relatively affordable. The waterways, like highways, are maintained by the taxpayers. Despite the worldwide economic downturn in recent years, maritime transport has continued to grow. According to information by Statistica, in 2020, containership capacity was 275 million metric tons of cargo compared to approximately 11 million metric tons in 1980. These and other modes of transport moved 1.83 billion metric tons of cargo in containers in 2017 (one quarter of all cargo by weight and one half of all cargo by value). According to Costamare Inc., containerized cargo trade tripled between 2000 and 2017, which was twice the rate of the growth in GDP. Maritime container volume is also continuing to grow. The area of oil transport has also shown significant growth. Per Statistica, the world’s oil tanker fleet’s capacity grew by over 77 percent to about 601 million deadweight tonnage from 1980 to 2020, and this reflects about 29 percent of global ocean trade.

Issues/Challenges

There are two obvious drawbacks that might prevent a logistics manager from using water transport: limited accessibility and lack of speed. There are fewer miles of inland waterways than there are roads and railroad tracks, and if the shipper and the recipient have no direct access to a port, they have to use another mode of transportation to get products to and from the carrier. Once on the water, progress is slow on a barge or in a deep-water vessel. Not only are barges—or the diesel-engine vehicle that tows them—slow-moving, but on natural waterways they must make their way through a series of locks. When rail lines run parallel to a waterway, trains make strong competitors for water carriers for transporting the kinds of heavy, low-value goods carried on barges. The tradeoff is between the greater speed of the train and the far lower rates for water transport. Barges using major waterways must compete with other important uses, such as passenger transport, fishing, recreation, drinking water, nature conservancy, and energy generation. Discharges from cargo carriers can be a significant source of pollution, along with runoff from mining and agriculture, and pollution is incompatible with the competing uses of rivers for recreation and drinking water. Some of the major waterways in Europe, which pass through many

countries with separate and various levels of regulation, have become seriously polluted over the years. Globalization has increased the need for efficient and reliable international transport routes and networks. Their development requires creating new infrastructure or upgrading existing national and international infrastructures to accommodate the increase in maritime traffic volumes. The use of containers for intermodal logistics can reduce staffing needs, minimize in-transit damage and pilferage, and shorten transit time. But there can be problems at the ports impacting the timeliness of unloading containers from ocean liners. In some countries, the shortage of containers can limit supply chain capabilities. The increase in import volumes, aging port equipment, shortage of rail capacities, and limited numbers of truck drivers and carriers can lead to delays. For example, the 2015 U.S. West Coast port strikes created severe backlogs for the trucking and container/tanker shipping industries. With 70 percent of imports from Asia coming through the West Coast, the strike impacted all organizations shipping or awaiting their goods. Ports were gridlocked, and dozens of containerships were queued for miles during the nine-month strike. Some supply chain managers had to resort to expensive air shipment, including Fuji

Heavy Industries, which flew parts to its Subaru auto plants, adding approximately US$59 million per month in transportation costs. The risk that terrorist organizations could use the mechanisms of international trade and commerce poses additional considerations, including specific concerns that containers could be used to transport dangerous goods or carry out large-scale attacks. The challenge is to advance port and maritime container security while ensuring continued free movement of legitimate trade.

Pipeline Transport There’s a reason pipelines aren’t the first mode of transport that comes to mind. Other modes move the entire vehicle; the pipeline instead holds still while the cargo moves. Pipelines move a higher percentage of U.S. freight than water transport, largely because of their special adaptation to conveying crude oil and petroleum products. Natural gas is also transported in pipelines. Although there are about 305,000 miles of inter- and intrastate pipelines in the U.S., many carrying natural gas are nearing their capacity. Due to the aging infrastructure of some underground pipelines, gas companies are compelled to invest in ongoing maintenance and repair work.

Capabilities Not only are pipelines unique in being stationary carriers; they generally move their cargo in only one direction—thus eliminating the need to be concerned about backhaul carriage. Also, no packaging is required to move cargo through a pipe. The pipe is the package and also a storage facility. Pipelines are special, too, in that they are available for continuous use on all days, in all seasons, and at all hours. Unlike air, motor, and rail carriers, they pose no noise problems. They will, however, cease to move cargo during power outages, since the pumps that cause the contents to flow depend upon electricity. Even an information systems failure could stop a pipeline, as the ransomware attack on the Colonial pipeline in 2021 showed. (It caused widespread gas shortages.) Also on the downside, pipelines are expensive to construct and maintain. Since pipelines are fixed in place, they have the highest fixed costs of all modes of cargo transport but the lowest variable costs—a cost structure otherwise similar to that of rail transport. The fixed costs are mainly due to right of way, construction of facilities, and pumping capacity. The costs of operation are very low. In general, the carrying capacity of pipelines increases relative to pipe diameter. Also, increasing diameter reduces the amount of

liquid in contact with the pipe for a slight friction decrease and efficiency gain. In the past, safety has been one of the major benefits of pipeline transport. They are unaffected by weather conditions and highly unlikely to rupture. Cargo damage and loss are virtually nonexistent. The main natural enemy of the pipeline is seismic activity. The catastrophic Hurricane Katrina that devastated the U.S. city of New Orleans in 2005 closed the port and destroyed much pumping and refining capacity but did not rupture the pipes that run cross-country to the East Coast. The rise of international terrorism, however, creates risk because long pipelines are difficult or perhaps impossible to secure against attack. Aside from crude oil and petroleum products, pipelines carry manufacturing chemicals, municipal sewage and water, and dry materials such as cement that can be pulverized or flour that can be suspended in liquid. One coal slurry pipeline exists in the United States, and research continues into transporting other materials in suspension or slurry form. Pipelines are natural monopolies, since constructing parallel pipelines to compete for the same business would be far too costly. In the United States, some pipelines are owned by shippers, but most operate as common carriers.

Issues/Challenges Only liquids or liquefiable products can move through the pipe. Construction is costly. Pipes are inflexible delivery vehicles, and access to the pipeline is limited to those with facilities adjacent to it. Others have to bring their product to the pipe using other modes of transport, thus losing the benefits of the pipeline for that portion of the trip and adding variable costs of loading, unloading, and operating a vehicle. Pipelines are of limited use in international carriage, because they are vulnerable to political disputes between the countries whose borders they cross—also a problem for other modes of transport that cross boundaries.

Air Transport Airplanes constitute both the newest and the least-used method of transporting cargo, although they have been carrying mail for about 100 years. The primary business of the major air carriers is the transport of passengers. Commercial cargo, for the most part, has been relegated to filling up space not occupied by people and their luggage.

Capabilities

The clear advantage in speed of delivery goes to the airplane over all other modes of transport. Cruising near the speed of sound, newer airplanes can cross entire continents and oceans in a matter of hours. This allows logistics managers to reduce or eliminate safety stock and warehouses. Because air travel is relatively smooth and fast, it is especially well suited to carrying valuable, fragile, and perishable cargoes. However, air cargo is not limited to such items. Any commodity can travel by air, subject only to restrictions on weight and size. The military, perhaps the world’s first and best logistics manager, air-lifts heavy equipment to battle zones. Cargo destined for travel in an airliner’s hold requires significantly less packaging. Air transport benefits from low fixed costs, ranking second in that regard only to over-the-road motor carriers. Airports are generally constructed and maintained by taxpayers—federal or local—with gates leased to carriers. Shippers can afford to purchase or lease their own fleet of airplanes. Variable costs, however, are high, due to the rising cost of fuel and the expenses accruing to a very laborintensive business.

Market Conditions Some industries are important to a country but may not ever be considered profitable. Transportation is a market sector where this is

particularly true, especially in the case of airlines. Around the world, airlines tend to be run by governments or may be regulated, with the requirement that they persist in serving markets that may be important from a public perspective but are not necessarily profitable. The United States, where airlines have always been privately held, is the exception. Until 1978, the U.S. airline industry was highly regulated. After legislation eased regulation, airlines were allowed to set their own rates and choose which markets to serve or abandon. Since that time, air rates have fallen dramatically, and carriers once restricted to U.S. markets have added international flights. While this might seem to offer better access for logistics purposes, the downside of deregulation has been increased instability in the industry, including many airline bankruptcies. On the positive side, international air transport has become a strong competitor with water transport for transoceanic carriage. Air cargo (with the exception of small parcels) often flies on the same planes as passengers. Freight forwarders contract with these airlines. In addition, specialized package services, such as Federal Express and United Parcel Service in the United States, use dedicated cargo planes—no passengers allowed—to offer a range of transport services.

Issues/Challenges Speed is the air carriers’ primary advantage, with low loss and damage rates tagging along behind, but with speed comes a higher price tag. At around three times the cost of road carriage and more than 30 times the cost per ton-mile of rail carriage, air transport exacts a high cost in exchange for rapid delivery. When comparing air to ocean transport in terms of efficiency and lower cost, items that fit into the categories of smaller, express, high-value, and timesensitive shipments are still best served by air. Generally speaking, to justify the transport cost, air cargo almost always has to be high in value, at least to the buyer. For example, fresh fish for high-end restaurants is usually shipped via air. Accessibility, too, is sacrificed for speed, especially in comparison to trucking. Airports are extremely expensive to build and very difficult to site. They require vast expanses of flat land and may require condemnation of existing homes and businesses, given their usual placement near cities. The major airports serve the world’s large cities—for the convenience of the airlines’ primary business of transporting passengers. There is little call for building airstrips near mines, forests, or farms for pickup of raw materials. However, many major cities have made huge investments in their airports in recent years, and many are now or are rapidly becoming world-class, with

high capacity for cargo. In Asia, Beijing, Ho Chi Minh City, Singapore, Bangkok, Hyderabad, and Bangalore are all examples. Air transport can suffer from delays caused by weather conditions, though advances in air control and instrumentation have somewhat decreased these problems. Major air carriers are considered to be prime targets of terrorism, but this is a drawback they share with other modes. While security concerns may add to costs and delays, they probably are not major factors in the logistics manager’s calculations. Although air carriers have made some progress in establishing intermodal service with road carriers, there is a natural limit on the establishment of direct links between airports and rail terminals or ports.

Intermodal Transport Intermodal transport includes package delivery, container hauling, and other intermodal services. Many deliveries cannot be accomplished by a single mode of transport—for reasons of access, price, size or weight of cargo, etc. Therefore, intermodal integrates the different modes of transportation in various combinations to take advantage of their specific capabilities. Since deregulation, the legal barriers to mixed mode and specialized services have decreased

and new types of specialized or hybrid transport providers have entered the marketplace. In global logistics, the question of what is the most efficient and costeffective mode of international shipping poses additional considerations. There is no definitive answer as to the ideal mode. The choice in hybrid transportation modes is driven by an organization’s specific needs and the capabilities of the shipping and logistics entities.

Package Delivery Services Package delivery services developed because traditional singlemode operators have generally been unable to carry small packages at a reasonable cost. Among the challenges to overcome when delivering small parcels are collecting enough packages from diverse shippers to constitute a load and distributing the packages to diverse, perhaps inherently unprofitable, locations. Government-run postal services have traditionally filled this niche in the market alongside, or in place of, private carriers. In the 1970s, specialized package carriers such as UPS, DHL Express, and Federal Express (FedEx) were growing in importance, generally beginning in the United States and then spreading around the world. In addition to those U.S. services, TNT began in Australia

and eventually grew into another dominant worldwide express service—all of which developed sophisticated, multimodal logistics expertise. A 2020 article on supplychaindigital.com identified the top ten largest couriers in the world, from largest to smallest, as DHL Express, UPS, FedEx, Deutsche Post, SF Express, Japan Post Holdings, Poste Italiane, Royal Mail, ZTO Express, Osterreichische Post, and PostNL. Another large service is the United States Postal Service. It had 2020 revenue of over $73 billion and employs over 644,000 people. Many other express carriers exist, such as OCS, a provider of worldwide delivery and logistics services based in Canada since 1963, and Aramex, based in Amman, Jordan, which primarily serves the Mideast. The major benefit offered by the express carriers is speed; the major drawback is price. Manufacturers and distributors that value speed have come to depend upon same- and next-day service from express carriers. These include pharmaceutical companies, hospital suppliers, food retailers, financial services, and suppliers of repair parts to companies anxious to build customer loyalty. In the expanding marketplace of lean manufacturing, Just-in-Time delivery, and global supply chains, however, speed is becoming more a competitive necessity and less a marginal benefit.

According to Statistica, in 2020, the express carrier industry was expected to be worth 375.5 billion euros. Express services not only assist other businesses; they are, in fact, substantial contributors to national and regional economies. Their hubs attract other businesses that rely upon the express carrier for their deliveries. Express services also play an essential part in the rapidly growing marketplace of goods sold outside of stores. Online sales depend upon national postal services and their express service competitors to make their businesses attractive to customers. Finally, because they can combine deliveries from many customers, package delivery services offer small and medium-sized companies a chance to benefit from economies of scale.

Container Hauling and Other Intermodal Services Container transport makes up a significant amount of the intermodal traffic, but other methods exist, such as transporting a truck and trailer or a truck trailer using a different mode. Air also requires truck service. Intermodal services include piggyback, trainship or containership, truck-plane, and freight truck on railcar. Piggyback service (TOFC, COFC, RoadRailer). The nickname “piggyback” signifies the placement of a truck trailer or a container of cargo on a railroad flatcar, hence the names TOFC (trailer on flatcar) or COFC (container on flatcar). The cargo travels part of its

way via truck and the rest of the way by train. While the trailer provides the more direct link between train and truck, the fact that it sits on wheels creates more wind resistance during the rail portion of the shipment. Aside from their better aerodynamics, cargo containers provide more efficiency and flexibility, since they can be double-stacked on railcars or loaded onto water carriers as well as flatcars and flatbed trucks. RoadRailers are trailers that ride on either regular tires/wheels or steel wheels. A simple change of wheels allows them to ride on the highway behind a tractor or be pulled along the tracks as short railcars. This eliminates the need for expensive materials-handling equipment. The RoadRailer is highly cost-effective when compared with simple over-the-road hauling. Trainship or containership service. “Trainship” and “containership” refer to mixed mode transport that includes water carriage. It also is sometimes referred to as “fishyback.” As the names signify, the cargo is loaded into a truck trailer, a railcar (trainship), or a container that also spends part of its shipment time on board ship or barge. These combinations use domestic waterways—rivers, canals, the U.S. Great Lakes, and coastal waters, and similar setups are used in overseas transport. The land bridge, for instance, combines rail

and sea transport. The land bridge route may run from the coast of Asia to the U.S. West Coast by ocean vessel, from the West to East Coasts on rails, and then from the Atlantic coast to Europe on another ship. The alternative is an all-water route through the Panama Canal. In contrast, the micro land bridge moves goods over water and then land, with the final destination inland. Mini land bridge traffic moves goods over water and then land, with the final destination being on the opposite coast. Truck-plane services. Air transport generally requires some intermediary surface travel (sometimes referred to as “birdyback” services), since airport terminals are not usually located near manufacturing, harvesting, or extraction sites, and those sites are generally not equipped with their own private airstrips. Intermodal air-truck shipments, such as those routinely scheduled by UPS and FedEx, simply formalize the process and put it under unified management. But small package shippers are not the only ones relying upon truck-plane services. Other commodities travel via this mixture of modes, especially those that originate or conclude in smaller cities and towns not served by major airports and large planes. The package carriers do serve smaller cities, of course, but heavier freight generally goes to other carriers.

Freight truck on railcar. In Europe (for instance, in Austria), there are now laws restricting driving at night by truck drivers hauling freight. So a truck is loaded onto a flatbed railroad car, which is transported to another location via rail while the truck driver sleeps on the train to continue moving during prohibited hours (the required rest period). The intermodal concept offers logistics managers flexibility, efficiency, and reduced costs. The future of the combinations outlined above most likely rests upon the cargo container rather than the truck trailer or the railcar. The container provides the maximum flexibility, since it can be loaded onto trucks, trains, barges, or oceangoing ships. Transportation management software is available to help determine the best intermodal combinations and can assist the logistics team with identifying the optimal mix in order to get materials to where they need to be in a timely manner as well as at the lowest price.

Types of Carriers After selecting the most effective mode, or modes, of transportation, the logistics manager must decide on the appropriate type of carrier —common (public), private, contract, or exempt. This decision is influenced by consideration of each carrier’s “legal type,” that is, the

operating authority granted the carrier by the relevant government regulatory body. For example, in the U.S., the authority to operate under a given legal type is regulated by federal statute and the U.S. Surface Transportation Board (STB). In the EU, it is regulated by the European Commission’s Directorate-General for Mobility and Transport. The four types of carriers discussed below are generic in nature, and each provides a set of advantages and tradeoffs. While much of the discussion uses U.S. examples, these general types are relevant in many other countries.

Common (Public) Carriers The APICS Dictionary, 16th edition, defines a common carrier as transportation available to the public that does not provide special treatment to any one party and is regulated as to the rates charged, the liability assumed, and the service provided. A common carrier must obtain a certificate of public convenience and necessity from the Federal Trade Commission for interstate traffic. The opposite of a common carrier is a private carrier. “Public carrier,” or simply “carrier,” is a term used in continental Europe and elsewhere and is the functional equivalent of a common carrier. However, to confuse the issue, in U.K. English, a public carrier refers

to a contract carrier, defined later, not a common carrier. The remainder of this discussion uses the term “common carrier.” Common carriers perform the bulk of shipping in the United States, form the basis of public, commercial transportation, and are used extensively in most logistics systems. Common carriers operate in the public interest. Granted the authority to enter the market by a country’s federal government, they are also subject to the greatest amount of regulation governing rates and the scope of their service. Government licensing and regulatory restrictions are designed to guarantee that the economy will not suffer from a lack of commercial transportation at reasonable rates. While such regulation ensures logistics managers that carriers will be available for their products and within their geographic markets, it also means that managers must understand the relevant regulations and take their effects into account when selecting modes of transport and types of carriers. To enter the common carrier business in the United States, for example, a company must demonstrate that it is able and willing to provide service. The U.S. STB governs entry into the common carrier market for rail, motor, and marine transport; the U.S. Department of Transportation (DOT) regulates entry into air transport.

Regulation of common carriers governs public service, liability, discrimination, and rates. Public service. Common carriers may be licensed to carry all types of goods or only certain types (household goods, computers, etc.), depending upon their capabilities. Within the scope of its license, the common carrier must transport whatever goods are offered to it and deliver the goods to any point within its designated territory. Assumption of liability. Common carriers assume the risks inherent in transport—a definite benefit for the shipping company. The carrier is responsible for any damage, loss, or delays that occur while the goods are in its custody—with certain exceptions, such as inherent product defects and acts of God, public enemies (criminals, terrorists, etc.), or the shipper itself. No discrimination. Common carriers are required to take all legitimate business within the scope of their licenses, even at a loss. They may not discriminate among shippers, products, or places by charging different rates or providing different levels of service. There is some flexibility for varying rates in line with differences in the costs of doing business. Common carriers in the trucking sector generally specialize in either full truckload or lessthan-truckload carriage.

Reasonable rates. Common carriers must publish their rates, and the rates must not be too high (thus limiting shippers) or too low (thus endangering the carriers).

Private Carriers A private carrier is a company that owns or leases a fleet of vehicles to transport its own products. A private carrier that purchases a fleet of vehicles incurs the costs of ownership—such as maintenance, insurance, depreciation, and financing. The vehicles also count as assets on the balance sheet, which worsens certain financial ratios. Ownership requires decisions about when to buy and sell the vehicles; leasing eliminates some of the concern with depreciation, financing, and term of possession. Ownership and leasing are otherwise similar. In both cases the vehicles are in the possession of the company and are its responsibility. To qualify as a private carrier, a company must own or lease vehicles for its use, manage their operation, and not be primarily in the transportation business. While private carriers are free from economic regulations that apply to other legal types of carriers, they must follow regulations that apply to hazardous materials, safety, and other matters regulated by the government.

Owning or leasing a fleet has advantages and disadvantages. On the positive side, the company has control of the vehicles for its own use. On the negative side, the size of the fleet is relatively inflexible. If business turns down, the company either has to maintain unused vehicles or divest itself of some vehicles through sale or a lease buyout. Neither tactic is likely to be profitable. Before deregulation in 1980 in the U.S., private carriers were forbidden to carry the goods of other companies. Since deregulation, they have been able to do so, and some private carriers are licensed in more than one legal class—a significant benefit if the vehicles can fill up with another company’s products when they would otherwise be making empty backhaul trips. At first the benefits of deregulation resulted in an increase in the number of private carriers. Eventually, however, that trend reversed as more companies sold off their private fleets and outsourced logistics functions in order to focus on their core businesses.

Contract Carriers Unlike common carriers, contract carriers are not required to make their services available to the general shipping public, though they do require government authorization to do business and are governed by economic regulations. They enter into contracts with

terms specific to the customer and then receive a permit to carry out the business defined by the contract. Contracts specify rates, type of service (number and frequency of trips, etc.), and liability. Although U.S. contract carriers were once subject to strict regulatory limits on the number and terms of their contracts, since the MotorCarrier Act of 1980 they are more free to compete with other types of carriers. For example, before 1980 contract carriers were limited by law to have no more than eight active contracts; now they may serve any number of current customers. Contract carriers offer several advantages to logistics managers. Their rates are generally lower than those of common carriers, and because they aren’t required to serve the general shipping public, they can adapt their business to a customer’s specific needs by, for example, scheduling special deliveries or using specialized equipment. They rival private carriage in that regard while providing added flexibility. The independent trucker is a special type of contract carrier who owns a tractor (and perhaps a trailer) and makes arrangements to subcontract with other types of carriers, including common, private, contract, and exempt carriers.

Exempt Carriers

Exempt carriers are not subject to economic regulation of their rates and terms of service. They are, however, responsible for compliance with licensing and safety laws (which are state-based in the U.S.). In the U.S. they must publish their rates if they operate across state lines. (Most exempt carriers operate locally.) The market determines their rates, services, and availability. Exemptions are granted for specific commodities and for certain areas of operation, such as the zones around airports. Typical exempt commodities include raw materials and unprocessed agricultural products. Logistics managers rely on exempt carriers for a significant amount of business in their niches, such as local transport of agricultural products. The primary benefit offered by exempt carriers is lower rates. Their primary drawback is limited availability for many products and a limited range of operation.

Section C: Trade Considerations This section is designed to Describe some common security and regulatory concerns, including risk of loss and complying with import and export requirements Understand the benefits of participating in voluntary security partnerships with various nations, such as C-TPAT in the U.S. Understand customs regulations related to prohibited goods and documentation Understand the impact that differences in international, country, and local labor laws can have on global supply chains Describe how to efficiently deal with customs when importing or exporting goods Enumerate the operational considerations of importing and exporting Define the Incoterms® trade terms used in foreign trade contracts and distinguish where and when cost responsibilities shift between seller and buyer Identify and describe the intermediaries involved in import and export

Describe how the Harmonized Tariff Schedule is used in import and export transactions Define free trade zones and describe the requirements for and benefits of participation Explain trading blocs and how they impact the participants as well as those outside the supply chain. This section examines security, legal, and regulatory factors, including customs best practices and the use of Incoterms® trade terms. It also addresses export and import documentation requirements. The section concludes with a discussion of trade considerations, including free trade zones and trading blocs.

Topic 1: Legal, Security, and Regulatory Requirements After presenting general processes that can be used to identify, assess, and implement compliance and risk management related to legal, security, and regulatory requirements, we discuss voluntary security partnerships, import and export requirements, and compliance with labor laws.

Legal, Security, and Regulatory Requirements Road Map Effective supply chain management encompasses a wide array of security and regulatory concerns, especially in material movements and transaction reporting. Security and compliance issues often have implications for supply chain cost management, timing, or information systems that require management’s involvement. Failure to comply with security and other regulations and requirements can result in problems ranging from costs and delays to significant fines or even complete shutdown of business activity followed by civil or criminal penalties. The management challenge is to meet the requirements imposed by countries and trading blocs as well as those mandated by tax revenue, environmental, and security agencies and to do so with the least possible financial impact. Supply chain risk management has increased in importance and has become a major focus for supply chain managers. Key security and regulatory issues include the following: Ensuring the physical security of modes of transportation and storage Complying with import and export regulations and documentation requirements

Meeting increased identification requirements and establishing systems to deny access of unauthorized people to supply chain materials Keeping supply chain information systems secure from hacking Deciding whether to voluntarily comply with global antiterrorism initiatives, such as the C-TPAT (Customs-Trade Partnership Against Terrorism) initiative in the United States or the AEO (Authorized Economic Operator) program of the European Union Maintaining proper internal operational and financial controls An example of a risk related to physical security and compliance is the limitation on the amount of flammable materials that can be stored in a given warehouse. Warehouses with flammable (or explosive or otherwise unstable) materials need to manage risks by ensuring that there is sufficient stock of inventory to conduct business while staying below the regulatory limits for the materials. Ensuring compliance with all safety protocols is also a key risk control. An example of a risk related to internal operational and financial controls is compliance with the U.S. Sarbanes-Oxley Act (SOX). Compliance with this act is required for any U.S. or foreign organization whose stock is publicly traded on U.S. stock exchanges. Segregation of duties to prevent conflicts of interest is a

key concern. For example, the buyer in a transaction should not also be the seller or any associate of the seller who might profit from the transaction. SOX also requires that the organization’s quarterly and annual financial reports disclose certain off-balance-sheet transactions and provide detailed descriptions of certain internal control systems. The off-balance-sheet reporting disclosure requirement could impact vendor-managed inventory (VMI) arrangements, for example, because this could involve moving an asset (inventory) off of the balance sheet. Similarly, outsourcing arrangements may need to show that adequate internal controls exist. Penalties for noncompliance could include fines from civil lawsuits brought by the U.S. Securities and Exchange Commission, reputation damage, or criminal suits against executive officers accused of falsely certifying reports. The key processes that supply chain managers need to be able to perform related to complying with standards, regulations, and sustainable best practices are Identifying applicable standards, regulations, and sustainable best practices Performing a gap analysis for compliance Developing and implementing an action plan.

Each of these processes is introduced next. Note that these are general overviews. The information required to plan and execute these processes is presented elsewhere in this section.

Identifying Standards, Regulations, and Best Practices The process of identifying applicable standards, regulations, and sustainable best practices (compliance items) involves the following steps: Reviewing organizational processes (existing procedures, tools, and documentation) for currently applicable compliance items Developing, hiring, or contracting with applicable persons or organizations to gain expertise in compliance items Scanning for global, national, regional, community, and industryspecific compliance items (including laws and taxes) in each area of operation, differentiating between applicable versus nonapplicable items, and identifying applicable compliance items that Promote operations such as by leveraging reduced tax zones Constrain operations such as by imposing end-of-life reverse supply chain requirements Differentiating between mandatory and voluntary items

Updating records and procedures to add any new mandatory items For voluntary items, doing a benefit-cost analysis to determine which compliance items are advantageous to pursue Updating records and procedures to add new voluntary items that are advantageous to pursue

Performing Gap Analysis for Compliance The process of performing a gap analysis for compliance involves the following steps: For all mandatory compliance items, determining level of existing compliance Comparing actual compliance against baselines for minimum compliance Creating a list of mandatory item gaps For all voluntary compliance items, determining desired level of compliance Comparing actual voluntary compliance against desired compliance targets Creating a list of voluntary item gaps

Developing and Implementing Action Plan The process of developing and implementing an action plan involves the following steps:

For mandatory compliance gaps, developing and executing project plans to address the issue(s) Keeping relevant regulatory authorities appraised with all necessary information on remediation plans and status For voluntary compliance gaps, developing a feasibility study to better understand the scope of the changes, their costs, and the timeline Implementing approved voluntary compliance programs as projects Updating relevant policies, procedures, processes, and metrics to enforce compliance steps and ensure that the changes become part of operations Using change management to change the culture and get the workforce behind the new methods

Security Partnerships and Regulations Because most of the imports and exports to and from a country are in the form of private party trade goods, governments wanting to increase border security and prevent terrorists from intrusion into supply chains have a choice: Subject all imports to additional security measures at enormous expense for the government and with lengthy delays to the movement of goods, or forge partnerships

with organizations and other customs agencies to improve security. The primary benefit for organizations is that the customs process may be faster and smoother. Examples of security partnerships include C-TPAT for imports (defined below)—U.S. Authorized Economic Operator (AEO) program—EU Partners in Protection (PIP)—Canada Secure Trade Partnership (STP)—Singapore AA rating for customs—China. The Customs-Trade Partnership Against Terrorism (C-TPAT) is a joint government-business endeavor for imports (not exports) to increase the security of supply chains and U.S. borders. Initiated by U.S. Customs, C-TPAT is based upon the idea that achieving the highest levels of security requires cooperation between the U.S. government and supply chain participants such as importers, carriers, brokers, warehouse operators, and manufacturers. U.S. Customs has used C-TPAT to establish mutual recognition security arrangements with New Zealand, Canada, Jordan, Japan, Korea, the EU, Taiwan, Israel, Mexico, Singapore, the Dominican Republic, and Peru (as of 2021).

Costs and Benefits of Participating in Security Partnerships

C-TPAT will be used to illustrate the costs and benefits of participating in security partnerships. Various partnerships have differences, but the costs and benefits should be comparable. Costs Participation in C-TPAT by businesses is voluntary, but participation will result in costs related to implementation, audits, and compliance actions. Acceptance in C-TPAT is based on submission of an online application and a signed agreement to take the following actions: Assess/validate the company’s own supply chain security in accordance with C-TPAT guidelines that encompass procedural security, physical security, personnel security, education and training, access controls, manifest procedures, and conveyance security. Guidelines are available in the Resource Center. Submit a supply chain security profile questionnaire to U.S. Customs. Develop and implement a program to enhance supply chain security in accordance with C-TPAT guidelines. Communicate the C-TPAT guidelines to partners in the supply chain and work toward including the guidelines in relationships with those companies.

Benefits In return for instituting C-TPAT security guidelines, participating businesses receive the following benefits (after evaluation of the application): Fewer inspections, for reduced border time (Note that while many partners do experience these benefits, C-TPAT legal language specifically states that membership will not speed up clearance or help avoid searches.) Assigned account manager Access to the C-TPAT membership list (provides members with access to C-TPAT–certified providers that may be appropriate to their supply chains) Eligibility for account-based processes such as bimonthly or monthly payments Emphasis on self-policing rather than customs verifications Membership treated as a positive risk-assessment factor by customs Helps establish the organization as a good community partner When mutual recognition arrangements exist, less duplication of effort between the countries’ customs authorities (Participants have to conform to only one set of standards, not two.) C-TPAT began offering partnership admission to importers and carriers with the intent to expand enrollment to all supply chain

participants. Partly because of this and partly because the program is voluntary, supply chains may have some partners who are compliant and some who are not. Often a transportation partner such as a freight forwarder will participate in C-TPAT while the manufacturer may not. Business partners cooperate with customs in developing security guidelines, with the explicit intention of keeping costs down and reflecting a realistic business perspective. Noncompliant C-TPAT participants may have their benefits suspended or the participation canceled. Otherwise, C-TPAT creates no new liabilities beyond existing trade laws and regulations.

Complying with Import/Export Requirements Compliance with import/export requirements can be complex due to the myriad requirements and trade agreements in both the importer’s and the exporter’s country. International shipping laws may also need to be considered. Many times, these regulations contain numerous exceptions that can save the organization considerable expense if it understands and applies them without inadvertently violating the regulation. For example, the harmonized system classification codes are used to identify a product’s type, but there may be leeway to classify a good

as one type or another, possibly resulting in a tax or customs advantage. However, a risk is that customs could disagree with the classification, resulting in delays and/or fines. Legal review is needed. In addition, import/export can create significant risks of delays at customs. One way to mitigate this risk is to use electronic messaging to preclear product shipments rather than risking problems at the port of entry/exit. This is especially the case when the supplier lacks the trust of the importing government. Complex electronics or chemicals may experience customs delays as they are checked for contraband. Sourcing these goods domestically may be the only way to reduce this risk. Two examples of import/export requirements are prohibited goods and labeling and documentation requirements.

Prohibited Goods Countries may prohibit certain goods from entering or leaving the country for national security reasons, domestic trade protection, or protection of the health and safety of its citizens. Some potential suppliers are banned because they are connected to terrorist organizations or organized crime. For example, in the U.S., several agencies maintain lists of prohibited individuals and entities,

including the Office of Foreign Assets Control (OFAC). U.S.-based organizations and citizens are not allowed to trade with or have financial transactions with these entities. It is the organization’s responsibility to check such lists for the countries in which they operate, although trade relationship management software can automate verification. Another reason goods may be prohibited is due to a pandemic outbreak of disease or other source of contamination of foods or other goods. For example, a country could ban imports of toys if testing confirmed the presence of lead. After the 2011 earthquake in Japan, the U.S. prohibited imports of milk, fruits, and vegetables from Japan due to the radiation from damaged nuclear reactors. Many nations prohibited the export of masks, medical equipment, and raw materials used to make vaccines as part of their response to the 2020 global pandemic. Dangerous goods also face restrictions. There is a movement to support more thorough documentation and disclosure of potentially problematic material content of goods exchanged in trade. One risk is having out-of-date information, which can be prevented by regular checking. Organizations face serious consequences such as significant fines for failing to verify that goods can be imported or exported prior to

attempting the transaction. The risk of ones’ own goods being prohibited due to contamination is likely a type of risk that cannot be adequately planned for and may or may not be covered by insurance.

Labeling and Documentation Product labeling and documentation regulations for imports and exports often require organizations to label goods in the import country’s local language(s). Delayed differentiation and delayed packaging strategies can reduce the risks of carrying too much product in one country and not enough in another solely due to packaging. Organizations should verify that they understand all labeling requirements such as product warnings, ingredient lists, or health facts. Also, many regulations exist related to misleading labeling, which creates a risk that a product could be banned. There is a large amount of documentation for international trade, and as such there is a risk that some of it could be missing or incorrect. Documentation may include letters of credit, bank drafts, bills of lading, combined transportation documents, commercial invoices, certificates of origin, material safety data sheets, and insurance certificates. Each must comply with regulations. Such documentation may be required to be multilingual, not only for the country of import and export but for every country the goods pass through. When this

documentation is complex, it creates a risk of delaying shipments to get the documents translated. One way this risk can be mitigated is for organizations to use standardized electronic messages when they are allowed (or required) in place of physical documentation.

Labor Law Compliance Since global supply chains often employ workers in multiple countries, it is important to understand how to navigate country and local labor laws and to know some international labor considerations and best practices.

Country and Local Labor Laws Country and local labor laws can differ significantly. Labor laws in centralized economies may look quite different from those in decentralized economies. Some governments are organized around religious law or have a dual system of civil and religious laws that need to be navigated when working to comply with labor laws. Workers in centralized economies may have fewer rights to privacy or ability to lodge grievances. Even hiring may be regulated; managers in Chinese corporations used to be assigned for political reasons rather than for job skills. All Chinese employees also require an employment contract, while in other countries these are used for only a certain class of nonemployee worker. When a government

requires employment contracts, these need to be formally amended whenever there is a change in contract or work period. However, even in decentralized economies there is a wide difference in labor laws. Unlike the U.S., most other countries do not use the atwill employment law that allows for termination without cause. The European Union and Australia also have more stringent protections for worker privacy, collective bargaining, and employee benefits than the U.S. Organizations therefore need to ensure that they have competent human resources staff that are knowledgeable about each of the countries and local areas in which they have significant operations. Even if local countries do not effectively enforce their labor laws, interest groups can bring home-country legal action against an organization that is operating in violation of a different country’s labor laws. U.S. extraterritorial laws also exist to control the behavior of U.S. employees overseas. Finally, governments are often parties to treaties or global compacts that may apply to labor. These would be enforced through the courts. A key point for supply chain managers, however, is to gain enough familiarity with the country and local labor laws of their suppliers to know when they are in compliance. An organization may have less legal liability in these cases but can face significant reputation

damage and loss of customers if a supplier is operating in violation of laws or international ethical standards. Two major areas where these laws may differ significantly are in collective and individual rights. Collective rights include rights to collectively bargain, congregate together, discuss employment matters, or receive fair warning of layoffs or plant closings. Individual rights are more extensive and include equal treatment of various classes of persons; child labor; forced labor; terminations; data privacy; wage and hour laws, including overtime, maximum hours, and pay reductions; vacation or sick pay and leave; pregnancy regulations; part-time, temporary, and contract worker restrictions; workplace health and safety; and alternative dispute resolution methods. Some countries even have laws in place that restrict companies from exclusively using independent contractors in order to avoid providing employee benefits.

International Labor Considerations A number of international organizations support labor rights. For example, the United Nations has a large number of declarations that support human rights, labor organization, economic rights, and prevention of discrimination against women. The Organisation for Economic Co-operation and Development (OECD) has Guidelines for Multinational Enterprises, and the International Labour

Organization (ILO) has a Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy. The United Nations Global Reporting Initiative (GRI) draws upon information in these standards. Its categories of information on the social impact of organizations help illustrate some prominent international labor considerations. Organizations need to consider the impact of the following in each significant region of operations: How entry-level wages compare to local minimum wage laws and any gender disparity How average wages compare to market rates and any gender disparity Proportion of senior management positions filled by persons from local community Local infrastructure or job base investments Diversity of new hires and retention for age, gender, ethnicity, and so on Benefit differential between full- and part-time employees and if the proportion of the two groups is reasonably allocated Parental leave time support and post-leave retention How layoffs and plant closings are communicated with/without unions and whether support services for career transitioning are offered Whether employees are represented on health and safety committees

Worker injuries or health issues by region or gender How well health and safety is handled in union/nonunion shops Proper and sufficient worker training by gender or employee category Existence and efficacy of grievance mechanisms The labor practices regarding suppliers by region are also of concern: Proportion of local suppliers that are used Whether suppliers are screened for labor practices Proportion of suppliers with negative impact labor incidents and their significance Whether supplier labor ethical policies exist and their degree of enforcement, including any contract terminations for poor labor practices A special international labor consideration is a deemed export. Deemed Export A deemed export can arise when certain technology or software source code is released to a foreign national, usually for purposes of employment or contract work. When this technology is not normally allowed to be exported to that foreign national’s home country without a license, the home country considers this to be a deemed export. In the U.S., for example, the Bureau of Industry and Security

of the U.S. Commerce Department requires submission of an export license application if the software or application would need an export license to be released to the foreign national’s country in question. The rule does not apply to lawful permanent residents of the U.S. or to persons with asylum status.

Topic 2: Import/Export Regulations and Documentation Here we address regulatory and documentation details related to importing or exporting goods and services, including an overview that addresses the role of customs in both importing and exporting. This is followed by discussions of Incoterms® trade terms, exportimport intermediaries, export packaging, and export and import documentation.

Import/Export Road Map Customs refers to a country’s regulation of import and export trade at its international ports and borders. The purposes of customs are to ensure border security, to collect all required tariffs, and to enforce trade restrictions. A tariff , according to the APICS Dictionary, 16th edition, is “an official schedule of taxes and fees imposed by a country on imports or exports.”

Organizations that engage in international trade use global trade management to ensure that interactions with customs proceed in a smooth and cost-effective manner. The Dictionary defines global trade management as the management and optimization of shipments across international borders including: ensuring compliance with all international regulations and documentation, streamlining and accelerating the movement of goods, to improve operating efficiencies and cash flows. Global supply chains need to operate efficiently as goods and services move between countries. This includes making wise import and export decisions, including how to arrange contracts for carriage so all parties clearly understand their roles and where risk of loss transfers between parties, how to facilitate clearing customs between countries, how to package goods for export, and how to satisfy all related export and import documentation requirements. Let’s start with an overview of these subjects. International contracts for carriage (contracts for transport and materials handling, as opposed to contracts for sale and transfer of title) often rely on Incoterms® trade terms, which are simply agreedupon international standards for the language to use in certain portions of such contracts. While these terms are voluntary, the contracts create an obligation.

Facilitating customs clearance is often done through the use of intermediaries, such as freight forwarders or export management companies. Since complex international transactions often have many of these intermediaries, it is important to understand how the various roles interact with each other and what value each should provide. Export packaging needs to meet a number of objectives. The primary objective of industrial packaging (as opposed to consumer packaging) is protecting the goods from damage in a way appropriate to the chosen mode. Other objectives include minimizing the use of unsustainable materials or the overall use of materials. Imports and exports require a significant amount of documentation. It is important to understand what documents will be required and what information the organization will need to collect and report. In general, exports require certain proofs such as proof of sourcing origin while imports require proper classification for assessment of tariffs. The Harmonized Tariff Schedule is used to assign a numeric code to the shipment so the correct tariffs can be assigned. Goods also need to have their value declared. Since customs regulations are driving much of the complexity in international shipping, let’s get an idea of why these regulations exist and learn about some best practices to follow in navigating customs.

We will look at some import regulations and restrictions at a high level after that.

Customs Regulations and Best Practices The purposes of each country’s customs regulations are twofold: to provide revenue and to protect domestic industries. Imported goods, therefore, can be seen as a source of national revenue, as a threat, or—ambivalently—as both. This built-in conflict of interest makes the job of importing (or exporting) into a country difficult and sometimes expensive. Aside from assessing import duties, customs also inspects shipments with the following intentions: To confirm that the goods actually have the value stated on the shipment’s documentation, since that value partly determines the amount of the import duties To determine that the items have all the correct markings, including safety labels, instructions, identification of country of origin, and any special marks required To weed out any forbidden items, such as illegal drugs and goods judged not to meet certain national standards To enforce quotas To ensure that the invoice is correct and that the shipment contains the number of items claimed in the documentation

To discourage dumping of products by imposing a high-percentage duty (Dumping is when a company exports a product at a price lower than it normally sells for in the country where the company operates. There is a link for additional anti-dumping information online in the Resource Center.) Clearing customs can be routine, or it can be a serious obstacle to delivering cargo on time. To expedite a successful clearance of customs, both importer and exporter should either do thorough research on the importing country’s import regulations or hire competent intermediaries to guide them. Customs regulations are a moving target, subject to change whenever new threats arise (or are perceived to arise); hiring a specialist who keeps an eye on that target improves a company’s chance of getting the job done right on the first try. Intermediaries such as freight forwarders, export management companies (EMCs), and export packagers can help with the preparations. Because clearing customs successfully is so important, most companies—even the largest ones—rely upon experienced customs house brokers. Here are a few general considerations to keep in mind when formulating a strategy for getting your cargo through customs unimpeded:

Use a customs house broker with proven expertise. Only a licensed broker can transact business with customs, which means that importers must use a broker to submit documents to customs to release their goods. Importers are responsible for providing the necessary documents and information to the broker according to customs time lines and regulations and arranging for the payment of duties found due. (A broker can pay on the importer’s behalf.) A licensed broker must have a power of attorney from the importer to act as its agent unless it is an in-house broker. Have the customs house broker begin the process before the shipment arrives at the port or air terminal, if possible. Use electronic documentation rather than hard-copy printouts whenever possible. Make sure your counterparty in the trade (or its intermediaries) has done its research. Check the backgrounds of your intermediaries carefully. Long-term relationships with trusted consultants are the most productive. The importer of record, or the company that caused the importation of goods, is responsible in the end. Inexperienced forwarders have been known to guess at the proper code for items, causing problems for the importer trying to pick up its goods at customs.

Import Requirements and Restrictions

Governments generally look with less favor on importing than on exporting, since exports bring money into the country and imports take money out. Moreover, goods coming into the country may pose various threats, including such hazards as competition with domestic goods; potential contamination of the environment; infectious diseases affecting livestock, wildlife, or humans; and terrorism. Governments around the world create numerous import licensing requirements, regulations, and restrictions to guard against these dangers, and they enforce these regulations through customs inspections. These restrictions pose problems for importers and exporters alike. The problems for importers are obvious enough. In the United States, for example, there might be a market for European cheeses produced from nonpasteurized milk, but the Department of Agriculture won’t license a distributor to sell such cheeses in the U.S. market—ostensibly for health reasons. Japan protects its domestic rice growers from imported rice for cultural reasons. On the other side of such restrictions, exporters may be easily able to acquire an export license from their own government but not able to get an import license to enable foreigners to buy their products. The World Trade Organization, which includes in its membership the vast majority of trading nations, takes as part of its mission the

creation of free and fair trade around the world by eliminating many of these barriers against imports. It pays special attention to providing less-developed nations with better access to world markets for their exportable products. Membership in the WTO also means that businesses headquartered in one member nation should be able to open branches in another member nation and be subject to the same rules applying to domestic businesses in that nation, thus gaining access to their markets directly rather than through imports. After China joined the WTO in 2001, for example, many foreign companies rushed in, hoping to capture a slice of the potentially enormous market there. These early efforts were sometimes disappointing for a variety of reasons. Even when trade and investment barriers begin to fall, the exportimport business may still be stymied by problems with entrenched bureaucracy, lack of infrastructure, and simple lack of buying power.

Incoterms® Trade Terms Incoterms ® (International Commercial Terms) trade terms, as defined in the APICS Dictionary, 16th edition, are a set of rules established by the International Chamber of Commerce that provides internationally recognized rules

for the interpretation of the most commonly used trade terms in foreign trade and are routinely incorporated in the contracts for the sale of goods worldwide to provide guidance to all parties involved in the transaction. The terms are used in foreign trade contracts to identify which parties are responsible for which transportation and customs clearance costs as well as when responsibility for the cargo transfers to the other party. Instead of waiting for title to transfer, which may be held up by the financing side of the transaction, the transfer of control and thus risk of damage or loss is specified by these terms. This is an important distinction because Incoterms do not address the transfer of title or ownership; this is addressed in a different contract. Some Incoterms® trade terms define who needs to get insurance for which parts of the journey; others leave this up to the parties to specify themselves. Some of the terms also outline import or export obligations for customs clearance and packaging requirements. The terms are defined and issued by the International Chamber of Commerce (ICC) in Paris. Although Incoterms® trade terms are not legally binding, exporters and importers around the world accept them as the standard terms to use in contracts of carriage (not contracts of sale). The Incoterms® rules are frequently included on

shipping company websites and are frequently added to purchase orders to clarify the terms and conditions. The key things to know about use of Incoterms® trade terms is to know enough about these terms to select the most appropriate rule, to clearly specify the correct port or other named place, and to ensure that these details are correctly recorded in the contract for carriage, the letter of credit or other financial instrument, and the invoice. The ICC recommends using their most recent version, Incoterms® 2020, although parties to a contract for the sale of goods can agree to choose older versions. It is important, however, to clearly specify the chosen version—Incoterms® 2020, Incoterms® 2010, or any earlier version, along with the specific trade term being used and a location. Depending on the point of responsibility transfer, the location is either an origin shipping port, a port of call for pickup, or a plant location for local pickup or delivery. For example, CIF Los Angeles, U.S.A., Incoterms® 2020 would show that cost, insurance, and freight are paid by the seller when exporting to the Port of Los Angeles. General changes in the 2020 version include a clarification that an owned fleet might be used instead of a third party. Who pays for what is now more obvious, in a clear table format, for all of the terms.

Also, security requirement costs are now clearly allocated in the rules. Incoterms® trade terms are organized into two groups: Rules for any mode or modes of transport Rules for sea and inland waterway transport A complete list of Incoterms® 2020, organized into these two groups, and a definition of each term appear in Exhibit 5-22. Buyer and seller responsibilities are shown in Exhibit 5-23. For more detailed information or to order a copy of the terms, visit the ICC website. Exhibit 5-22: Incoterms Trade Terms—Definitions Terms for Any Mode or Modes of Transport EXW Ex Works (Buyer loads goods and takes control at seller’s location.) The buyer pays all transportation costs and bears all risks for transporting the goods to their final destination. Therefore, the buyer (or its 3PL) must be experienced enough to do export tasks in the country of supply. The buyer gets maximum control but also the most liability risk with this method. FCA

Free Carrier (Seller delivers to main carrier; seller loads.) The seller delivers the goods into the carrier’s custody and loads the goods on the buyer’s chosen carrier. This is where risk passes from seller to buyer. The buyer pays for the transportation from the named place. The seller is responsible for problems or costs of clearing export customs. Since a letter of credit requires an onboard bill of lading, FCA indicates that given both party’s agreement, the buyer must tell the carrier to issue to the seller (at the buyer’s cost and risk) an onboard bill of lading (to encourage the

use of this term over FOB for container shipments, since FOB has more seller risk). CPT

Carriage Paid To (Seller selects and pays for main carriage.) The seller pays for the freight to the named destination. Risk transfers when the goods are delivered into the first carrier’s custody.

CIP

Carriage and Insurance Paid To (Seller pays main carriage and insurance.) Risk transfers when the goods are delivered into the first carrier’s custody. Afterward, the buyer bears all risk and costs. CIP is similar to CPT except that the seller also pays for the insurance, which must be comprehensive insurance (more than just liability insurance). Under CIP, the seller is also required to clear the goods for export.

DPU Delivered at Place Unloaded (Seller delivers goods to a location and unloads them.) The seller delivers the goods at a named location, such as a terminal at a named port or destination. Parties should specify the location where the risk is transferred from seller to buyer. If the parties agree that the seller is responsible for the costs and risks of taking the goods to another place, then DAP may apply. Note that in Incoterms® 2010 this was called DAT (delivered at terminal). DAP Delivered at Place (Seller delivers goods and buyer unloads them.) The seller delivers the goods to the buyer, who assumes responsibility for their unloading at a named destination. Parties should specify exactly at what point at the destination the risks transfer from seller to buyer. If the seller is responsible for clearing customs and paying duties, then DDP may apply. DDP Delivered Duty Paid (Seller incurs all costs, including import duty.) The seller pays for all transportation costs, bears all risk until the goods have been delivered, and pays the duty. This method allows buyers to have the lowest level of involvement of all the terms. Terms for Sea and Inland Waterway Transport FOB Free on Board (Seller puts goods on main transport vessel.) This term is only for ocean shipments. It is useful for bulk cargo, break-bulk cargo, and roll-on-roll-off cargo. Containerized cargo is better handled using DAT. FOB shifts control when goods are “on board” the vessel. “On board” is true after an ocean bill of lading or sea waybill is issued. Sellers pay for all

costs to transport and load the cargo on the ocean vessel, including export customs. Buyers pay ocean carrier costs and inbound customs. FAS

Free Alongside Ship (Buyer lifts cargo onboard.) The seller pays for transportation of the goods to the port of shipment. This includes oversized bulk or commodity cargo tendered to the carrier at the inland waterway or ocean port of loading. The buyer pays loading costs, freight, insurance, unloading costs, and transportation from the port of destination. Risk is passed once the goods are delivered to the quay (pier) at the port of shipment.

CFR Cost and Freight (Seller selects/pays main carriage.) The seller pays for costs and freight of the goods to the named destination port. The buyer pays for the insurance and transportation from the port of discharge (POD). Risk of loss shifts when the goods are on board at the port of shipment. CFR is inappropriate for most container sea shipments. (The correct term for these is CPT.) CFR is intended for use in shipping ocean freight pier-to-pier cargo that is not containerized (e.g., oversized or overweight goods). CIF

Cost, Insurance and Freight (Seller pays main carriage and insurance.) A price quoted as CIF means that the selling price includes the cost of the goods, the freight or transport costs, and the cost of marine insurance. Under CIF, the seller must obtain in transferable form a marine insurance policy to cover the risks of transit. The seller’s control transfers when the goods have been delivered on board the vessel at the port of shipment.

Exhibit 5-23: Buyer/Seller Responsibilities (B—Buyer, S—Seller) Terms for Sea and Inland Waterway Transport

Terms for Any Mode or Modes of Transport

EXW FCA CPT CIP DPU DAP DDP FAS FOB CFR CIF Export packing

S

S

S

S

S

S

S

S

S

S

S

Export clearance

B

S

S

S

S

S

S

S

S

S

S

Inland transport (domestic)

B

B/S

S

S

S

S

S

S

S

S

S

Forwarder’s fees

B

B

S

S

S

S

S

B

B

S

S

Terms for Sea and Inland Waterway Transport

Terms for Any Mode or Modes of Transport Loading on vessel

B

B

S

S

S

S

S

B

S

S

S

Ocean/airfreight

B

B

S

S

S

S

S

B

B

S

S

Cargo insurance

*

*

*

S

*

*

*

*

*

*

S

Duties, taxes, customs clearance

B

B

B

B

B

B

S

B

B

B

B

Delivery to destination

B

B

B

B

B

B

S

B

B

B

B

* Incoterms®2020 recommend explicitly stating who will pay for the insurance in a contract or quote. Incoterms®trade terms indicate where risk/liability is transferred but do not actually obligate the buyer or seller to carry insurance except when explicitly noted in the term. In most cases, companies will maintain cargo insurance as a backup.

Export-Import Participants International commerce takes place between an exporter (the seller) and an importer (the buyer or customer). A number of intermediaries may perform one or more specialized services before the items sold in one country arrive at the customer’s dock in another. Elsewhere we cover the growing use of logistics specialists to carry out specific operations for a client company (3PLs) or to coordinate the entire logistics function (4PLs). The use of specialized logistics intermediaries is even more common in the export-import business than in domestic supply chains. There are simply many more issues to contemplate when you send a product across borders into countries with different rules, a different currency, and a different

language. And so it may be cost-effective for a company sending or receiving an international shipment to pay considerable fees or commissions for these services. We’ll explore the roles of several types of intermediaries who assist in getting cargo across borders and through customs: freight forwarders, non-vessel operating common carriers, consolidators, customs house brokers, export management and export trading companies, shipping associations, ship brokers and ship agents, and export packing companies. After that there are flowcharts showing how the parties may interact and a summary of the types.

Freight Forwarders The freight forwarder, foreign freight forwarder, or just plain forwarder is a company that arranges transportation for commercial cargo. The APICS Dictionary, 16th edition, defines a freight forwarder as the “middle man” between the carrier and the organization shipping the product. Often combines smaller shipments to take advantage of lower bulk costs. The Dictionary defines a foreign freight forwarder as an entity that picks up goods at the production site and coordinates transport to the foreign customer’s location.

Foreign freight forwarders are not themselves carriers, nor do they buy and resell space on carriers. They are, instead, independent agents. In the United States, for example, they are regulated by the Federal Maritime Commission. A great majority of international shippers use forwarders. Small companies use them because they can’t afford to maintain a staff with the expertise required to handle foreign shipping and because one of the forwarder’s functions is to consolidate smaller shipments into larger ones that qualify for discounts. But even large companies use forwarders, because they can benefit from the expertise of such specialists. Forwarders may perform many different functions in the course of moving goods across international borders, including Quoting carrier rates Arranging charters or booking vessel space Preparing and presenting documents Obtaining insurance Handling payments Translating Tracing and expediting shipments Arranging inland transportation.

Although forwarders in the United States must be licensed by the government, they are not subject to certification requirements. However, certification is available for ocean forwarders from the U.S. National Customs Brokers and Forwarders Association, which will designate someone as a “Certified Ocean Forwarder” based upon a combination of experience and passing a certification exam. Airfreight forwarders may be either independent contractors or affiliated with a single air carrier. They require neither licensing nor certification. However, they may obtain certification from the relevant country’s regulatory body. In the U.S., this is the U.S. Federal Aviation Administration (FAA). In that jurisdiction, clients generally prefer to work only with FAA-certified airfreight forwarders. A major source of competition for airfreight forwarders comes from the carriers themselves, who can work directly with shippers. Companies like FedEx and UPS Air also compete with forwarders for small shipments. Forwarders derive income from a combination of fees, markups, and commissions from carriers.

Non-Vessel Operating Common Carriers The non-vessel operating common carrier (NVOCC) buys space on inland carriers and resells it to shippers at a marked-up price.

NVOCCs handle only the part of the shipment traveling from a port to the importer’s dock or from an exporter’s dock to a port. NVOCCs originated in the United States in the 1970s as a costeffective alternative to the carriers. At the time, trains and trucks often returned to port empty after unloading cargo at inland destinations and charged the shipper for both halves of the round trip —even though the shipper made no money on the turnaround. The NVOCCs were able to solve the problem by finding cargo for the return trips to port. Using their own containers for the inland journey, NVOCCs scout around for port-bound shipments to consolidate into those same containers for the trip back to port. They also provide container service for trips to and from foreign ports. Both shippers and carriers benefit from the intermediary work of the NVOCCs. The shippers receive reduced rates; the carriers gain access to a wider market. NVOCCs can be distinguished from forwarders in three ways: NVOCCs actually buy and resell space on carriers; forwarders do not. NVOCCs perform the physical work of consolidating, loading, and unloading cargo; forwarders do not provide labor. NVOCCs can handle inland freight in many cases, such as shipping by a motor freight carrier from Charlotte, North Carolina,

to Hawaii. A freight forwarder could perform those inland functions for the NVOCC, and this could very well be a division of the freight line or their contractor. The NVOCC can arrange for transport, but these are common carriers that do not operate the vessels by which the ocean transportation is provided and are considered shippers in their relationship with an ocean common carrier. Some NVOCCs are affiliated with freight forwarders; some are independent and are therefore able to work with a variety of forwarders. The independent NVOCCs can offer lower rates than those affiliated with a forwarder, but the affiliated NVOCC and forwarder can offer door-to-door service. Though they neither own nor operate vessels, NVOCCs are regulated in the U.S. by the Federal Maritime Commission, which requires them to publish rates and not discriminate in hiring. However, they are also subject to different regulations from carriers, and this may put them at a disadvantage. Under the Ocean Shipping and Reform Act (OSRA) of 1998, for instance, NVOCCs are forbidden to enter into service agreements with shippers, while carriers are allowed to do so.

Consolidators

The consolidator combines small shipments into larger ones to qualify for full-vehicle discounts. Generally this service is provided to fill containers for intermodal shipment, such as turnarounds carrying cargo between an inland warehouse and a port. Consolidators are distinct from NVOCCs, but they may work under them. A consolidator that is not affiliated with an NVOCC contracts with a forwarder or a carrier to arrange the transportation.

Customs House Brokers Customs house brokers assist importers by moving shipments through customs. Their job is to ensure that all documentation required to pass customs is complete and accurate. These days, the information required to clear customs is electronic and paperless, such as the Automated Broker Interface System in the United States and the Pre-Arrival Review System in Canada. Replacing paperwork with electronic data transfer has sped up the process of getting cargo through customs. The customs house broker pays all import duties under a power of attorney from the importer. Liability for any unpaid duties lies with the importer, not the broker.

Export Management Companies and Export Trading Companies When companies want to expand from domestic to foreign markets, they may turn for assistance to foreign trade specialists in either export management companies (EMCs) or export trading companies (ETCs) rather than adding internal expertise. While there may be some overlap in the types of services offered by EMCs and ETCs, there is a distinct line between their approaches. The EMC is generally not an exporter itself but rather a consultant to the exporters that hire it. The ETC, on the other hand, is itself an exporter. A common reason to hire an EMC is to acquire representation in a particular market where the EMC has special knowledge and connections. By working with an EMC, the exporter gains access to current information about the preferences of consumers in that market and about local customs and government regulations. Knowledge of local conditions enables an EMC to help the exporter avoid offending consumers or officials by inadvertent misinterpretations of the culture or the politics of the importer’s country. Finally, EMCs often cultivate friendly relationships with host governments, and this can help ease the exporter’s goods through customs. EMCs may also buy the exporter’s goods and resell them in the foreign market (in the manner of an ETC), but generally they

act as a company’s long-term consulting partner, not as a buyer of its products. An ETC, by contrast, looks for companies making goods that it wants to buy and resell in a foreign market. Its functions, therefore, may include locating importers to buy the goods, overseeing export arrangements, preparing and presenting documentation, arranging transportation overseas and inland, and complying with regulations. More expansively structured ETCs are known as general trading companies. These entities may comprise banks, steamship lines, warehouses, insurance services, a communications network, and a sales force. Japan’s success in international trade has been facilitated by such general trading companies, known in Japan as “sogo shosha.” These enormous conglomerates are some of the world’s highest revenue generators, including familiar names such as Mitsui and Mitsubishi. With offices in over 100 countries, the sogo shosha handle more than three-fifths of Japan’s imports and over one-third of its exports. Other countries with very large general trading companies include Germany, South Korea, China, and the Netherlands.

Shipping Associations

Before deregulation, ocean liners were required to publish their rates. Smaller shippers, seeing the rate schedules, could ask for similar deals. Since deregulation, carriers and the larger shippers have been able to sign confidential rate agreements. In response, smaller shippers have formed shipping associations—usually nonprofit organizations—to negotiate with carriers for rate discounts on the same terms as larger shipping companies.

Ship Brokers and Ship Agents Ship brokers and ship agents assist exporters with the details of arranging ocean transport. A ship broker is an independent contractor that brings exporters together with ship operators that have appropriate vessels available to carry the shipper’s freight. With detailed knowledge of carrier schedules, the broker can help the exporter find a ship that will be in port when its cargo is ready to travel. A ship agent works for the carrier rather than being an independent contractor. When a ship is headed for port, the ship agent arranges for its arrival, berthing, and clearance; while the ship is in port, the agent coordinates unloading, loading, and fee payment. Shippers contact ship agents for information about the arrival and availability of ships.

Export Packing Companies

Export packing companies provide the specialized packaging services required for cargo that may have to undergo long journeys and pass customs inspections in another country. The packing company can choose packaging materials that provide adequate protection with the least bulk and weight.

Export-Import Participant Flows and Summary Exhibit 5-24 illustrates two paths that cargo might travel to get from an exporter to an importer—(a) the simplest possible journey and (b) a journey aided by a full complement of intermediaries.

Exhibit 5-24: Export-Import Flowcharts

In sum, the participants in export-import trade have the features and advantages described in Exhibit 5-25. Exhibit 5-25: Roles of Export-Import Participants Participant

Role

Exporter

Shipper and seller of the cargo

Importer

Exporter’s customer, who buys the cargo and is sometimes responsible for payment of import duties at customs (usually handled by customs house broker)

Participant

Role

Domestic carrier

Train, truck, or air carrier that takes cargo to the outgoing port

Overseas carrier

Ship operator or air carrier that takes the cargo from the domestic port to the foreign port (assuming overseas transport)

Freight forwarder

Contractor responsible for getting goods from dock to dock and who arranges transportation for exporter’s cargo

NVOCC

Non-vessel common carrier that arranges transport of cargo from port to importer and contracts for or purchases space on the ocean vessel for resale or its own use

Consolidator

Independent company or affiliate of NVOCC that consolidates shipments to load into empty vehicles for return trip from importer’s dock to port

Customs house Licensed broker who has the expertise to move a shipment broker through customs expeditiously and to ensure complete, accurate documentation Export management company (EMC)

Company that acts as a consultant or an export department for one or several producers of goods and services; often has wellestablished network of foreign distributors, accelerating access into foreign markets

Export trading Company that identifies companies making goods that it wants company (ETC) to buy and resell in a foreign market Shipping association

Nonprofit association of smaller shippers banded together to negotiate better rates from carriers

Ship broker

Independent contractor who brings together the exporter with a ship operator that has a vessel available with the right services at the right time

Ship agent

Representative of a ship operator who is available to coordinate in-port activities for the shipper with cargo to export

Export packing company

Specialist in packaging cargo for export so as to combine lightest practical weight (for reduced duties) with maximum protection

Export Packaging Concerns Industrial packing and proper labeling for export present special problems and may be handled by an export packaging company. Packaging for delivery to a foreign buyer requires consideration of issues such as the following.

Packaging for Rough Ride International cargo needs to be packaged with materials and techniques chosen to protect the cargo from damage caused by rough handling, rough seas, extremes of temperature, and other hazards of long international journeys. The choice of mode has a large impact on the type of packaging that will be needed. For example, air requires and demands very little packaging due to the gentle ride and need to maximize the amount of cargo. On the other hand, ocean shipping requires significant industrial packaging, for example, internal braces built around the cargo in a container to keep the load from shifting. Export packaging companies are familiar with what materials are available and which are most suited to the destination, type of cargo, and mode of transportation

Packaging for Perishables Perishable shipments include (but are not limited to) foodstuffs, floral products, plants, animals, and medical and chemical products. Due

to their nature, perishables deteriorate over time or if exposed to harsh environmental conditions, such as excessive temperature or humidity and other forms of improper care and handling. Numerous domestic and international safety regulations and packaging standards are in place to ensure that perishable shipments are properly insulated and cushioned and to prevent leakage, spillage, and contamination from other cargo during transit. Temperature extremes and transit times are also monitored. Live plants and animals need additional considerations.

Packaging for Customs Customs will need to be able to access the cargo, and industrial packaging needs to accommodate this possibility. Also, for some countries, customs duties are based in part on the weight of the cargo (package included) and on the country of origin. For certain other countries, customs duties are based on weight only. In either case, this means that packaging needs to be as lightweight as possible while still protecting the cargo. Export packagers should be familiar with the customs requirements of each country.

Packaging for Sustainability and Reverse Logistics

Packaging using lighter materials or fewer materials can provide multiple benefits simultaneously. Not only can it reduce customs costs and save money on non-value-added items for increased profitability; it can also help an organization meet its sustainability goals. For example, Walmart used its leverage to get its suppliers to reduce their total amounts of packaging significantly. It developed an online scorecard to help suppliers meet these goals. When it extended these goals to Asia, it significantly reduced its environmental impact. Packaging for reverse logistics can include reusable packaging or packaging that is designed to be biodegradable so it can be disposed of responsibly. Packaging can enable sustainability and reverse logistics in the following ways: Use of the fewest resources possible compatible with the other demands of export packaging Selection of reusable materials as often as possible—and preparing to harvest them for reuse Selection of biodegradable materials when reusable materials aren’t available or appropriate Preparation for disposal of any nonreusable, nonrecyclable materials in a responsible landfill, with use of released energy if

possible

Labeling When the shipment arrives at the buyer’s port, customs will inspect the items to be sure that they contain all necessary markings, including safety labels, instructions, country of origin, and any special marks required. Experienced packagers who are familiar with regulations in the importer’s country can help ease shipments through the customs inspection by getting the labeling right.

Consolidation for Backhaul Consolidators, export packagers, freight forwarders, and NVOCCs all should be able to deal with the problem of empty turnaround trips in the importer’s home country, either directly or by contracting with a knowledgeable specialist. Packaging needs to be chosen with an eye to the available transportation in the destination country and the potential packaging needs of exporters whose shipments can be consolidated for the backhaul trip to the port or terminal. Generally this means using containers.

Export Documentation Export requires considerably more extensive documentation than domestic transactions. Using the U.S. as an example, an overview of

the major export document types follows.

Export Declaration The U.S. Census Bureau uses the Automated Export System (called AESDirect) to capture and store U.S. export data electronically. AESDirect is provided free of charge to allow exporters to self-file their Electronic Export Information (EEI), previously known as the Shipper’s Export Declaration (SED). The EEI must be filed for exports valued at US$2,500 or more when shipped to any country except Canada. (Shipments to Canada are exempt from the AES regulation.) Paper copies of the EEI are no longer accepted. In most cases, the broker will file the EEI instead of an individual person working in the supply chain. Related links about the AES program and AESDirect are available online in the Resource Center. The U.S. form includes such basic information as A description of the commodity The shipping weight (with packaging) A list of marks and numbers on the containers The number and dates of any required export license The place and country of destination The parties to the transaction.

Although some commodities are forbidden for export or limited in some way, the form exists as much for the purpose of compiling trade statistics as for enforcement.

Export License Shippers need to acquire an export license. The licenses come in two types: A general export license allows export of most goods without restrictions. A validation export license is required for shippers who wish to sell strategically sensitive items abroad. (Countries may limit export of certain items of strategic significance, including military hardware, medical supplies, and high-tech products.)

Commercial Invoice The commercial invoice states the value of the goods in the shipment and specifies payment terms and methods. It constitutes the seller’s and buyer’s invoice for the transaction. It also may be required for the letter of credit and by other entities that need to know the value of the goods for insurance or the assessment of duties. The information required and the language it’s written in may vary from country to country.

A consular invoice, required by many countries for incoming shipments, is similar to the commercial invoice but also contains information needed for customs in the importer’s country. Generally the consular invoice must be written in the language of the importing country, where it will be used for compiling trade statistics. A pro forma commercial invoice is basically a quoted invoice (not yet official) that may be sent to a potential buyer in advance of the actual sale. It may contain the same information as a regular commercial invoice and serve as both a price quote and documentation for the potential buyer to use in securing a letter of credit to finance the purchase. Carefully documenting all costs in the pro forma invoice can help the exporter properly price the product by accounting for hidden costs.

ATA Carnet Containers traveling under an ATA Carnet can cross several boundaries duty- and tax-free without customs inspection. (ATA stands for “Admission Temporaire/Temporary Admission.”) The Carnet convention was adopted for western Europe in 1961 and was intended to apply to commercial samples, professional equipment, and items for presentation at tradeshows and other similar events that were merely passing through a jurisdiction, not being imported into it. Despite their original use for these specific purposes and

items, Carnets now cover almost any type of goods, excluding disposable and consumable items, and they are used worldwide.

Certificate of Origin A certificate of origin provides information on the country where the goods were produced (country of origin) for assigning tariffs and for compliance with government trade restrictions. It often accompanies cargo exported into a country that has signed a treaty granting favorable import duty rates to the exporting country. The certificate states that the goods actually did originate in the exporting country and are not merely being reshipped from there to benefit from the lower duty. There is more discussion on the complexities of the origin of goods elsewhere.

Bills of Lading and Air Waybills A shipping company issues a bill of lading (B/L) with the buyer as a way of demonstrating ownership of goods. All international shipments are initiated by a B/L that serves as the carrier’s contract and receipt for goods the carrier will transport from one destination and shipper to another specified destination and recipient. The B/L also serves to document claims if the shipment is delayed, damaged, or lost.

An international shipment may be covered by multiple B/Ls, each initiating a new leg of the journey. An export B/L applies to the carriage from the exporter’s dock to its country’s port, while an ocean B/L governs the port-to-port portion of the shipment. A combined transportation document groups the B/Ls from various modes into one document. Order bills of lading provide evidence of ownership and are negotiable. Sellers may use them to transfer title to an intermediary, bank, or importer. A straight bill of lading, by contrast, is nonnegotiable and governs cargo that must be delivered straight to the consignee. A clean bill of lading, issued by the carrier, certifies that the goods have arrived at the ship undamaged. If the goods appear to have been damaged, the carrier will note that on the original B/L and will not issue a clean bill. The ship’s manifest, based on processed B/Ls, summarizes the vessel’s cargo, noting the port where the cargo came aboard and the port to which it’s bound. A statement of liabilities appears in the primary B/L. According to the U.S. Carriage of Goods by Sea Act (1936), the shipper bears responsibility for losses that result from perils of the sea, acts of God, acts of public enemies (such as pirates or terrorists), or its own negligence. The carrier is responsible for maintaining the ship in

good working order—literally, “ship-shape”—and is liable for its own acts of negligence. (Ocean carriers have fewer legal responsibilities than overland carriers.) The air waybill (AWB), or airway bill of lading, is a standardized form used for all air shipments. Use of a uniform document has reduced processing costs for air shipping and facilitated faster clearing through customs. Unlike a steamship B/L (and except for a straight B/L), the air waybill doesn’t provide title to the cargo. Instead, it serves only as a receipt for goods and as evidence of the contract of carriage. The cargo is delivered straight to the consignee named in the letter of credit financing the transaction—which may be either the importer or the bank issuing the letter of credit. If the goods are not designated for delivery to the bank, the importer can simply show up at the carrier’s destination and claim the cargo. Therefore, unless there has been a cash payment to the exporter (or the importer is known and trusted at the destination), the AWB arrangement involves some risk. Some destinations provide for cash on delivery, with consignment contingent upon receipt of the payment from the importer. The exporter often engages a freight forwarder or consolidator to handle the shipment and provides a Shipper’s Letter of Instructions authorizing the forwarding agent to sign the AWB on its behalf.

Exhibit 5-26 shows an air waybill.

Exhibit 5-26: Universal Air Waybill

Dock Receipt A dock receipt, issued by a ship agent, signifies that a steamship company has received cargo from a domestic carrier.

Certificate of Insurance If the terms of sale require insurance, a certificate of insurance will attest that either the buyer or the seller (according to the relevant Incoterms® trade terms) has taken out a policy covering the cargo. The certificate indicates types of insured losses, the amount of insurance, who issued it, and so on.

TIR Convention and TIR Carnet The Customs Convention on the International Transport of Goods under Cover of TIR Carnets (TIR Convention) is a 1975 United Nations treaty that established a common customs document called a TIR Carnet and established other trade-facilitating agreements, such as a mutual recognition of customs controls among participating countries. TIR stands for “transport international routier” (international road transport). As of 2021, the TIR Convention has 77 contracting parties, one of which is the European Union. There are over 30,000 authorized operators (trusted carriers) and 3,500 customs offices in the system. In May 2021, the fully digitalized eTIR system came online.

The TIR Carnet enables sealed road transport trailers and containers to avoid customs inspections until they reach their destination country. (However, customs can still claim the right to conduct an inspection.) In the case of the European Union, the TIR Carnet is used only when the shipment originates or ends outside of EU customs territory or if the transit will involve movement temporarily out of and back into EU customs territory. Because the United Kingdom has exited from the European Union, it now needs to use TIR Carnets for European Union trade.

CMR Convention and CMR Waybill The Convention on the Contract for the International Carriage of Goods by Road (CMR Convention) is a 1956 United Nations treaty that has been ratified by 58 parties, including most of Europe and almost all of the European Union. Its main instrument is a CMR waybill or consignment note. This is a standardized waybill provided in electronic form since 2017 as an eCMR waybill. Otherwise it is prepared in triplicate. It is prepared in three languages for ease of use in Europe or elsewhere. This waybill helps regulate carrier liability and requires standardized information about the shipment, origin, and destination, including information about dangerous goods. It also requires carriers to provide prompt notification of damages.

ATR Certificate The APICS Dictionary, 16th edition, defines an ATR certificate as a certificate that is required for trade between the EU and Turkey. It grants zero duty to “free circulating” goods in the EU, which are goods originating in the EU or imported to the EU with all import duties and taxes paid. Agricultural goods, minerals, and steel are excluded and must use form EUR1.

Import Documentation Most countries are eager to promote the international sale of domestic manufactures and agricultural products. However, getting the goods into the buyer’s domain can often be a struggle. The consignee’s country has to worry about the balance of trade, contaminants, invasive species, and collecting the full amount of import duties. The customs office is the focal point of the importing country’s concerns. In this section on the documentation concerns of importers, we’ll look at Classifying merchandise using the Harmonized Tariff Schedule Declared value and duty drawbacks Calculating import costs

Harmonized Tariff Schedule It’s imperative that all parties, including customs, know exactly what is being shipped. The Harmonized Tariff Schedule (HTS), which is administered by the World Customs Organization in Brussels, serves as a set of standard numerical descriptions of products exchanged in export-import transactions. The APICS Dictionary, 16th edition, defines the Harmonized Tariff Schedule as follows: The mechanism by which international tariffs are standardized. Importers and exporters classify all goods moved across international borders using the Harmonized System of the country of import. Then based on this classification the HTS is used to determine the amount of tariff they must pay. A synonym is the harmonized system classification codes, which the Dictionary defines as an internationally standardized description of goods that uses a system of numbers to provide increasingly detailed classification and descriptions. The HTS coding system is used by more than 200 countries and economies as a basis for their customs tariffs and for the collection of international trade statistics. Over 98 percent of the merchandise

in international trade is classified in terms of the HTS. It is important to note that while HTS codes are required for businesses selling merchandise internationally, they are not currently required for individuals (for example, selling from a website like eBay and shipping internationally). If you do not provide a code while shipping an item, the broker will typically assign an HTS code. The basic HTS number is made up of six digits. Each country can assign up to four additional numbers, to make a 10-digit code. The United States, for example, maintains two versions of the harmonized code, both expanded to 10 digits. One is used for imports and is administered by the U.S. International Trade Commission (USITC); the other, called Schedule B, is used to classify exports and is administered by the Census Bureau. Many other countries use six- to nine-digit versions of the HTS number. For instance, Japan uses 39 codes to classify its salmon products. As you see in the excerpt of codes in Exhibit 5-27, Japan has used nine-digit codes to classify its live, fresh, chilled, and frozen salmon products.

Exhibit 5-27: Import and Export Salmon Commodity Codes for Japan

Declared Value and Duty Drawbacks Once the exporter has determined the identity of the cargo by reference to the harmonized code, the importer is responsible for declaring the value of the cargo. That value, along with other factors, influences the amount of any import duty. According to the World Trade Organization (WTO), the declared value of the cargo should ideally be the actual price paid (or to be paid) by the importer. Goods shipped between one company’s divisions located in different

countries are valued by a transfer price, which is a standard cost plus a surcharge. The WTO recognizes other reasonable ways of determining value, such as the value of identical or similar merchandise. Duty drawback is a refund of all or part of duty paid on goods that were first imported and then reexported. Governments differ on the details of drawbacks. In every case, however, the importer pays the import duty when the goods initially come into the country and then applies for the drawback after reexporting. The duty will be based on the increase in value based on a component or module, not on the increase in value due to transformation.

Calculating Import Costs The assessment of costs due at customs varies from country to country. In addition to the import duty or tariff (the words “duty” and “tariff” are interchangeable), there will be customs-related fees and, in some countries, a value-added tax (VAT). Note that Canada has a VAT equivalent called a goods and services tax (GST) and that the provincial tax plus the federal GST is called a harmonized sales tax (HST). Import duties are generally assessed as a percentage of either the Incoterms® CIF (Cost, Insurance, Freight) or FOB (Free on Board)

value. (Note that there is also a UCC F.O.B. term used just in North America but this is not what is being discussed here.) The FOB value includes the cost of goods plus the amounts paid by the exporter to transport the freight from its dock and load it on the ship. If the cargo consisted of goods subject to a 5 percent tariff and the CIF were 1 million euro, then the tariff (duty) would be 50,000 euro. Value-added taxes (which resemble sales taxes in the United States) are assessed on the CIF or FOB plus the import duties. In the EU countries, for example, VAT is assessed against the CIF plus the import duty. VAT percentages in the EU are subject to change, of course, but as of 2021, the standard VAT in the U.K. was set at 20 percent. Reduced or zero VAT (5 or 0 percent) rates are available from each country for certain goods and necessities such as home energy, food, clothing, and books.

Topic 3: Trade Zones and Blocs Here we discuss the importance of taking advantage of free trade zones and trading blocs.

Free Trade Zones

A free trade zone (FTZ), called a foreign trade zone in the United States, is a geographic area in a country in which some normal trade barriers such as tariffs and quotas are eliminated and bureaucratic requirements are lowered in hopes of attracting new business and foreign investments. Typically, goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities. Only when the goods are moved to consumers outside the zone do they become subject to the prevailing customs duties. FTZs are part of a wider category of special economic zones (SEZs). Types of SEZs include FTZs with an objective of supporting domestic or re-export trade Export processing zones (EPZs) with an objective of enabling export manufacturing (Subtypes include traditional EPZs, which designate the entire area for export manufacturing, hybrids, which designate some part of the area as open to all industries regardless of export status, and single-factory EPZs, which designate the activities of an individual enterprise somewhere in the country as EPZ activities. A bonded logistics park [BLP] is a type of EPZ.) Urban enterprise zones, which have an objective of urban revitalization

Freeports, which have an objective of multi-use, integrated development Free trade zones are usually organized around major seaports, international airports, and national frontiers. The United Arab Emirates has created 45 “free zones,” including one at its international airport. China has 13 FTZs as of 2021 and will be designating the entire island of Hainan as another FTZ in 2025. This is an effort to attract more European companies to invest in mainland China. In the U.S., a foreign trade zone is a federally sanctioned site where foreign and domestic goods are considered to be outside of U.S. customs territory. Merchandise can be brought into an FTZ to be stored, exhibited, repackaged, assembled, or used for manufacturing free of customs duty, quota, and other import restrictions until the decision is made to enter the goods into the U.S. market. No duty is ever paid on foreign goods that are reexported from the FTZ. There are approximately 250 FTZs in the United States, with at least one in each of the 50 states.

Benefits Importers and manufacturers benefit from FTZs in the following ways:

Exemption from customs formalities, duties, or quotas. Shippers land their goods in FTZs without going through customs formalities or import duties. They are also exempt from quotas. Exemption from duties or quotas on reexports. Goods can be reexported from an FTZ without having been subject to duties and, therefore, without having to go through a lengthy process to receive a duty drawback refund. Deferral of duties on imports. Duties and federal excise taxes are deferred on imports while they are in the FTZ. They will go through customs on the way out of the zone into customs territory. Avoidance of fines. Imports can be processed, remarked, and repackaged in an FTZ before going through customs. Therefore, a shipment with potential compliance problems can be brought into compliance in the FTZ before going through customs. Reduction of import duties on some cargoes. Shippers can land cargo in an FTZ, complete the break-bulk, and then go through customs with just those goods destined for that country. Inspection of merchandise before paying duties. An importer can have cargo brought into an FTZ for inspection and testing before paying import duties, thus eliminating the possibility of having to reject a shipment after paying the duty on it.

Avoidance of quota problems. If a shipment of goods exceeds an import quota, the shipper can hold the cargo in an FTZ until it can come in under quota. Indefinite, cost-effective storage. Goods can be stored in an FTZ indefinitely without being subject to local and state inventory taxes. The zones are under customs control, so they provide excellent security for stored items. Manufacture and assembly without “inverted duties.” When the duty on imported components is higher than the duty on the finished product, it is called an “inverted duty.” To avoid paying an inverted duty, a domestic manufacturer can bring low-priced production materials into an FTZ and process them into a finished product for export. When going through customs, the manufacturer pays the duty on either the components or the finished goods, whichever is more advantageous. The FTZ board (in the United States) must approve any manufacturing or processing that results in a tariff reclassification. It’s important to emphasize that any retail trade is forbidden in a free trade zone.

Drawback

A disadvantage of having a free trade zone is that the host country receives reduced revenues from import duties. However, with the numerous advantages of an FTZ, many countries do provide them.

Trading Blocs As defined in the APICS Dictionary, 16th edition, a trading bloc (or trade bloc) is an agreement between countries intended to reduce or remove barriers to trade within member countries. Frequently, but not always, those countries are geographically close. According to Mansfield and Milner in their book The Political Economy of Regionalism, there are different types of trading blocs, including Free trade areas or zones Preferential trade agreements (which allow member countries to have preferential access to certain products from other member countries) Customs unions (made up of free trade areas with common external staff) Common markets (made up of free trade areas in which physical, technical, and fiscal barriers are reduced as much as possible)

Economic unions (made up of common markets and customs unions as described above) Customs and monetary unions (made up of customs and currency unions that share the same external trade policy and currency) Economic and monetary unions (made up of common markets and customs and monetary unions). In these instances, “union” refers to a group of two or more countries that form a unit that shares the same philosophies on certain aspects of trade. (This is not be confused with an employee collective bargaining group.) Countries can belong to a variety of different trading blocs, and the World Trade Organization tracks the status of proposed blocs. There are also regional trading blocs that form when nations within a particular region join together to reap the benefits. The European Union (EU) is a regional organization that is a trade bloc. Some of the larger stand-alone agreements between states to form trading blocs include the United States-Mexico-Canada Agreement (USMCA), the European Free Trade Association (EFTA), the Caribbean Community (CARICOM), the African Union (AU), the Union of South American Nations (UNASUR), the Eurasian Economic Community (EurAsEC), the Arab League (AL), the Association of Southeast Asian Nations (ASEAN), the Central

European Free Trade Agreement (CEFTA), and the Pacific Islands Forum (PIF). One of the newer agreements is the Regional Comprehensive Economic Partnership (RCEP), which was signed in 2020 and had been ratified by China, Japan, and Singapore at the time of this writing. Other parties that have yet to ratify and put the agreement into full force include South Korea, most of the SouthEast Asian island countries, Australia, and New Zealand. There is a dynamic range of opinions on how trading blocs impact the global economy—that is, whether they create or divert trade. According to the author of the Routledge Encyclopedia of International Political Economy, the answer is not clear-cut. Now let’s take a closer look at one of the major trading blocs, the USMCA.

USMCA The USMCA went into effect on July 1, 2020. It replaces the North American Free Trade Agreement (NAFTA). The USMCA is generally consistent with NAFTA; for example, steel and aluminum tariffs are unchanged. The new agreement is designed, however, to deliver greater consistency among ports of entry, improved efficiency and less paperwork, and greater transparency. Notable differences between the two agreements include the following.

Agricultural tariffs. Zero tariffs remain for agricultural products, but the U.S. is allowed to export more dairy products to Canada— 3.6 percent of the Canadian dairy market rather than the 1 percent allowed under NAFTA. Rules of origin. To qualify for zero tariffs, products must meet certain levels of manufacture within the treaty area, called rules of origin. Rules of origin are product-specific, and USMCA rules may have changed from NAFTA requirements. For example, the rule of origin for automotive manufactures has been raised to 75 percent, as opposed to 62.5 percent under NAFTA. This increase is seen as an attempt to strengthen automotive manufacturing in North America. Shippers should consult the agreement for guidance on their own situations. Certificate of origin. Certificates of origin have been eliminated to reduce paperwork for shippers. Importers can claim favored trade status by providing certain data, including the name of the importer, exporter, or producer and their addresses; the name and address of the certifier; the tariff classification code; the criteria under which the good meets rule-of-origin requirements; the blanket period (which can be as much as 12 months for multiple shipments of identical goods); and a dated signature. Certification is not required for imports of US$2,500 or less. While these

changes have simplified the import process, they do not relieve importers of the need to document transactions carefully. De minimis levels. To streamline trade and support small and medium-sized enterprises (whose imports may be small), the USMCA raised thresholds (de minimis levels) for taxes and dutyfree treatment. Canada treats North American express shipments valued at up to US$40 as exempt from taxes; express shipments up to US$250 are duty-free. Mexico provides duty-free treatment for express shipments up to US$117. Environmental and labor chapters. These new chapters require the U.S., Canada, and Mexico to enforce environmental and labor laws, such as commitments to air quality and prohibitions against forced labor. These requirements reinforce the importance of conducting due diligence of supply chain members. Sunset clause. While NAFTA was declared to be in force until the agreement was removed by its members, the USMCA actually has an expiration date of 16 years, or July 1, 2036. The parties must formally review the agreement every six years, address problems, and discuss extensions.

Effects of Trading Blocs on Supply Chains

In order to have the complete picture of trading blocs, the effects on supply chains within and outside blocs should be explained. Effects Within Blocs The gravity model is used by social scientists to predict the movement of people and ideas between two population centers as a function of the population of each area and the distance between the areas. According to the gravity model, countries that are geographically closer tend to have a high volume of trade. Because transportation costs and trade barriers tend to be lower, countries that are closer to one another are more likely to become trading partners by forming a trading bloc. Supply chains in the respective member countries usually reap the benefits of volume, quantity, and better prices and terms as well as lower levels of tariffs. With membership in a bloc, supply chain management may find that it’s easier and less complicated to negotiate with fewer partners. With this smaller number, concessions between members can be more easily made and enforced, making the process less painful. Supply chains from lesser-developed member countries with more economic and political variability can take advantage of agreements with larger entities that they would otherwise not be able to access. Effects Outside Blocs

If a trading bloc is large, nonmembers may see their prices and demand for exports decrease. This can result in deterioration in trade terms and decreased market power of these nonmembers. Seeing a decrease in their exports, they may resort to protectionist tactics and increase their lobbying efforts. The effects of trade diverted from nonmembers’ supply chains can impact the nonmembers’ ability to make multicountry negotiations feasible and increase the difficulty of doing business across borders, even if it’s with the country right next door or one with which they’ve previously traded. Sometime if they are fortunate enough to continue to trade, the nonmembers may be forced to pay optimal tariffs to the bloc members.

Section D: Reverse Flow This section is designed to Identify activities supported by reverse logistics Enumerate the business advantages and common requirements motivating development of a reverse logistics supply chain Describe the strategic impact on reverse logistics and design considerations related to network locations, warranty policies, return authorization policies, logistical network make-or-buy decisions, and product life cycle Describe the benefits of a well-organized reverse supply chain Explain how the waste hierarchy provides various options for handling waste but places prevention ahead of mitigation Show how in some cases waste exchange can repurpose certain types of waste and provide an additional revenue stream Explain how a waste exchange is a market exchange that links buyers with sellers of waste and byproducts Define hazardous waste and describe how it requires special transportation, storage, and disposal. In this section we’ll look at reverse logistics and explore some of the strategic approaches that, in some cases, not only mitigate the

negative impact of product returns but also help in finding ways to make a profit on the back side of the supply chain.

Topic 1: Reverse Logistics Reverse logistics facilitates returns, repairs, remanufacture, and recycling. After providing an overview of the subject, this topic addresses the processes of developing reverse logistics requirements and designing a reverse logistics system in more detail.

Reverse Logistics Road Map Reverse logistics is defined in the APICS Dictionary, 16th edition, as a complete supply chain dedicated to the reverse flow of products and materials for the purpose of returns, repair, remanufacture, and/or recycling. The Dictionary defines the reverse supply chain as the planning and controlling of the processes of moving goods from the point of consumption back to the point of origin for repair, reclamation, recycling, or disposal.

The reverse supply chain is a complete chain, a mirror image of the forward chain that carried the product to the customer in the first place. As such, it has operations that are similar to those in the forward chain—customer service (marketing in reverse), warehousing and transportation going in the opposite direction, unpackaging, disassembly, and disposition in the form of resale, remanufacturing, recycling (a return to raw materials), donation, or disposal. The products in the reverse chain won’t necessarily move through the same nodes as products in the forward chain because fewer, and different, warehouses, may be required. Exhibit 5-28 shows the direction of material and cash flows in the reverse supply chain and lists some reverse logistics activities.

Exhibit 5-28: Reverse Logistics

Reverse logistics can occur not only as customers are returning products that were purchased but also as retailers or distributors return products that failed to sell (e.g., if there are contractual agreements to take back unsold inventory for some amount of refund or rebate on future purchases) or were defective. Similarly, manufacturers might return defective or excess components to suppliers. As a relatively new concern, reverse logistics does not yet have the same level of support by strategists and software engineers as forward logistics, but it isn’t a small phenomenon. In some online businesses, returns can be as high as 50 percent; in addition, returns can include containers, etc., as well as products. At one time, Estée Lauder was dumping about US$60 million worth of its products into landfills every year. Some estimates put the total spent on reverse logistics in the United States as high as US$50 billion, with the value of returned goods at around $550 billion. Strategic solutions are on the way, though. Reverse logistics is often a required cost of doing business, especially in a “customer is always right” world. It can be a severe drain on organizational profitability and could eventually contribute to an organization’s demise if it is continually just an expensive afterthought. However, if it is handled strategically and the

organization invests time and energy in planning the returns, repairs, reuse, recycling, and responsible disposals they are obligated to handle—including the disposal of hazardous waste—the organization can, in some cases, generate revenue from these sources to offset the costs, and the costs themselves can be kept reasonable by focusing on smart policy and efficient practices. Many major companies have taken up the challenge of improving their management of the reverse flow of products, among them Dell, HP, Home Depot, Lenovo, and Google. Since at this point reverse logistics is unlikely to be a core business for many companies, 3PLs and 4PLs are adding reverse logistics to their portfolios. UPS, for instance, features its expertise on its website. GENCO ATC is a 3PL that has been in the reverse logistics business since the 1980s and includes clients such as Walmart, Target, Levi’s, Dell, and KraftHeinz. It also sells reverse logistics software for the retail industry. The focus needs to be on integrating returns, recalls, repairs, remanufacturing, and other end-of-life topics into the supply chain so that these can not only be dealt with efficiently but also become a source of revenue. National and local governments are increasing regulations in this area, so getting reverse logistics right will help compliance be just a regular part of doing business and keep waste and hazardous materials out of landfills.

Reverse Information, Cash, and Product Flow Information, cash, and products flow through the reverse logistics chain just as in the forward chain. Software for managing this process does exist but isn’t as well adopted as software for forward logistics applications. Reverse information flows and reverse logistics information systems. Legacy systems cannot effectively be used for tracking returns. Cloud-based systems will be needed to capture data on product identifiers and link them to the point of return, the reason for the return (e.g., defective, unsatisfactory, incorrect order, unsold or excess inventory, repairs or refurbishment, remanufacture, or regulatory recycling or disposal), and warranty status. The status of each product also needs to be tracked from its entry into the reverse flow until its final disposition, along with the costs or revenues accumulated at each step. A bill of material for disassembly can be produced to help track the disposition of components. Unique product (and, in some cases, subcomponent) identifiers are needed for this type of information to be tracked. The path that a returned item takes through the reverse supply chain may also require the management of new partners that handle tasks such as material recovery. An organization also needs information on product failures for product redesign or recall purposes.

Organizations lacking reverse logistics information systems will need to acquire these to provide the required visibility, possibly as add-ons to existing systems. Such systems should be capable of managing return center operations; repair, remanufacture, and recycling centers; product recalls; vendor returns; and tracking, tracing, and compliance reporting. Reverse cash flows. Cash flows in the reverse supply chain take the form of credits and discounts. This all needs to be done as simply as possible from the perspective of the customer (who is often not happy while these transactions are taking place) as well as placing the least possible burden on customer service. Product return policies should match strategy. The total cost of returns needs to be calculated in the aggregate by product line. Reverse product flows. Product returns require reverse forecasting and establishment of locations for collecting, reprocessing, or disposing of the goods on their return trips.

Reverse Logistics Benefits The benefits of a carefully designed reverse logistics supply chain that maximizes resource conservation, reuse of components, and recycling of materials include

Potential for highly lucrative customer service contracts and extended warranties (especially if the products are well designed and reliable) Mitigation or elimination of the unprofitable effects of high-volume returns Enhanced customer loyalty and corporate reputation Return of valuable raw materials for other industrial uses Development of more efficient products and logistical tactics Profits from resale of refurbished products and parts that would otherwise go into landfills at a cost to the company Creation of new types of jobs More efficient use of energy Conservation of resources for future generations Reduced emission of many greenhouse gases and water pollutants Development of “greener” technologies Reduced need for new landfills and incinerators. A key benefit of reverse logistics is that many activities can generate revenue. These revenues come from several sources: Service contracts and extended warranties bring in substantial cash flows and provide peace of mind for customers. Remanufactured products and recovered materials are finding profitable markets.

Repair fees can be in excess of repair costs. Recycling fees can offset any costs involved in taking back products. Charges for recycling motor oil after an oil change, for example, are now taken for granted in some markets.

Reverse Logistics Costs Costs from several sources have to be considered when determining profitable fees and prices, for example, costs for providing return labels in packaging. Other associated expenses affect the supply chain in the following ways: Only a small percentage of returned items may be easily restocked or resold. Warranty repairs have to be charged off. Spare parts may be needed for repairs. There may be special processing and handling costs involved in returned materials, including new packaging for resale items. Freight costs can be high for sporadic, low-volume shipment, and extra transportation legs may have to be added to the network to accommodate destinations specific to returns and recycling. Warehousing costs can be higher for small numbers of items that need to be restocked or stored in separate locations. Total cost calculations for returns sum the various revenues and deduct the various expenses. This amount can be tracked for

benchmarking purposes and for comparison to other options in a make-versus-buy analysis. The total cost of reverse logistics can be calculated as follows:

Processes for Managing Reverse Logistics Key processes that supply chain managers need to be able to perform related to managing reverse logistics are Identifying requirements of reverse logistics Designing a reverse strategy and process Implementing reverse logistics. The following is a general overview of these processes. Identifying Requirements of Reverse Logistics

Identifying the requirements of reverse logistics involves the following steps: Assessing the as-is state of reverse logistics strategy and processes Determining the stakeholders for each product family’s reverse logistics requirements (e.g., customers; finance and other executives; health, safety, and environmental regulators; interest groups; transporters and 3PLs, etc.) Gathering requirements from each stakeholder group Consolidating and categorizing requirements Determining the impact of stakeholder requirements on strategic priorities (e.g., customer service impact) Reviewing organizational and supply chain strategy to determine if stakeholders’ reverse supply chain requirements necessitate modifications to these strategies (i.e., these requirements are often overlooked during strategic planning) Designing Reverse Strategy and Process Designing a reverse strategy and process involves the following steps: Prioritizing requirements based on organizational and supply chain strategy Designing the to-be state of reverse logistics, either during the product development and introduction stages or as modifications

to existing operations Analyzing the gaps between the as-is and to-be states Developing a quantitative and qualitative benefit-cost analysis to justify strategic choices and tradeoffs Generating a reverse logistics strategy, including how the strategy might need to change at various points in the product life cycle Influencing executive support to champion and lead the strategy and allocate funding Designing information systems and network locations for reverse supply chain activities Designing processes and policies for each product, subcomponent, waste item, and raw material entering the reverse logistics hierarchy (i.e., whether to reduce, reuse, recycle, recover energy during disposal, or dispose in a responsible landfill) Implementing Reverse Logistics Implementing reverse logistics involves the following steps: Gaining final executive approval and funding for specific infrastructure and process changes or contract negotiations to implement the strategy Planning and implementing projects to change processes and infrastructure Contracting with third-party participants

Using change management and training to alter the culture of the organization to support the changes over the long term Setting up metrics and goals for monitoring and controlling operations and customer service impact Monitoring and controlling the processes and operations Gathering feedback and implementing continuous improvement

Requirements for Reverse Logistics What drives the upsurge of organizations’ interest in reverse logistics? Here are a number of motivating factors underlying various stakeholders’ requirements. Cost avoidance. A primary purpose of reverse logistics for many organizations is to mitigate loss from returned items. A return is a reduction in sales revenue. Traditional brick-and-mortar retailers experience returns in the range of 8 to 10 percent, while online retailers have it even worse, with 20 to 30 percent or more of products being returned. In addition to the loss of revenue, return processes are typically more expensive than their forward supply chain counterparts. This includes higher transportation costs for handling small shipments of oddly assorted items; warehouse costs that may include testing, refurbishment, repair, and restocking; and inventory costs of write-

down or write-off and proper recycling or disposal. Returned items that are unused and fully functional may or may not be able to be marketed as new, depending on regulatory requirements for the industry, and may need new packaging if they can be resold as new. Since certain items such as electronics become obsolete quickly, the longer the return process takes, the less value returned items have from a resale standpoint. Administratively, organizations often are unable to properly quantify how much returns are actually costing, because it is difficult to estimate the value of any returned items (if any) until they are actually refurbished and resold or recycled. This results in a lack of priority for reverse logistics and thus inefficiencies in the reverse supply chain. Savings in the aftermarket. Sometimes there is literally gold in the reverse supply chain, not to mention silver, platinum, copper, zinc, mercury, lead, and the whole range of commercial metals. Returned products can be “mined” for scarce materials—many of which should definitely be kept out of landfills. Products can be repaired for continued use, refurbished for resale, or disassembled for their usable components. AT&T’s Network Systems Division, for example, realizes significant savings by operating a reverse logistics system for telephone switching equipment.

Competitive edge. Consumers can be wooed and won with products that promise good service. For example, if customers have easy and free return experiences, they are far more likely to become loyal and profitable. A study by Moore et al. placed this value at 5 to 20 times the initial sales price of the returned product. Ease of return, repair, and recycling may add to a product’s value in the consumer’s mind. Many consumers are daunted by the need to pay to dispose of a defunct television or appliance. The idea that a manufacturer or retailer might take responsibility for such items at the end of their days—as AT&T has done with phone equipment—can definitely be attractive to some customers. Consumer and shareholder pressure. Consumer groups have learned to make themselves heard through direct action and lobbying. As part of this movement, shareholder groups bring resolutions to corporate annual meetings proposing various “green” or consumer-oriented policies. Sometimes these pressures result in changed corporate policies when companies sense an opportunity to turn such sentiments into customer loyalty and sales. Or consumer pressures result in the adoption of new government regulations at the local, national, or regional level. Growing market for environmentally safe products. The desire for access to products that are simple, clean, and less threatening

to the health of persons or the environment can be a legitimate source of ideas for innovative approaches to product design. Some customers will pay a premium for products that promise to protect their health and their world. Some corporations provide incentives for product ideas that incorporate reverse logistics thinking. Safety and environmental awareness and regulations. In 1962, with the publication of Silent Spring by oceanographer Rachel Carson, the usually quiet undercurrent of concern for nature erupted into the public consciousness. Carson’s subject was the unacknowledged side effects of the use of the pesticide DDT. The world has never again been able to view the impact of our activities on the environment with casual disregard for unintended consequences. That concern is a root cause of the growing attention to the afterlife of commercial products—especially hazardous materials such as pesticides and industrial chemicals. We know now that discarded items don’t harmlessly fade away unless they are quickly biodegradable. Safety and environmental regulations on hazardous waste or items that need to be kept out of or reduced in landfills provide a reason for logistics managers to pay more attention to the defective or obsolete products that return and move back up the

supply chain. The EU has made a strong commitment to waste reduction. For example, Germany requires that all German businesses must accept returns of their packaging. In the Netherlands, a disposal fee is charged when many kinds of new products—appliances, TVs, cars—are purchased. These funds are used to disassemble products at the end of their life.

Reverse Logistics Design Reverse logistics networks need to be consciously designed to satisfy reverse logistics requirements while also avoiding causing too many tradeoffs or issues for the forward supply chain. When designing the reverse logistics network, keep the following factors in mind: Warranty and returns authorization policies strongly affect the cost of reverse logistics, so these need to reflect strategy in their designs. The infrastructure and processes in reverse logistics networks also need sound strategy and designs. Reverse logistics affects all stages of a product’s life cycle, not just the last stage; a design for reverse logistics strategy can be used to ensure that product design considers how to promote reverse logistics efficiency.

Next we’ll look at how these factors affect the strategy and design of reverse logistics.

Warranty Strategy and Design A product’s warranty period creates a liability for an organization since defective products will need to be replaced for no charge during this period. Warranties are offered to promote sales by providing peace of mind for buyers, so both the costs and the benefits of these programs should be estimated. The benefit is the increase in sales from the warranty. The costs are the cost of returns that need to be charged off as well as the financial uncertainty of how many returns there will be. (It could be as much as all products sold, for example, in a recall situation.) A complication arises when the warranty periods on supplier components differ from the warranty period on the final product offered to customers. A repair on a product warranty may require replacing parts that are not under warranty for the manufacturer, meaning that this cost cannot be passed on to the supplier. This can create a hidden liability that is difficult to calculate when determining the costs of reverse logistics.

Returns Authorization Strategy and Design

Organizations need to set policies for how and when returns will be accepted as part of their overall reverse logistics strategy. Many retail organizations promote liberal returns policies, for example, allowing returns of any unbroken item with no reason needed, given just the receipt or the credit card used to make the purchase. This is a strategic decision to prioritize customer service and thus encourage customer loyalty. The costs and benefits of these policies need to be measured over time. Other organizations will impose more strict returns policies, such as only defective returns or all sales being final. The idea is to reduce the number of returns without having too many unintended consequences for customer service and thus sales. Ensuring that this process is fast and easy for customers and clearly communicating the return policy at the time of the sale (setting expectations) can go a long way toward creating a good customer experience. Companies often contract with external returns specialists who provide customer service support while minimizing unnecessary returns. For B2B returns, a lot-size return policy might make sense. This involves requiring corporate customers to hold returns until full truckload quantities can be sent, to make transportation more economical. In a B2C (business-to-consumer) example, Dell allows

products to be returned only after the customer speaks directly with a live customer service representative. While there is a cost for this direct support from what they call “gatekeepers,” the representative is given the opportunity to provide instructions on how to properly set up the device, up-sell support devices, or otherwise talk the customer out of the return. This investment is cost-effective; it results in a 5 percent level of returns, much lower than the average return rate.

Logistical Network Strategy and Design The design of the reverse logistics network involves determining where in the process to locate the various reverse logistics activities. Returns happen at the retail level and back up the chain from there to distribution centers, manufacturers, suppliers, and so on. Determining where products will be tested, remanufactured, and so on requires a total cost of ownership analysis that may involve collaboration among many supply chain partners to determine the best point overall. The location or locations that make the most sense may involve weighing cost, customer service, and speed. These activities could be centralized at one location or distributed among retailers, distribution centers, or suppliers. Another important consideration in the design of the reverse logistics network is whether all or parts of the function will be contracted out

to 3PLs. Organizations such as Frito-Lay remove expired inventory as part of the process of stocking new inventory at retail locations using their own drivers. Transportation might be outsourced to small package services such as UPS or FedEx, while testing and refurbishment is retained as a distribution center responsibility. At the other end of the spectrum, the entirety of the process could be outsourced. Organizations such as GENCO ATC specialize in liquidating returns, which could result in some amount of revenue inflow to the organization or at least lower revenue losses than the organization could achieve on its own.

Life Cycle Design Reverse logistics considerations affect the entire product life cycle, not just the last phase. Exhibit 5-29 shows how the forward product life cycle and the reverse logistics cycle create similar curves when measured as volume of activity over time. However, the reverse logistics curve is shifted forward, since returns don’t start until products are shipped, and it is smaller, because only a percentage of products will be returned.

Exhibit 5-29: Product Life Cycle with Reverse Logistics Cycle

A continuing support phase is also added in the exhibit. This is added here to illustrate that the reverse logistics cycle may have ongoing costs and revenues. Such a period may be necessary if there is a warranty period, a service contract period, a period of guaranteed service or parts availability for discontinued models, or a period in which products will be accepted for hazardous or other waste recycling or disposal. This period could last indefinitely, depending on organizational policy. Design and Development Using a design for reverse logistics strategy as one aspect of product/service development can help keep the costs of reverse logistics down. Several aspects of reverse logistics should be built into product design and ramp-up: Plans need to be made during product design for potential reuse of the product or its components.

Avoiding use of hazardous or scarce materials, especially rare earth elements (REE) and metals (REM), can be designed in if substitutes can be found. How to make good use of resources, including energy, should be incorporated into design decisions. Consideration of how to package and ship the product most efficiently needs to be considered early in design. As supply chains going forward and backward extend across oceans and national boundaries, reverse network design becomes increasingly important. Forecasts should be done for the amount of each type of product that is likely to be returned. Long-term return forecasts can be used to determine the number and location of return facilities as well as the number of dedicated staff that will be needed. Customer service, materials handling. and other functions need to be trained to handle the procedures and paperwork involved in returns, refunds, and repairs. As an example of a process design, in the Netherlands, DAF Trucks has a long-term relationship with Van Gansewinkel, their garbage and scrap metal collector. Formerly, the garbage bins (rolling containers) were filled in the plant and pulled outside to a garbage compressor. Now a small garbage truck drives into the plant to collect the garbage. Not needing to tow containers back and forth

has reduced costs by 5 percent per year. The same trucking company has also redesigned its product packaging. A DAF plant in Belgium produces body parts that are sealed in plastic to prevent scratching. Originally, DAF used the lowest-cost plastic and had to pay to dispose of the used plastic. Van Gansewinkel proposed using a different type of plastic, which was more expensive but had a market value after use. The total cost of plastic has worked out to be lower. New Product Introductions Even in the initial phase of a new product introduction, reverse logistics comes into play: Customer service has to be prepared for early returns of the new product, since defects and disappointments are more likely during ramp-up than during later stages of a product’s life. High-quality customer service can prevent the worst effects of early product failures. (There’s a role for sales and marketing here, too.) In addition to the negative impact on reputation, a flood of early returns can cause serious logistical problems if the reverse supply chain hasn’t been set up to handle such an unpleasant surprise. If early product returns are heavy, design engineers need to be prepared to make rapid improvements in the product. The service department needs to be in place at this time, as does an inventory of replacement parts.

Maturity Reverse logistics events continue into product maturity: Returns are a high-volume operation in some industries. Receiving areas need to be designed to accommodate operations required in handling returns, such as repackaging and inspections. Packaging for returns needs to be considered along with packaging for forward shipping. For example, HP laser cartridges are delivered to consumers in a box with simple instructions for how to repackage the used cartridge in the same box and give it, free of charge, to any UPS driver or facility for shipping back to the manufacturer. This reverse network, complete with training for UPS, had to be in place and ready to receive cartridges when the first products were shipped to retailers. Decline, Return, and Continuing Support The reverse supply chain should be designed to anticipate issues that will arise as products reach the end of their useful lives. The following are significant concerns relevant to product decline, return, and continuing support: Preparation should be made for any environmental and legal exposures. This is especially true with hazardous materials that are subject to extra regulations locally, nationally, and internationally.

Nonhazardous materials may also be subject to extra regulations. For example, one beer manufacturer requires its distributors to have a permit to dump recalled beer. The glass and cardboard packaging also have to be recycled at the same time. Final disposal needs to be documented and the records kept for a period of years. Packaging as well as products should be designed for reuse or made biodegradable. Parts, customer service support, and other services may need to be provided for a certain period following the discontinuation of a product.

Topic 2: Waste The waste hierarchy is a simple but powerful policy tool to help organizations design a reverse supply chain that prioritizes the most environmentally friendly disposition processes. Since the better methods are often also the more cost-effective options, this is a winwin. Waste, hazardous waste, and waste exchanges are addressed here.

Waste Hierarchy Elements The APICS Dictionary, 16th edition, defines waste hierarchy as

a tool that ranks waste management options according to what is most environmentally sound. It gives top priority to preventing waste in the first place, and can be applied to various applications. The waste hierarchy is sometimes called the reverse logistics hierarchy or the four Rs. In order of importance, the Rs are reduce (use of resources), reuse, recycle, and recover (energy). Exhibit 5-30 shows the relationship of the four Rs and places an additional item, the least desirable option—disposal in a landfill—at the bottom. We’ll look briefly at each of these activities to see why they are considered beneficial to business, society, and the environment.

Exhibit 5-30: Waste Hierarchy

Reduce Resource Use.

Reducing the use of resources in the first place is considered the most responsible option in the waste hierarchy. Companies can incorporate this principle into their business in the following ways: Reduce costs by designing products and packaging that make the most efficient use of physical resources. Design products with an eye to reducing the consumption of energy in their manufacture and use. Design the logistics network for efficient use of resources and energy in warehousing and transportation. (This is a straightforward matter of cost containment.) Reduce excess inventories by investing in supply chain demand management, visibility, and so on. Repair or restore products and return them to the customer for an appropriate fee (unless under warranty). This strategy requires maintaining a repair department, contracting this service out, and/or allowing the market to provide these services independently (e.g., automotive repair shops). The reduce step in the hierarchy is a preventive measure that ideally takes place during the design and development phase of a product’s life cycle but could be implemented as part of a continuous improvement initiative. For example, a clean technology such as a new machine press that produces less waste could be included in

production plans or as an upgrade. The Dictionary defines clean technology as a technical measure taken to reduce or eliminate at the source the production of any nuisance, pollution, or waste and to help save raw materials, natural resources, and energy. The importance of considering waste during product design and development is illustrated by the 40/30/30 rule. The Dictionary defines the 40/30/30 rule as a rule that identifies the sources of scrap, rework, and waste as 40 percent product design, 30 percent manufacturing processing, and 30 percent from suppliers. While this is a rule of thumb and could differ depending on the product, it shows how up-front work during the design of products and manufacturing processes and supplier selection will have big payoffs in waste reduction, which will lead to efficiency improvements and thus to higher profitability.

Reuse Products or Components. Potential reuse of products or parts of products is considered second in importance to resource conservation. The payoff is a reduction of

the costs involved in purchasing, transportation, and disposal. This can be accomplished in several ways. Resell returned products that pass quality control, repackaging and relocating products as needed (to new selling locations, including resellers). Donate excess inventory to charities as appropriate and allowed, which may provide a tax benefit. (For example, Habitat for Humanity, a charity that builds homes, is a common recipient of excess building materials.) Remanufacture products to like-new condition by replacing worn parts with new parts and sell at a discount or as part of a trade-in program. This is especially appropriate for big-ticket items; for example, Caterpillar has a program like this for industrial equipment. Sell byproducts to organizations that can use them as raw materials (discussed in detail elsewhere). Design products so materials and components can be more easily separated for reuse. This is called design for disassembly and recycling. In addition, intelligently designed product upgrades can extend the life of durable components if they are easy to install. Software upgrades delivered online, for example, extend the life of programs without requiring physical delivery. Such upgrades result in savings

in the logistics network and for the consumer. Rechargeable batteries enable reuse of a battery that would otherwise need recycling.

Recycle Materials. After resource conservation and reuse, recycling is the third most important aftermarket principle. The concept of recycling isn’t easily separable from the concept of reuse, and, in fact, the two can be combined. When containers (bottles, barrels, totes, drums, etc.) are cleaned, sterilized, and filled again, they are reused. When containers are reprocessed into other products, such as landscaping materials, they have been recycled. When a product is broken down into components, some parts may be reused, some recycled, and some sent to the landfill. Recycling reduces disposal costs; reuse can reduce purchasing and transportation costs as well. Recycling can run into problems when different regions enact different requirements, creating diseconomies of scale. Organizations are often forced to customize programs for multiple local areas, which entails different methods, different training, and so on. Recycling requirements can also change. For example, a third-party recycling industry has not yet been developed for the lithium-ion

batteries used in electric cars (such as Tesla). However, individual companies are reusing or recycling batteries. Volkswagen, for example, has a pilot battery recycling plant in Salzgitter, Germany. Since this market is growing fast, especially in Europe, there will soon be a huge number of electric cars reaching their end of life, and this issue will become critical. Advocating now for solutions at the federal levels of government would allow this process to be consistent.

Recover Energy. Disposal with energy recovery doesn’t put a product’s physical materials or components back into service, but it can still provide benefits. “Trash to energy” facilities essentially harvest the energy contained in products that are no longer usable in their physical form. This results in savings for the community. Organizations might directly benefit from this practice as well, for example, by using oil that has already been used to the maximum extent as a lubricant as fuel to run generators. Some of the more modern trash-burning facilities in Europe have very low emissions. In addition to incinerators, energy can also be recovered from biodegradable materials by capturing the gases they release.

Dispose in Responsible Landfill. The Dictionary defines a responsible landfill as

landfill operations designed to turn waste into recoverable resources, minimize the amount of space consumed, and maximize the operational life of the landfill. Some physical products must go to the landfill, but this is the least desirable option. Incineration is generally considered the preferable alternative. If the landfill is the only possible way to dispose of a product, it’s still important to choose the best available one. Not all landfills are equal, so the final leg of a product’s reverse journey should end in a responsible landfill that prevents degrading items from leaching into a water source or polluting the air.

Waste, Hazardous Waste, and Waste Exchange The APICS Dictionary, 16th edition, defines waste as follows: 1) Any activity that does not add value to the good or service in the eyes of the consumer. 2) A by-product of a process or task with unique characteristics requiring special management control. Waste production can usually be planned and somewhat controlled. Scrap is typically not planned and may result from the same production run as waste. Waste is a consideration not only for compliance and ethical reasons but also for economic ones. Some forms of waste may be inevitable

given the nature of a manufacturing process. Some options for processing or disposing of waste will result in significant costs, with some being more expensive than others. The idea is to find the best option that addresses compliance, organizational risks, liabilities, ethics, and reputation while remaining a cost-effective choice. Dealing with waste in this way is called total waste management. The Dictionary defines total waste management (TWM) as a methodology that enables finding solutions to waste issues while keeping in mind financial elements and the business case. Organizations that produce less waste have more of their cost of goods sold going into what the customer considers to be valueadded. (Proper handling of toxic wastewater is an example of something that the customer indirectly pays for but does not value.) This is why the definition of waste discusses how waste “can usually be planned and somewhat controlled.” Preventing waste in the first place is the best option for keeping an operation profitable. This is never more true than for hazardous waste. The Dictionary defines hazardous waste as waste, such as chemicals or nuclear material, that is hazardous to humans or animals and requires special handling.

Hazardous material includes chemicals; wastewater; various forms of human and agricultural waste and sewage; radioactive, construction, electronic, and biohazard waste; and many other types. In many cases, hazardous waste is more than one type because multiple types of pollutants are mixed together. Some hazardous waste is relatively safe for humans but highly toxic to other organisms such as fish or bees.

Compliance with Regulations Various government agencies enact regulations based on hazardous waste legislation. These agencies will monitor or audit organizations for compliance in addition to requiring reporting and record keeping. Monitoring and audits may include plant inspections, testing discharge sources at the point of discharge or in the local area (such as downstream from a river discharge point), or testing nearby groundwater. Hazardous waste regulations also specify the means to be used for its transportation, storage, and disposal. These methods will differ by type of material. Necessary safety procedures take into account whether the waste could be explosive or corrosive, form a toxic gas cloud, and so on.

Compliance with hazardous waste regulations requires keeping careful records of what categories of hazardous waste are being processed along with a chain of custody that provides evidence that the materials were properly processed. When it comes to disposal, options may include supervised incineration on site or transportation to a specially designated hazardous waste disposal site with the proper permits for handling the type of hazardous waste in question. Proof of delivery needs to be provided in reports and retained in archive records. To assist with compliance efforts, the United Nations has created an international standard for identifying hazardous chemicals. The Dictionary defines the Globally Harmonized System of Classification and Labeling of Chemicals (GHS) as an international standard, created by the United Nations Economic Commission for Europe (UNECE), for classifying chemicals according to their health, physical and environmental hazards. The system defines and classifies the hazards of chemical products, and communicates health and safety information on labels and material safety data sheets. While this system exists primarily for hazardous materials used in products, it does specify how to properly dispose of hazardous waste once the product has been used or is no longer needed. In either

case, safety data sheets (SDS) indicate proper safety gear to use, what to do if exposure occurs, and the possible effects of any exposure on humans, animals, or plants. When products with hazardous ingredients are provided to consumers, the consumers also need to be educated as to their proper use and disposal. Note that there is a link to an example of an SDS in the Resource Center. Strict waste regulations exist in the European Union and in many other places. Let’s look at two regulations used in the EU as examples. The Wastes of Electric and Electronic Equipment (WEEE) legislation in the European Union places the burden of disposing of computers, monitors, televisions, printers, and other peripherals on the manufacturers. Consumers can deliver the devices to the manufacturer, and the manufacturer cannot charge a fee. The manufacturer is required to properly identify and dispose of the materials. This legislation provides incentives to rely more on the higher activities in the waste hierarchy, for example, recycling before responsible landfill. A large number of U.S. states have similar “e-waste” legislation. The EU’s Restriction on Hazardous Substances (RoHS) Directive is aimed at the apex of the waste hierarchy—reduce—and the product development life cycle stage. It limits the amounts of lead,

cadmium, mercury, hexavalent chromium, polybrominated biphenyl, and polybrominated diphenyl ether that new electrical and electric equipment can contain for it to be sold within the EU from any source. Organizations can partner with regulatory agencies to make compliance easier. They can also exert lobbying influence on the regulations themselves or through an industry nonprofit association to ensure that the regulations are clear and easy to follow.

Waste Exchange Waste exchange is a way of reusing waste so that it does not need to be recycled or disposed of. The APICS Dictionary, 16th edition, defines waste exchange as follows: 1) Arrangement in which companies exchange their wastes for the benefit of both parties. 2) An exchange service of valuable information between generators and potential users of industrial and commercial wastes, whereby a beneficial use rather than disposal is the end result. This service identifies both the producers and potential markets for by-products, surpluses, unspent materials and other forms of solid waste that is no longer needed. One organization’s byproduct or other type of waste may be another organization’s raw material. Long ago, tanners would collect

chamber pots around the community each morning to use when tanning leather, which provided a side benefit of reducing the amount of human waste flowing through the streets. Today, many organizations seek to sell their byproducts or other waste at market rates, both generating revenue and reducing disposal costs. In the waste hierarchy, this would qualify as reuse of materials, so it is quite high on the scale of effective responses. The second part of the definition of waste exchange reveals that organized information exchanges are the key to finding or creating a market for certain waste products. Tyson used to discard its chicken feet until it discovered that there was a huge demand for them in Asia. Now it ships these overseas. In fact, every part of the chicken is used for something. Even the feathers are baked and become a powder additive to pet food. Nonprofit information exchanges exist on a regional basis to help connect buyers with sellers and thus create a market. Either party can specify what they have or need. Buyers may specify how frequently they need it and in what quantity. Transportation and handling could be part of the negotiated price; for example, a lowvalue waste product could be offered for free provided that the buyer pays for shipping and handling.

Index A AESDirect [1] Air transport [1] Air transport issues/challenges [1] Air transport market structures [1] Anticipation inventory [1] Assortment [1] ATR certificates [1] Automated sortation systems [1] Automated sorting systems [1] Automated systems Automated sorting systems [1] Live racks [1] Robotics [1]

B B/Ls [1] Bills of lading (B/Ls) [1] Break-bulk [1] Bridge cranes [1] Brokers

Customs brokers [1] , [2] Ship brokers [1]

C Capacity planning [1] See also: Capacity control, Capacity management Carnets [1] Carousels [1] Carriers Common carriers [1] Contract carriers [1] Exempt carriers [1] Motor carriers [1] Cash flows Reverse cash flows [1] Certificates of insurance [1] Certificates of origin [1] Clean technologies [1] COFC [1] Commercial invoices [1] Common carriers [1] Compliance [1] , [2] Conflicts of interest [1] Consolidation [1] , [2]

Consolidators [1] Container on a flatcar (COFC) [1] Container shipping [1] See also: Intermodal transport Contract carriers [1] Contracts [1] See also: Terms and conditions Contract warehouses [1] Conveyors [1] Costs Import costs [1] Reverse logistics costs [1] , [2] Transportation costs [1] Cranes Bridge cranes [1] Wagon cranes [1] Cross-docking [1] Customer service [1] Customs [1] See also: Import/export Customs brokers [1] , [2] Customs security [1]

D

Declared value [1] Deemed exports [1] Delivery patterns [1] Density Packaging density [1] Value density [1] Design for reverse logistics [1] Direct loading [1] Direct-to-consumer model [1] Distribution center location [1] Dock receipts [1] Duty drawbacks [1] Duty paid-warehouse [1]

E Echelons [1] Economies of distance [1] Economies of scale [1] Environment [1] EPZs [1] ETCs [1] Exempt carriers [1] Export declarations [1] Export licenses [1]

Export packaging [1] Export packing companies [1] Export processing zones [1] Export processing zones (EPZs) [1] Export trading companies (ETCs) [1]

F Fixed-location storage [1] Forecasting [1] Foreign freight forwarders [1] Foreign trade zones [1] Forklift trucks [1] Forwarders [1] Fourth-party logistics (4PLs) [1] Free trade zones (FTZs) [1] Freight consolidation [1] , [2] Freight forwarders [1] FTZs [1]

G Global trade management [1] Government regulations [1]

H

Harmonized Tariff Schedule (HTS) [1] See also: Harmonized system classification codes Hazardous waste [1] HTS [1]

I Import/export [1] , [3] , [5] See also: Customs Import/export documentation ATR certificates [1] Carnets [1] Certificates of insurance [1] Certificates of origin [1] Commercial invoices [1] Dock receipts [1] Export declarations [1] Export licenses [1] Import costs [1] Incoterms [1] Incoterms trade terms [1] Information flows Reverse information flows [1] Intermodal transport Container on a flatcar (COFC) [1]

Package delivery services [1] Piggyback [1] RoadRailer [1] Trailer on a flatcar (TOFC) [1] Trainship [1] International Commercial Terms [1] Inventory Anticipation inventory [1]

L Labeling [1] , [2] Labor laws [1] Landfills [1] See also: Waste Lead time [1] Liabilities [1] Line-haul costs [1] Live racks [1] Logistics [1] Logistics service providers [1] Logistics service providers (LSPs) Fourth-party logistics (4PLs) [1] Third-party logistics (3PLs) [1] Logistics strategy [1] , [2]

M Materials handling [1] , [2] Mechanized materials-handling systems Bridge cranes [1] Carousels [1] Conveyors [1] Forklift trucks [1] Towlines [1] Tow tractors with trailers [1] Wagon cranes [1] Mixing [1] Motor carriers [1] Moving [1]

O Order fulfillment channels [1] Order picking [1] Order selection [1] Outsourcing [1] See also: Subcontracting

P Package delivery services [1] Packaging

Export packaging [1] Packaging density [1] Packing and marking [1] Piggyback [1] Pipeline transport [1] Pipeline transport capability [1] Pipeline transport issues/challenges [1] Postponement [1] Prepackaging [1] Private carriers [1] Private warehouses [1] Product flows Reverse product flows [1] Product life cycle [1] Product movement [1] Prohibited goods [1] Public warehouses [1] Put-away [1]

R Rail-road transport [1] Rail transport [1] Rail transport capability [1] Rail transport issues/challenges [1]

Rail transport market structures [1] Random-location storage [1] Receiving [1] Recycling [1] Returns [1] See also: Reverse supply chains Reuse of materials [1] Reverse cash flows [1] Reverse information flows [1] Reverse logistics [1] , [2] , [3] , [4] Reverse logistics costs [1] , [2] Reverse logistics hierarchy [1] Reverse product flows [1] Reverse supply chains [1] See also: Returns Risk pooling [1] RoadRailer [1] Road transport capability [1] Road transport issues/challenges [1] Road transport market structures [1] Robotics [1]

S Security partnerships [1]

SEZs [1] Ship agents [1] Ship brokers [1] Shipper's agents [1] Shipping [1] Shipping associations [1] Shipping costs Line-haul costs [1] Shipping patterns [1] Sourcing Outsourcing [1] Special export zones (SEZs) [1] Spot-stocking [1] Stock locations [1] Stockpiling inventory [1] Storage Fixed-location storage [1] Random-location storage [1] Temporary storage [1] Storing [1] Stowability [1] Supply chain integration [1] Supply chain partners [1] Supply chains

Reverse supply chains [1] Supply chain security [1]

T Tariffs [1] Temporary storage [1] Third-party logistics (3PLs) [1] TOFC [1] Total cost concept [1] Total waste management (TWM) [1] Towlines [1] Tow tractors with trailers [1] Trade blocs [1] Trading blocs [1] Trailer on a flatcar (TOFC) [1] Trainship [1] Transportation [1] Transportation costs [1] Transportation documentation Bills of lading (B/Ls) [1] Waybills [1] Transportation intermediaries Export packing companies [1] Export trading companies (ETCs) [1]

Foreign freight forwarders [1] Freight forwarders [1] Logistics service providers (LSPs) [1] Ship agents [1] Shipping associations [1] Transportation mode selection [1] TWM [1]

U Uniform bills of lading [1]

V Value density [1] Variety [1] See also: Three Vs

W Wagon cranes [1] Warehouse capacity [1] Warehouse design [1] Warehouse functions Assortment [1] Break-bulk [1] Consolidation [1] , [2]

Cross-docking [1] Mixing [1] Spot-stocking [1] Stockpiling inventory [1] Warehouse layouts [1] Warehouse location [1] See also: Warehouse number Warehouse number [1] See also: Warehouse location Warehouse processes Moving [1] Order picking [1] Packaging [1] , [2] Packing and marking [1] Prepackaging [1] Put-away [1] Receiving [1] Shipping [1] Storing [1] Warehouses Contract warehouses [1] Private warehouses [1] Public warehouses [1] Warehousing [1]

Warranties [1] Waste Hazardous waste [1] Waste exchange [1] Waste hierarchy [1] Water carriers Private carriers [1] Water transport [1] Water transport capability [1] Water transport issues/challenges [1] Water transport market structures [1] Waybills [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Module 6: Supply Chain Relationships This module focuses on customer relationship management (CRM), supplier relationship management (SRM), and overall supply chain relationship management advice. CRM is developed and implemented as a social relations strategy that has some enabling technologies. It fulfills requirements for improved demand management, customer service, and alignment of customer-facing processes and resources. CRM helps create and maintain demand for the products and services being produced. SRM requires an understanding of the underlying concepts, the enabling technologies, and the requirements for improved management of sources of supply. While CRM focuses on creating demand, SRM helps ensure that this demand can be fulfilled in a way that delivers profit to all members of the supply chain and satisfaction to the supply chain customers. Looking at CRM and SRM as two sides of the same process can help organizations better implement these types of relationship management, because they can take lessons learned from one area and apply them to the other area.

Section A: Customer Relationships This section is designed to Describe reasons to identify and understand market segments Define the concepts behind customer-focused marketing Describe the benefits of market segmentation Describe how markets can be segmented by demographics, attitudes, psychological profiles, customer value, customer needs, or contact channel Describe the Pareto effect in relation to customer value Explain how customer data can be used to understand segment wants and needs Define customer relationship management (CRM) Explain why CRM is critical to a supply chain’s success Describe the scope of CRM, including sales operations, analysis, customer information dissemination, relationship building, and collaboration Explain the relationship between CRM and the concept of the lifetime customer Describe the benefits of CRM, including increased customer retention

Describe the need for and uses of customer information in CRM Discuss the components of a CRM strategy Trace the changes in CRM factors throughout the product life cycle Describe how CRM strategy can use demographics, customer value, needs, etc. Explain how to use customer type (prospects, vulnerable, winback, loyal) in CRM strategy Explain the relationship between CRM, technology and creating lifetime customers Describe the sources of customer information, including the voice of the customer Review how technology can be used to enhance the CRM process Describe how customer-focused metrics can improve overall satisfaction Understand how to measure key customer service metrics, including fill rates, lead time, order status, inventory turnover, and on-time delivery. In this section we explore the need for segmenting customers in various ways, such as by lifetime value. The section then explores CRM, its scope and benefits, and how companies develop and implement CRM strategies. The section also provides examples of

how organizations use customer information and metrics to refine both relationships and the CRM process.

Topic 1: Customer Relationships and Segmentation Customer relationship management (CRM) is a philosophy that recognizes that all companies are at least in part service companies and that the quality of that service matters. Segmenting customers helps provide tailored services to different groups. Various methods of segmenting customers and complementary CRM strategies are described here.

Customer Relationships and Segmentation Road Map The 16th edition of the APICS Dictionary defines customer relationship management as a marketing philosophy based on putting the customer first. The collection and analysis of information designed for sales and marketing decision support (as contrasted to enterprise resources planning information) to understand and support existing and potential customer needs. It includes account management, catalog and order entry,

payment processing, credits and adjustments, and other functions. The definition suggests that CRM starts with an adjustment of philosophy in an organization—the shift to a customer-centric way of doing business—and then moves to a retooling of all the business processes that touch on the relationship with the customer, from customer acquisition to order fulfillment. CRM’s focus on the customer is both broad and deep. It is broad in that it covers every interaction with customers; it is deep in that it focuses on the development of long-term relationships with customers whenever possible. A premise of lifetime customer value is that retaining customers is more profitable than finding new ones. While CRM is often identified with the software of the same name, the focus on long-term customer relationship building is one of the reasons why CRM is a philosophy first and not just a technology solution. While the software provides a repository for customer data to facilitate consistency in service interactions, ongoing communications with customers requires soft skills such as listening, the ability to demonstrate an understanding of the customers’ perspectives, and the championing of customer needs to others in the organization.

Need for CRM

In his book Business @ the Speed of Thought, Microsoft founder Bill Gates comments that a manufacturer or retailer that responds to changes in sales in hours instead of weeks is no longer at heart a product company, but a service company that has a product offering. This statement underscores some key points. First, responding to change quickly has become the differentiator between winners and losers in today’s business world. Second, if businesses fail to understand that their prime mission is to satisfy their customers’ needs and wants—to provide a product/service package rather than push boxes out the factory door—then those businesses will simply fail. CRM has been adopted as a competitive survival strategy. By definition, if a firm embraces the philosophies behind CRM, it naturally must elevate customer-centric concepts above other considerations and engage in the difficult tasks of gathering, sharing, and acting on end customer information. Without embracing these supply chain changes wholeheartedly, a supply chain will remain a series of uncooperative and inefficient firms and will likely be bypassed by competitors who have embraced CRM (and other collaboration tools) to become more agile and efficient.

The focus on creating and sustaining more profitable relationships with customers has led organizations to transform themselves into customer-centric organizations. Customer-centric organizations Are easy to do business with…anytime, anywhere Add value to their products or services, integrating products and information so that customers feel more educated during and after the decision-making process Are innovative not only in their design of services and products but in their marketing, delivery, and customer care (An example may include how customer care strives to improve customer service while reducing costs and provides self-service and support so the customer feels in control.) Design all business contact points from the customer’s perspective Share detailed insights about customers within the organization or supply chain. Because different types of customers have different needs, the CRM philosophy requires that organizations segment their customers and engage in customer-focused marketing.

Segmentation and Customer-Focused Marketing According to the APICS Dictionary, 16th edition, customer segmentation is

the practice of dividing a customer base into groups of individuals that are similar in specific ways relevant to marketing. Traditional segmentation focuses on identifying customer groups based on demographics and attributes such as attitude and psychological profiles. Potential customers form a very large group that can be segmented based on market analysis and information from existing customers. Segmentation can be based on any number of criteria selected to suit a particular purpose, and each class may be segmented in more than one way. Market segments can be defined by demographic characteristics such as gender, geography, age, occupation, and wealth. Demographic categories can also be refined or customized. For example, geographic segmentation could be based on the likelihood of visiting a particular retail location, by ZIP or area code, or by zones that contain relatively equal demand (i.e., the size of each zone would vary). Customers can also be segmented by attitudes or psychological profiles, such as willingness to engage in social media or self-identification in a social group such as a biker or a wine lover. During product or service design or redesign, marketing can ask more specific questions about the potential market. As always, the basic questions are the best questions: Who? Where? When? Why? What? How many? In other words, who is interested in the new

product, and where are they located? Are they low-income urban apartment dwellers, suburban homeowners, or farmers and ranchers? The answers to such questions constitute segmentation. When discussing market segments in a supply chain, there may be more than one perspective of who the customer is. For example: Intermediate customers are not at the end of the supply chain. A raw material supplier may count several manufacturers among its intermediate customers, and one or more of these manufacturers could be grouped by similar requirements. Ultimate customers are the final recipients of the products or services. The ultimate customer could be an organization that is purchasing goods or services for its employees or constituents, in which case segmentation must also differentiate between organizational customers (the ultimate payor) and end users (the ultimate user). Here we will focus primarily on the ultimate customer. However, the concepts can be carried back through the supply chain to decisions regarding intermediate customers. The primary reason to identify and understand market segments is to increase the organization’s profits (or its equivalent) over the long term; therefore, customers are the primary group that requires

segmentation. However, organizations can segment suppliers and other stakeholders using very similar methods. Customer-Focused Marketing Most organizations now recognize that a successful business strategy is customer-focused. According to the Dictionary, customer-driven (another term for customer-focused) is “a company’s consideration of customer wants and desires in deciding what is produced and its quality.” Customer-focused marketing is based on several fundamental concepts: Customer requirements must drive product and service design. Rather than designing a product or service with multiple varieties in features, colors, and prices, design should start with analysis of actual customer requirements or needs. For example, the results could show that color is irrelevant but a particular design feature is worth a premium. All products and services have more than one market segment. The primary justification for defining market segments is the marketing assertion that no single set of customer requirements describes all potential customers. Each customer will have unique requirements, but groups of customers with similar

requirements can be identified. For example, a furnace repair/replacement service may require that a new heating system be delivered as soon as possible to replace a broken unit, while a home builder may order in bulk and always order with lead time, valuing consistency over fast delivery. Logistics and marketing strategy must focus on customer segments. In addition to designing the form of a product or service to meet customer requirements, marketing provides marketing information in a manner likely to reach and be appreciated by that segment. Logistics must then make that product or service available to the customer at a time and place the customer segment finds convenient. This often involves developing multiple supply chains tailored to specific customer segments and/or product types. Profitability is more important than sales volume. All strategic decisions on product form, marketing expense, and logistics (methodology, timing, and placement) have an associated cost. Each additional cost must be justified by incremental (marginal) increases in profits. An essential benefit of customer segmentation is an identification of the size and value of each segment, which can help predict whether a given change in strategy will increase profits. The situation to avoid is a feature or investment that

increases revenue but also increases expenses by a similar amount. What Is Driving the Change to Being Customer-Focused? Today’s customer is harder and more expensive to win and to keep, so businesses need to understand customer segments, improve twoway communications with them, and work to fulfill customer segment needs when it can be done profitably. Advances in technology and competition in a worldwide free marketplace have benefited customers by raising their expectations for quality, trouble-free products and services. For example, today’s automobile may be very difficult for an amateur mechanic to repair, but it is also relatively trouble-free compared with the automobile of the 1950s. Car buyers today expect that their vehicles will last at least 10 years and will experience only minor problems for the first six years. Meeting those expectations raises the costs of design and production. As customers begin to assume that products and services will be of high quality, the competitive differentiator becomes price or value. The internet makes it easy for customers to shop for lowest price. The market expands from the neighborhood retailer to a global marketplace of eager sellers. This creates further pressure on a business’s bottom line or profit. One way to respond to this pressure is to “niche market,” to develop and market products to specific

customer segments that have shown they value and are willing to pay for what this product or service offers. This again raises the costs of doing business, since the business must design profitable but customizable products while it develops and executes multiple marketing plans. The resulting pressure on profit makes it even more important that companies retain their customers, since customers become more profitable the longer they are retained. Creating customers for life has become a critical business goal. Reaching that goal requires understanding and then satisfying customer segment expectations and delivering greater perceived value than the competition. Benefits of Segmentation Words like “niche” and “customization” reflect the fact that customers increasingly expect the market to come to them rather than for them to go to the market. In other words, they expect to have things their way. In a satellite/cable communications world, they expect to find 500 channels, one of which is aimed precisely at their own interests. Runners expect to find a running shoe that exactly matches their own level of exercise, running style, terrain, and anatomy. The marketplace is more segmented every day, which could be seen as a drawback due to its complexity. However, CRM philosophies and technology systems exist to help manage that segmentation.

Segmentation also benefits organizations. Lifetime customer relationships are more likely when customers feel that a business is meeting their unique needs. This is a mutual dependency/mutual gain relationship. Customer-focused businesses have the opportunity to learn more about their individual customers and to use that information to increase sales and profit. Segmentation also helps businesses get a better return on their promotional budgets. Businesses that used to advertise in broadly targeted media sources have decreased or eliminated this form of advertising in favor of more narrowly targeted channels that are less expensive, like special interest magazines or internet or phone app ads. Businesses can be more confident that they are reaching the right audience with the message that is most meaningful to that audience.

Defining Segments The concept of segmentation has existed for some time, but the ways to segment markets have been evolving under customerfocused strategies. Historically, market segments were based, in the worst case, on preconceptions about the behaviors or desires of certain groups or, in the best case, on research into small “representative” groups of customers. Household cleaning products, for example, were aimed

at women and emphasized effectiveness and convenience. Clothing retailers aimed at price niches: inexpensive, moderate, designer. Entertainment producers aimed at age groups: children, adolescents, adults. This type of predictive segmentation can be inaccurate. For example, a large financial institution stereotyped young customers as being more interested in using the internet to fulfill their banking needs, and they directed most of their promotional efforts for online banking to this group. In fact, customers over age 50 (who tended to have more assets and were therefore more valuable to the bank) were increasingly turning to internet banking. The bank was missing a more valuable market segment. Today, segments can be defined by customers’ actual buying behaviors, and the result is more accurate segmentation. Customers for household cleaning products might be divided by a variety of factors other than effectiveness and convenience: customers who want ecologically oriented products, who need products free of scents and dyes, or who want to buy all of their products at the same time from a distributor who can offer savings or rewards. Clothing retailers have subdivided the youth market into four or five segments, each with its own buying habits and preferences. Segmentation may occur in a customer-focused strategy by customer value to the business, by customer needs, and by

preferred contact channel.

Segmentation by Customer Value Customer value can be defined as the actual or potential profit the organization can make by acquiring and retaining a given customer or customer type over the lifetime of the relationship. In the past, organizations treated customers as if they were all the same. Each received the same level of service and was charged the same fees for the products they purchased, regardless of how they affected the organization’s profit. Today more and more organizations are treating customers differently based on the differences in the customers’ contributions to the bottom line. A large computer manufacturer, for example, does not treat all customers equally. Their database tells them who their largest customers are and how much profit they represent. The greater the customer’s value, the better the treatment the customer receives. For example, someone who buys multiple servers is more likely to be offered special package pricing or be sent a postcard thanking the customer for their business. The computer manufacturer may decline to offer discounts to smaller businesses that don’t generate the profit opportunities that larger businesses do.

Leading-edge organizations are working to increase value generation from high-yield customers. They aim to acquire and retain profitable customers and get them to spend more. Exhibit 6-1 applies the Pareto principle to customer segments, showing how a small number of customers (about 20 percent) can generate a disproportionately large amount of total revenue (about 80 percent). Top tiers get more/better services.

Exhibit 6-1: Pareto Effect in Customer Segments

Segmentation by Customer Needs Segmentation by customer needs revolves around the services or product features that profitable customers desire. These needs may

refer to specific product or service features, contact channels, or logistics channels (time and placement). Defining what customers value can use customer-focused segmentation to analyze actual buying behaviors as well as information on the things customers are searching for, such as an entry into a search engine. When purchasing a product, most customers will search for the best value, but value does not equal price for all customer segments. Customers may perceive some purchases as commodities, and for those items they will seek the lowest price. Other items or services may be perceived as more critical. For these buying decisions, other factors, such as reliability, longevity, or the convenience of the purchasing and postpurchase experiences, may be as or more important than price. It is important for businesses, therefore, to understand what the customers want, why, and how much. This is called a value profile. Once the value profile has been created, a value proposition can then be drafted that details how each segment’s perception of value will be fulfilled by the product or service. The value proposition is a key part of the promotional strategy and customer relationship. For example, customers value something more than economy when they choose to shop in a retail environment for items they could obtain over the internet at a lower price. It may be the sensory

experience of seeing and touching the product or of the retail store itself. The internet may offer too many choices for some. It may be the personal service received in the retail environment and the relationships formed with sales or service staff. It may be that they don’t trust the internet; they may have been disappointed in the quality of products or services they have received or they may be doubtful of the security of online financial transactions. These are the kinds of values that must be identified for the targeted segments and addressed in the customer-focused strategy, often in the form of segment-specific supply chains.

Segmentation by Preferred Channel Over the past few years, technology has given customers more options and better service and has lowered the costs of doing business for organizations. Customers are increasingly comfortable making purchases or obtaining service without a “live” customer service representative and may prefer that contact point, or channel, for specific types of purchases or services. Organizations may allow customers to shop online, track order progress, and view account histories. Customers may use websites to obtain installation instructions or documentation. They may value and act on informational or promotional emails.

Because of potential savings, some business sectors have chosen to reward customers that use less expensive technology channels, such as a discount for setting up automated bill payment and paperless billing. Another option is to educate customers on the benefits of a particular channel. For example, automated callanswering systems usually refer callers to chat services or websites for faster service and a chance to avoid a lengthy wait in a phone queue.

Segmenting Customers To develop customer segments, one must first understand the wants and needs of individuals in terms of, for example, value or preferred contact channels, and then look for patterns that can become the basis for the segments. Customer information is the basis for customer segmentation and all marketing and sales strategies based on an understanding of the wants and needs of those segments. Acquiring this information involves information from multiple sources, including market research and the voice of the customer.

Sources of Customer Information Market intelligence can be purchased from outside sources but can also be derived from data gathered in every customer transaction.

Different sources can provide different elements of the complete picture of each customer segment: Transaction records can show purchase frequency and volume, information on customer complaints and feedback, and how purchases are financed by the customer segment. Sales representatives can relay information about what various customer segments are asking for, what they’re not interested in, what concerns they have in making the purchase, and why they may or may not be considering the competition. In the business-tobusiness world, sales representatives hold the key to educating the organization about the customer’s business and its unique needs. (Each business client may be its own segment.) Service representatives can provide information about how products or services are being used currently and how specific customer segments would like to use them. Their experiences can help gauge segment attitudes toward the company and its products and how well it is managing customer service. Distribution points (e.g., retailers, the internet, or self-serve kiosks) can provide information about customer segment values, purchasing habits, and preferences—information that can be

valuable in understanding the values of customers in different contact channel segments. Purchased data from survey companies, database marketing companies, and service or finance bureaus can provide general customer information.

Market Research and the Voice of the Customer In addition to external forms of market research, we shouldn’t overlook customers themselves as a source of information. Determining the wants and needs of prospective and existing customer segments may require phone surveys, questionnaires, focus groups, or a combination of these market research approaches. Successful organizations recognize market research as a way not only to understand existing customer segments better but also to increase loyalty and create mutually beneficial relationships. One way to involve the customer is by using the voice of the customer (VOC) . VOC is defined in the APICS Dictionary, 16th edition, as actual customer descriptions in words for the functions and features customers desire for goods and services. In the strict definition, as relates to quality function deployment (QFD), the term customer indicates the external customer of the supplying entity.

In a broader context, the voice of the customer is a research and measurement tool used in complex selling situations when it may not be easy to ask the right questions. It can be used to understand why a customer has chosen a business or has chosen to leave a business. It can be used to gauge satisfaction with after-sales service, order processing, billing, or delivery or to design new products or services. VOC can help in developing solutions to problems with existing products or services; it can assist in continual improvement. It may be a response to a particular situation, but it is better used in a continual fashion as a way of keeping in touch with customers and their perceptions of the value they are receiving. VOC allows customers to talk freely and identify topics for discussion rather than simply respond to topics chosen by the researcher. It may help businesses uncover previously unstated customer expectations or needs. The voice of the customer can be captured in a variety of ways: through direct discussion or interviews with individual customers; surveys and focus groups; customerdeveloped specifications or customer design groups; and collation of customer comments from warranty records, field reports, or complaint logs. This information can be collated by customer segment to help understand each segment’s wants and needs. Author Jim Barnes states

A Voice of the Customer (VOC) initiative should give voice to things that the firm would not normally hear. It should allow a firm to hear, straight from its customers, insightful things that do not surface through conventional marketing research. By continually uncovering and responding to customer needs, organizations using VOC know their customers intimately. They are more able to anticipate desired products and services. They also demonstrate the customer segment focus that differentiates them from their competition.

CRM Strategies by Customer Segment and Type Creating a CRM strategy involves translating an organization’s overall strategic goals and business plans into customer-centric selections in the four Ps of product, price, placement, and promotion for each product family or product. A very important element of CRM strategy is pricing. It is a strategic and critical decision that is often an order qualifier. Placement or channel strategy and segmentation are also important in terms of impact on the perceived value of an offer to a customer. In other words, the price must be right, and, if it is, the right customer segments must be made the offer and it must be conveyed in a manner that will be most likely to get and keep

their attention. The marketing, branding, and advertising aspects of CRM promotional strategy and product design are also important. However, there is a key element in a CRM strategy that must not be forgotten: the customer. A CRM strategy must factor in the customer segments being targeted, possibly leading to a different strategy for each of the organization’s targeted customer segments. CRM strategy also needs to consider customer type, which refers to the customer’s current relationship with the organization (e.g., prospects, win-back customers).

CRM Strategies for Customer Segments Customer segment strategies can be categorized by demographics, attitudes, or psychological profiles; as customer value, serviceminded customer, retail customer, or B2B customer strategies; and as strategies for reaching customers via technology channels. Demographic, Attitude, or Psychological Profile–Based Strategies When segmentation is performed based on demographics, attitudes, or psychological profiles, care must be taken not to make assumptions but to base the strategies on valid research. Some obvious demographic segmentation strategies can be valuable, such as for products designed only for women, but when it comes to more

nuanced segmentation, published scientific studies, census information, or broad-based market research from respected sources should be sought to support intuitive opinions. For example, while traditional marketing wisdom states that repetitive marketing is necessary and effective in getting a brand message to sink in, a study from Exact Target and CoTweet listed on www.marketingcharts.com indicates some contrary research: 52 percent of Twitter users state that messages that are too repetitive or boring are a reason to stop following a brand on that messaging and networking site. Value, Service, Retail, or B2B Strategies Customer value strategies. To retain the most profitable customers and increase business with high-value customers, businesses must develop customer-centric strategies that accomplish the following. Define “valuable” customers. Value may mean different things for different organizations, depending on their business goals. A business trying to establish dominance in a market may focus on customers it has converted from the competition. Volume may be meaningful to some businesses, while profit (perhaps subdivided into profitability in targeted products or lines) is meaningful to all for-profit organizations.

Deliver timely, detailed information that will help the organizations identify the most valuable customers. CRM information systems must capture and yield the right information for analysis. Define what features or services mean the most to the best customer segments. Data may be analyzed to identify the most commonly used or requested features or services. For example, an examination of interactions with the most profitable customers for an online merchant may uncover that they tend to choose the most rapid form of shipping. The merchant might form a closer relationship with these profitable customers by offering free express shipping for larger orders. Measure impact. Are we dealing with customers without measuring the effectiveness of the segmented customer-centric strategy? Are the costs of providing improved service to customers more than balanced by increased profit or growth? Is there any value to a segmented strategy? Service-minded customer strategies. For many customers who value service, the call center is the heart of the business with which they are dealing. While most organizations pride themselves on personalized service via the call center, the point of

differentiation is often technology. Technology makes information available to the call center operator, who can then use this information to assist the individual customer and resolve issues in a timely fashion. CRM technology allows a customer service representative to view detailed information about the customer’s history as well as the specific transaction during the call. A representative can see immediately if this is a high-value customer and escalate the service process (for example, by not placing the person on hold). The representative can demonstrate a high level of personal knowledge about the customer and the customer’s business that is valued by the service-minded customer. Retail customer strategies. Retail customers surveyed by a marketing research company reported that price was not the sole factor affecting their decision to purchase a product. Rather, customers actually were most influenced by the bundle of services surrounding the product, including in-store assistance, the availability of a website or toll-free number for preshopping research or postpurchase customer service, and product design that values easy assembly of the product and integration of the product into existing systems. The second issue driving retail customers was product quality. Price, as measured by both actual price and anticipated product life, ranked in third place. Customer-

centric strategies for retail customers should therefore consider and reflect this group’s complex contact channel preferences. B2B customer strategies. Business-to-business (B2B) customers (to be distinguished from customers buying products or services for personal use, or B2C) have specific areas of expectations from the companies with which they do business. Complementary core competencies. Business customers want to focus their main resources on their own core competencies while turning over the balance of functions to businesses with expertise in those areas. They rely heavily on the expertise and reliability of their product or service providers, because a failure by the provider puts the business customer at risk with its own customers. Knowledge of the customer’s business requirements. Business customers value a provider’s understanding of how their business operates, what its limitations and concerns are, how the product or service fits into their business, and what requirements may be part of the purchasing process. Business customers would rather not educate or re-educate each provider. For example, a manufacturing company’s supplier should have full online service and specification information for the manufacturer’s related products.

Continuous improvement. Business customers value suggestions regarding economic opportunities, improvements, and potential solutions to problems. These business customer expectations suggest that a successful customer-centric B2B strategy must include extensive training of sales and service representatives, with great attention paid to profiling customer and end user needs, avoiding problems or remedying them quickly, and analyzing account data periodically to identify areas for improvement. Technology Channel Strategies When developing a customer-centric strategy for reaching customers via technological channels, businesses must carefully test how receptive their customers are to the given contact point. Is this the type of purchase they feel comfortable making on their own? Is this a high-relationship, high-touch type of sale? How familiar is the targeted customer segment with the channel? How willing are they to learn? Some B2B systems may require extensive training. Will the decision to use a more technologically advanced channel drive some customers away? Will multiple channels be needed?

CRM Strategies for Customer Relationship Types

Just as products have a life cycle, so do customers. They progress in their relationship with a brand or a business from prospect to customer, and then, at critical decision points, they consider whether to continue or re-initiate the relationship. One of the key purposes of a CRM strategy is to allow an organization to address the various types of prospects and customers it serves at different stages in their particular life cycle. Very different marketing and customer care campaigns are developed based on these types of customer relationships. The four relationship types are prospective, vulnerable, win-back, and loyal customers. Prospective Customers Potential customers are included in the prospective type. CRM strategy related to prospective customers determines the market research, product pricing, audience segmentation, promotional message, and contact channel that should be selected for each customer segment. Captured data can help shape future prospecting activities. For example, a financial services company may discover that contact with prospects from carefully researched sources yields more new customers than traditional cold-calling over the telephone, while referrals from current customers are the best source

Vulnerable Customers Some customers may be vulnerable; for some reason, the likelihood of retaining their business is less than for other groups. Saving a customer who is about to discontinue service or stop purchasing product requires good target identification and prompt action. CRM data can be instrumental in early and accurate identification of vulnerable customers and in analyzing the most effective retention programs. According to the 16th edition of the APICS Dictionary, churn is “the process of customers changing their buying preferences because they find better and/or cheaper products and services elsewhere.” The predictive churn model uses customer information (including factors such as demographics and individual customer purchasing history and trends) to anticipate in what groups and at what levels customer attrition may occur. The model may also be used to measure annual turnover in the customer base and set goals for replacing lost customers through acquisition of new customers. The business may then decide to target special promotions to keep those customers they believe still have value. For example, credit card companies identify customers who have used their cards only minimally and offer them opportunities to transfer balances from other cards at no interest for a set period. Or they may institute a

“frequent user” reward program. Service companies such as phone and cable companies who have a very low marginal cost for customers will often offer special deals to customers who want to cancel (e.g., 50 percent off for the next six months). Win-Back Customers Customers may become ex-customers and good ones need to be won back. To win back a customer, communication should be made as soon as possible, within the first week after the customer has discontinued service. Rapid communication between different parts of the company is essential. For example, a phone company discovered that it had lost 27 percent of its mobile phone customers to other mobile providers. They quickly offered a special program to the most valuable customers and were able to win back approximately 50 percent of its profitable customers within 48 hours. (They left the unprofitable customers with the competition.) After additional research, the phone company learned valuable information from the customers who had left the company, such as how the competition enticed them to switch carriers and how perception of the quality of the service had affected that decision. With this new information in hand, the phone company set out to make changes based on the information communicated to them. Contracts may be used to keep customers long enough so they become profitable, but this means that the opportunity to win back

customers is often only before a customer signs a competitor’s contract. Automated CRM programs can trigger implementation of win-back programs as soon as the customer relationship is terminated or as it is being terminated. Customer data can support the decision to expend resources to win those customers back. Loyal Customers Other customers become loyal customers, the least vulnerable group and the foundation of successful businesses. The goal of any CRM strategy is to increase the number of loyal customers. It is obviously in the best interests of a business to cultivate customer loyalty. Loyal customers are less vulnerable to loss and will therefore not require the business to incur the costs of a win-back program. According to a poll published in USA Today, 44 percent of U.S.– based CEOs list customer loyalty as their number-one management challenge. The CRM response to that challenge has been the development of customer loyalty programs—CRM programs that reward loyal customers, in a way meaningful to those customers, for their continued or increased business. The following are some loyalty program design considerations:

Customer behavior. What type of customer behavior does the organization want to increase? For example, does an airline want to reward people who fly frequently and/or those who often upgrade services? Targeting. How should customers be segmented and how can their needs be addressed through the loyalty program? For example, a frequent purchaser of office supplies may be attracted through a program with less paperwork. Positioning. What are the implications of the loyalty program to other segments? How many resources should be directed toward these programs? Program offer. What will the program consist of? Bonus points? Higher discount levels? Additional services like free shipping or expedited service? Cost and benefit structure. What is the long-term net value of each program element? How will the value be sustained over the long term? Communication. How will customers be notified about the loyalty program?

A CRM program may also offer complementary products or services (cross-selling) or more profitable products or services (up-selling). With cross-selling, for example, if you buy a book or music from an online seller, you may automatically be shown a list of products purchased by customers with similar purchasing histories. If you order a part online or through a call center, the system or attendant may offer parts that could be required in the repair. Examples of upselling include preferential ordering of offerings in an online setting (e.g., prompting purchasers to choose more expensive components by listing them as the default feature) or suggestions by a call center operator to consider the increased benefits of a more expensive service program. For example, during an annual re-enrollment period, a credit card company offers a more expensive account program that has better insurance against credit fraud. Effectiveness of Customer-Type-Related CRM Campaigns When CRM is used to focus campaigns on the four customer relationship types, it can result in a larger customer base. According to a study by PricewaterhouseCoopers based on independent research, organizational profitability was improved as described below when CRM was used to manage campaigns: More prospective customers resulted in a three to four percent increase in profits.

More churn reduction in vulnerable customers resulted in a 15 to 20 percent increase in profits. More won-back customers resulted in a 10 to 20 percent increase in profits. More cross-selling and up-selling to loyal customers resulted in a two to three percent increase in profits.

Topic 2: Customer Relationship Management Customer relationship management (CRM) strategies will vary depending on what elements of CRM are selected, how the components will interact, and what technologies will be used. The organization also needs to determine how product life cycles and types of customer segments will influence the chosen strategy. CRM technologies are discussed in more detail after that, including core technologies and marketing/sales technologies. Implementation tips are also provided.

Scope of CRM A CRM strategy indicates how an organization plans to initiate, develop, and sustain relationships with its customers. The CRM strategy must support the overall business strategy and financial

goals. Carefully determining the scope of CRM is the first step in developing a CRM strategy. Exhibit 6-2 shows that the scope of CRM can involve sales operations (the most functional activity in CRM), analysis, customer information dissemination, and relationship building and collaboration (activities that require the most effort and skill to accomplish successfully). Each of these elements works toward a strategic focus on product, price, placement, and promotion (the four Ps of marketing). All of this is then focused toward one or more customer segments that can be served using a unique set of supply chain capabilities. The additional circles to the right of the graphic help illustrate that the organization may need multiple supply chains to serve other customer segments with their own distinct supply chain requirements.

Exhibit 6-2: Scope of CRM in Supply Chain

Sales Operations Order taking, invoicing, billing, call centers, help desks, retail locations, customer service centers, field service visits, and product returns or recalls are sales operations that all existed prior to the customer-centric organization but now fall within CRM. Sales operations from a CRM perspective also involve Optimizing the customer’s experience Collecting and storing comprehensive data on each transaction. Optimizing the customer’s experience requires providing each customer with what they value, which could include convenience, personalized service, guaranteeing a call back as promised, or the

ability to customize a product/service package. From an economic perspective, it also requires providing these features at the lowest possible cost to the organization, such as by providing some of the more expensive services on a fee basis or for free only to more profitable customer segments. Every person who has contact with the customer should have ready access to the data collected on the customer: all prior transactions/purchases, web visits, problems and complaints, and the status of problem resolution. Accomplishing a single virtual point of contact for each customer requires coordination with various departments, including customer service, credit checking functions, billing, accounts receivable, and so on. To keep everyone aligned and up to date, CRM sales operations rely heavily on technology.

Analysis Analysis in CRM involves customer data validation and aggregation into segments as well as association of segments with specific product/service packages. CRM can be used in some instances (e.g., automated website interactivity) to narrow the size of a segment to one (an individual customer). Another key element of analysis is the ability to query the data or build customized data

searches to analyze the data in innovative ways. These types of analyses fall under the category of business intelligence tools. While these analyses can use transactional databases as their sources, often organizations set up a separate database, called a data warehouse, just for analysis. Analysis also requires determining appropriate performance measurements for CRM initiatives and using the information to refine later initiatives.

Customer Information Dissemination Customer information dissemination means getting timely, focused information to the right groups in the organization and the extended supply chain. In an age when too much information can be as harmful as not enough, a function of CRM is to provide customer information and analysis specific to the needs of executives, product and brand management, marketing (e.g., lists for a promotion), sales (e.g., channel preferences, buying habits), operations, and other functions. For example, providing the right analysis to web developers can help develop better-tailored product or service recommendations. Customer information dissemination also requires integrating the information being disseminated to each group so that the overall

organizational strategy is being supported. CRM helps turn analysis into action.

Relationship Building and Collaboration Relationship building is the development of lifetime customers by training staff to optimize each customer’s experience at each interaction. It also involves the use of customer data to design and focus initiatives to acquire and retain customers. Relationship building requires providing staff with information on what an individual or customer segment values and designing policies and procedures to help staff make wise customer management decisions. It may involve soliciting product development ideas from customers or working to devise mutually profitable solutions to actual customer problems. The point of relationship building is to develop customer loyalty or even mutual dependence. The key to these initiatives is educating staff on the value of lifetime customers. The CRM business model is not about single transactions but about sustained relationships. Businesses are increasingly interested in lifetime customer relationships because they enhance profit in various ways:

Lifetime customers lower total marketing costs. As illustrated in , the costs of acquiring new customers tend to be front-loaded in the relationship. As the relationship develops, the expenses of marketing and sales (in the left-hand graphic, the darkened bars illustrating the expenses below the zero revenue line) decline.

Exhibit 6-3: Development of Lifetime Value

It is increasingly easier to satisfy lifetime customers. With improved technology, it becomes easier to retain customers through deeper knowledge of the customers’ needs and buying habits. A learning relationship is formed through which companies build user profiles, track previous purchases, and anticipate

trends. The longer one keeps a customer, the better one knows the customer and the greater the likelihood that one can fulfill the customer’s needs and deliver satisfaction. Lifetime customers offer increased revenue and profit opportunities. As the relationship matures, the revenue from these customers generally increases. This may be the result of increased customer satisfaction and confidence and larger orders or the result of efforts to cross-sell or up-sell. As revenue grows and the cost of customer acquisition decreases, profit increases. As shown in , from a negative profit point in Year 1, the relationship yields sustained net profit over the lifetime of six years (the circles on each bar). Although specific profit margins will vary, the right-hand graphic suggests the ultimate profitability of lifetime customers. Companies may also be better able to maintain profit margins with lifetime customers who value convenience and stability over price. Customers for whom time or quality is a major concern may also be more inclined to rely on established relationships with suppliers or companies. They can save time or manage their risk better by not “shopping around.” Often, loyal retail customers explain their behavior by saying, “I don’t have time to waste driving all the way over to X only to find that they don’t have what I’m looking for, or that

their quality is terrible, or that the whole experience is just depressing. I’d rather just go to Y. I know what to expect.” Similarly, in the business-to-business relationship, business customers may look at the establishment of a buying relationship as an expense item (because of the required research, creation of requests for proposals, review of proposals, contracting, etc.) and a risk exposure. (“Yes, this company may give me a better price on this component, but what if shipments are late or quality is poor?”) This thinking underlies the creation of preferred supplier lists or deeper relationship types.

Components of CRM Strategy Components of CRM strategy include those listed in Exhibit 6-4: enterprise business systems (EBS), web systems, marketing, external data, CRM applications, analytics, and service.

Exhibit 6-4: Components of CRM Strategy

The first component, EBS, is the technological backbone. EBS is the collective name for some critical applications: Customer database, which contains customer contact details, shipping preferences, and account information Transaction maintenance, which enables the electronic entry of sales orders, including those from the internet, and creation of sales history files Sales order status and updates Sales support data, including pricing, promotion, and inventory information Financial details of accounts receivables, interest, collections, and financial analysis

Quite often the data in EBS comes from an enterprise resources planning system. The second component is the web system, which enables customers to use the organization’s website to peruse product photos and information, order products, and participate in online auctions and even online learning. Marketing is the heart of customer management. Its critical role is to ensure that customers know about product, service, and company information that will lead them to making purchases. This component is pivotal when it comes to identifying the specific values a customer expects from the company’s products and services. Next, external data helps support the creation of collaborative partnerships among the company’s suppliers, resellers, and channel partners. This information is used to generate highly desirable bundles of products and promotions, attractive packaging design, order fulfillment, and product merchandising. It is also used in determining transportation choices. The CRM application, the fifth component, is actually made up of three elements: operations, collaborative, and analytical CRM. Operations CRM consists of web portals, email, customer service, ordering, invoicing and billing, and sales statistics from EBS.

Collaborative CRM is used to do forecasting and design processes. Analytical CRM is focused on the analysis of historical information on customers and how that information is captured, stored efficiently, and reported. Analytics includes the evaluation of sales activities and key databases tracking prospects, product lists, and payment data. The key here is having this information be “actionable” so that business processes are customer-centric. Service is the final component in this model, and its focus is on follow-up with the customer after the sale. This support function is instrumental in enriching customer relationships and may include cyberagents who assist customers live while in the midst of ordering, electronic service surveys, automated contact centers, and webbased self-service. Collectively, these components provide an organization with a 360degree view of the customer.

CRM Processes CRM processes indicate how to execute marketing, sales, and customer service activities and specify the order in which the activities should occur. Process strategy should focus on improving the time to market for these activities by

Reducing specific tasks and activities for demand management (planning, communicating, influencing, and managing and prioritizing demand) to just those that are value-added Executing demand management tasks as quickly as is feasible Maximizing the number of tasks that can be performed concurrently rather than sequentially. An essential element of CRM process strategy is a formal monitoring and feedback process. This will enable and require the strategy to adapt when actual results differ from planned results. The results of demand influencing and other CRM activities are difficult to accurately predict, so organizations should build in tolerances for sensing and responding to implementation difficulties or varying levels of customer awareness and demand for the product or service. It is also important to review the metrics that are being used to assess performance. Sometimes organizations continue to use metrics that have not been revised to be more customer-centric. For example, a common metric used for call center performance evaluation is the number of win-back customers that have been convinced to continue as customers. (A win-back customer is one who is terminating or has terminated their relationship.) However, a

better customer-centric metric would include the customer’s value to the organization in the calculation. Adopting process improvements can be challenging. One way to help drive process improvements in a busy environment where everyone is working on execution of CRM activities is to use a process such as the plan-do-check-action model so that plans can be linked to decisions, decisions linked to metrics, metrics linked to results, and results fed back into plans.

CRM Organizational Structures Organizational structures are important to CRM because demand management efforts can differ widely and teams need to be formed to handle each different type of activity. For example, media-based marketing is a very different activity from direct marketing, and separate teams typically are needed to handle these specialized tasks. Team members can focus on one type of marketing, and training can consist of job rotations (switching between jobs to learn each one) and mentoring so that teams can adapt to changes in demand plan priorities. When organizations shift from traditional marketing and sales to customer-centric demand management, organizational structures will also need to be adapted to ensure that job descriptions, policies,

workflow, and performance measurements reflect the focus on segmenting customers by organizational value and customer needs. Finally, organizational structure is an issue for CRM strategy because of the different types of customers that each require different types of sales and marketing campaigns: prospective, vulnerable, win-back, and loyal. CRM teams can specialize in a type of campaign or perform job rotation to learn the most effective approaches to succeeding with each type. Note that when performing job rotations or other learning activities, a best practice is to get experience while working with the less profitable customer segments so as not to endanger the more profitable segments (except with win-back customers, where it is always a priority to contact the most profitable segments first and usually not as a training exercise).

CRM Technologies Technology has driven the change toward a customer-centric and integrated marketplace, and it has also facilitated the way businesses can manage this change. If technology has made it easier for customers to shop for the best price, it has also made it easier for businesses to gather information about customer buying habits so that marketing programs can be adjusted to their targeted audiences. If electronic commerce has cut into the business of brick-

and-mortar retailers, it has also improved cash flow and significantly reduced costs associated with invoicing. Similarly, technology has been used to accomplish the levels of integration necessary for CRM. Suppliers can communicate with customers in real time, and information can be shared so that systems show current status. Processes can be automated, enabling spending more time on value-added work. Alerts and notifications can be made instantly so that corrective actions can be taken immediately. CRM technology strategy relies on proper collection, storage, and use of customer data. Storage of data is critical: All CRM transactional data should be stored in a single database that is integrated and capable of scaling up to handle a large amount of throughput from CRM operations. This database can also serve for data analysis and reporting purposes if it is robust enough to handle such demands, or a separate database for reporting and analysis can be developed, called a customer data warehouse (CDW). The important strategic choice is between a CDW and a single database. If a CDW is deemed necessary, it should be linked to the transactional database to receive regular automated batch updates so it can be kept synchronized. If the choice is to have a single integrated logical database, it can simplify reconciliation but must be robust enough not to slow down transactional processing tasks.

Cloud-based CRM databases are typically used for both transactional and analysis purposes. Data collection practices also need review in a CRM strategy. It is important to verify that transactions are being recorded and that there are steps to ensure data validity. For example, an organization can avoid common data collection issues by not allowing outbound call records to be deleted until they are first transferred to the CRM database. Other technology requirements for a successful CRM strategy include selection of tools for effective data mining (the process of studying data to search for previously unknown relationships) along with decision support systems, call center applications, and campaign management tools.

Product’s or Service’s Stage in Life Cycle The product life cycle is shown in Exhibit 6-5. Here we’ll look at the life cycle stages from the point of view of how they intersect with CRM, and we’ll use case studies to see how different businesses manage their CRM strategy relative to the stages of their products’ lives.

Exhibit 6-5: Product Life Cycle

Development Stage New product development (or modifications to existing products) is essential to cultivating brand loyalty and developing lifetime customers. CRM makes it both possible and necessary to align product development with what customers actually want. Information gathered through CRM (e.g., customer feedback, focus groups, online customer chat room comments, data on customer buying behaviors and trends, blogs, and social networking sites such as Facebook or LinkedIn) can be used to identify an idea or concept that has the potential to meet customer needs and increase profits. Once customer desires have been identified, a successful product design must be measured against profit goals and the product’s ability to meet those customer expectations and improve competitive position.

The next step is to gauge the success of the product in the actual marketplace. CRM can be employed here to select test customer segments. Both the product and its promotional plan can be tested against key performance indicators such as cost and profit goals, customer satisfaction measures, market penetration, or improvement in competitive position. Testing should confirm the accuracy and completeness of the CRM strategy: Is the product what this segment is looking for? Is the pricing correct? Is this the correct channel? Is the audience hearing and responding to promotions? What customer care issues have arisen? What infrastructure will be needed to tend to those issues? In some business types, the development stage offers an opportunity to create customer ownership. By involving key customers in the product- or service-crafting phase, the business creates a sense of partnership and mutual investment that will translate into greater potential for lifetime customers. These key customers will provide an early platform of sales to sustain the product until it begins to grow. They may become a source of recommendations, referrals, or “word of mouth”—person-to-person advertising.

Case study: development in clothing retail business. Here’s the background on the first case-study company, a clothing retailer that has outlets in major cities on three continents: This company targets the young shopper and offers a full line of clothing and accessories at moderate prices. Store designs reflect the shoppers’ cultures. Currently, buyers order products at quarterly shows from a variety of vendors. The problem with this is that the retailer is always chasing changing trends. Stock must reflect the very latest fashions. A complicating factor is the unpredictability of local markets. What’s “hot” in one area may not sell at all in another market. If the company guesses wrong on a fashion or if they take too long getting items into the stores, the stock must be moved to the deeply discounted sale racks. At best, the supply chain is wasting expensive floor space on items with little or no profit margin. At worst, items will have to be sold to a reseller or discarded. Profit margins are tight on some lines since price points (the points at which the young shopper with somewhat limited finances shrugs and goes somewhere else) dictate aggressive pricing. In spite of these challenges, competition is growing for this customer

segment, and it is becoming more difficult to distinguish the value the retailer is delivering and to remain profitable. Our case-study clothing company has a history of chasing trends and reducing prices on unsold clothing. It has always been customer-centric but not exactly from the right perspective. It responds to where its customers are right now by buying product designed and produced by other companies, but by the time product reaches the stores, the customers have moved on to new trends. The organization needs to predict or even create trends. However, the clothing company’s existing data are not very helpful; the information can identify strong and weak sellers in the past, but there’s little predictive value. To solve these issues, the clothing company decides to get better customer data in part by establishing its own credit card and frequent purchaser affinity card programs. This will ensure access to accurate data and also promotional access to targeted customers (through direct mailings, billing inserts, eco-friendly non-spam digital marketing, and so on). Working with marketing specialists, it uses focus groups of actual customers to explore how its young shoppers define style, what influences their judgments, what the anticipated product life is, how tastes may vary in different markets, and what restrictions may shape their decisions (like cost). With a better sense

of what its customers want, the clothing company can now work with designers and manufacturers to create lines of unique products and accessories that meet the customers’ product requirements. Introduction Stage CRM focus at the introduction stage is on supporting the promotional program. Advertising costs are typically high during this stage in order to rapidly increase customer awareness of the product. New customers must be supported to ensure a high level of satisfaction with the product and the business. Case study: introduction in leisure boat business. The next case-study company is a boat manufacturer that produces highperformance, complex, and expensive leisure watercraft aimed at very high-end consumers: The company was founded by an enthusiast who has always been focused on the boats’ performance on the water, designing the best boats with cutting-edge materials and processes. The manufacturer designs its own distinctive hulls but outsources engine design to a well-respected designer. Engines are built by subcontractors. Assembly and finishing is done in-house. The boats are sold through marinas, who act as distributors.

The marinas sell more than one manufacturer line, so there is some competition for the hearts and minds of the marina owners and their salespeople. The marinas do a considerable amount of customizing at their end, adding different electronic systems and accessories, changing seating, and even reconfiguring the interiors. Sometimes, the original design and unique look that the manufacturer prizes are obscured in the process. Components of poorer quality are sometimes used in the customization process, and the customer may associate the problems with the boat manufacturer rather than the marina distributor or parts manufacturers. This is an expensive item to produce and a challenging item to ship and sell. Component expense limits the amount of inventory that can be manufactured before sale; product size limits how much can be displayed at the point of sale. Delays in delivery can mean that a customer loses the use of the boat for an entire season; customers may cancel purchases and the manufacturer then has to pay for space at a marina. If delays occur repeatedly, the manufacturer risks losing distribution at a marina. Boats also frequently incur minor damage during transportation to the marina and eventual owners. These are small details, but they can seem like major issues to a customer who has paid a premium price. Customer care during and after the sale is a constant concern for

the marina owners, since this is a demanding customer segment. The marina owners frequently complain to the manufacturer’s sales representatives that the company just isn’t in touch with their needs or those of the customer. Our leisure watercraft company has the challenge of becoming more customer-centric as well as more sensitive to the needs of its supply chain partners—the marinas that distribute the product. So it involves its distributors in developing a new model and a promotional program. Marketing targeted at affluent previous boat owners succeeds in producing more-than-satisfactory initial sales. Trends in customization requests and aftermarket customization are carefully tracked so that these customer interests can be reflected in future models. The boat company creates customer care teams. Each new boat owner is assigned a specific customer care representative who has been thoroughly trained on the product and is empowered to authorize rapid correction of any product flaws. All new boat owners are automatically registered in an exclusive club that offers discounts on related products and invitations to special events. Growth Stage Customer care must be sustained during the growth phase. Information is used to identify strong and weak customer segments,

and advertising messages must be tested for their effectiveness in reaching these groups. Case study: growth in financial services business. The third case study looks at a financial services company that offers a variety of products and services to a wide range of customers: Some products are their own; others are created by specialized investment or financial services companies—for example, socially conscious investment, insurance, or credit card programs. The company sells its products and services through independent financial consultants who agree to sell only the company’s line of products and services. Tough markets and the internet have cut significantly into their business. Many people now handle their own investments. The market itself is almost too diverse. It is difficult to meet all the needs of these different customers and market to them successfully. The company also often loses lucrative high-value investors when financial consultants terminate their association and go off on their own. Generally, financial consultants leave when they become frustrated because they cannot offer the level of service or customer care that their clients expect. This is often due to

limitations in the company’s information systems architecture. At the same time, they are very sensitive to any infringement by the company into their relationships with clients. The financial consultants prefer that the clients think of them as the provider of product and service rather than the company itself. Our financial services business has developed new products and services that have resulted in stronger relationships with both its distributing brokers and the end customers. One of its innovations is an information system that allows brokers access to various information sources, analytical capabilities, and promotional vehicles (like customized mass emails or print newsletters); it also provides customers with online access to real-time account status and history reports. The company is comparing the effectiveness of these newer promotional activities with the more traditional ones of cold-calling prospects to offer new products. Maturity Stage During maturity, the organization focuses on using its dominant position to entice its competitors’ customers to switch. At the same time, it must continue to attract new customers. Sales promotions may be increased to encourage retailers to give priority in merchandising. Customer care activities that affect brand image are especially important as an answer to increased competition.

Case study: maturity in clothing retail business. Our clothing retailer (described above) knows that, for each product line, maturity arrives very quickly. Its strategy is to develop new product that is ready for introduction as soon as the old product has peaked. This requires careful tracking of purchasing numbers at all outlets. With real-time data, rather than weekly or monthly status reports, the company will be able to move quickly. It will identify those outlets in which sales numbers are strongest, move inventory to those outlets, and implement promotional programs to sell off stock at only modest discounts. Meanwhile new product will be introduced in the more mature markets. Decline Stage In this stage, customer care is critical. Customers with soon-to-beobsolete products must be assured that they can receive service and replacement parts. They can be provided a means of migrating to the newer products. Customer care now can promote lifetime customer development. Case study: decline in leisure boat business. Our leisure watercraft company is meeting the challenge of becoming more customer-centric. Its new model is well received by both marinas and customers. Unfortunately, it was also well observed by its competitors, who have copied some design elements. The company

decides to keep its image as a leader by developing and introducing an innovative new model. Customers who bought the first product are targeted for early promotions. A used boat program has been developed for marinas to handle the anticipated inventory of used boats. Meanwhile though, the company has worked through a plan with marina owners to ensure ample stock for repair and replacement. Customer care teams remain assigned to their existing customers to ensure continuity of service.

CRM Core Technologies The CRM processes depend on data, and CRM’s core technologies of customer data warehouses, business systems, and segmentation technologies can assist in the collection and analysis of customer data. An effective CRM system ensures that everyone who can influence the customer experience (e.g., sales, customer service, credit, accounts receivable) is provided with critical information about the customer, such as what the customer values and how each individual can help to provide a positive customer experience. Here are a couple of examples of how technology can be employed to support CRM strategies: Customer interaction centers (CICs) are a means of grouping service functions so that the overall customer experience can be

better managed. CICs often use multimedia and other technology tools so that the customer service representative and the customer can engage in a highly personalized verbal, texting, or chat interaction. The representative can pull up order, account status, product warranty, and maintenance information. The system will also suggest account upgrades that are pertinent to the customer. Customer experience management (CEM) technologies have been developed in response to customers wanting more control over their buying experience and their desire to be treated as individuals with unique needs and wants. Organizations with great supply chains are using CEM to generate enhanced customer loyalty and a competitive advantage by listening to the nuances of customer feedback. These technologies are intended to measure both tangible and intangible elements, such as customer feelings and expectations, so that the information can be used to create a superior buying experience. Let’s take a closer look at the CRM’s core technologies.

Customer Data Warehouses A data warehouse is “a repository of data that has been specially prepared to support decision-making applications” (APICS Dictionary, 16th edition). A customer data warehouse (CDW)

contains information about an organization’s customers, products, and marketplace. A CDW extracts information from internal and external sources, standardizes and consolidates the information, and stores it for easy access and retrieval. Organizations generally use CDWs in conjunction with their existing information technology infrastructures, which could be an enterprise resources planning (ERP) system or a dedicated CRM transactional system and database. Exhibit 6-6 shows how a customer data warehouse can interface with an organization’s ERP system to keep up to date with new transactions while providing a dedicated source for data analysis.

Exhibit 6-6: Example of CDW Interfacing with ERP

One alternative to using a CDW in conjunction with a transactional database is to use a cloud-based database (virtual database accessed via the web) for either transactional or analysis activities, or for both, as part of a software as a service (SaaS) or organizationhosted cloud. For organizations able to implement a customer data warehouse, there are many benefits: Strategic marketing. A CDW allows the organization to improve segmentation of the customer base by providing data about customers and their preferences and vulnerabilities. This helps make promotional programs more cost-effective. For example, the data can be used to identify and implement special offers to loyal customers while enticing prospects with low-cost introductory offers. New product development. Data on customer needs provide valuable input into product design and development decisions. Channel management. CDW data help compare the effectiveness of channels and rank the importance of the channel to various customer segments. Analysis of data on channels may indicate, for example, that moving certain customer segments to lower-cost channels will require incentives.

Sales productivity. Human and technology resources can be allocated according to customers’ channel preferences and purchasing patterns to increase sales productivity. One-to-one marketing. The ability to customize programs and create a one-to-one marketing approach cannot be achieved without a CDW. One-to-one marketing and customer care greatly enhance overall customer satisfaction and loyalty.

Business Systems Business systems provide the backbone for customer management. An organization’s business system has several critical areas: Transaction maintenance (order entry, status of open orders, sales history) Information (pricing, promotions, inventory balances) Financial details (account balance information, collections, payment records, financial analysis)

Segmentation Technology Creating useful segments often requires the use of CRM technology. Computer algorithms can be used to model customer behavior. A best practice is to base such algorithms on demographics and historical purchasing patterns and limit use of assumptions or projected behavioral traits. Once such a model is developed, it

should be validated to make sure that prospective customers are being placed in the correct segments.

Customer Care and Marketing/Sales Technology Web-enhanced customer service provides a variety of solutions to increased customer expectations in the areas of response, product customization, convenience, order status visibility, and returns processing. Solutions include online frequently asked questions and answers (FAQs), online customer service representatives, and online chat rooms dedicated to particular customer concerns. Customer service representatives are able to handle many complex issues immediately by accessing customer records or order status information and can resolve others via email. In addition, highly detailed product information that can be presented online (and may not be available otherwise or only at a high level) can actually reduce product returns. Traditional phone-based care has also become more sophisticated. Customers waiting in a universal queue are greeted with choices, which alleviates the feeling of being trapped on hold. Callers who don’t want to wait on hold can enter their phone number and request that they be called back when it’s their turn in the queue. Callers with

simple questions or issues can record a voice message, which is played back to the next available agent, along with a request for a return call if desired. Callers who choose to wait in the queue receive periodic announcements of expected hold time as well as targeted messages such as new product bulletins or holiday hours. They may also be directed to websites or chat/text services for faster service. CRM marketing technology supports marketing’s tasks: identifying the wants and needs of customers, determining which customer segments the business can best serve, and making decisions on the appropriate mix of products, services, and programs to offer to these markets. This component helps to identify what each customer considers as value; to set, track, and evaluate campaign and pricing strategies; and to assess customer satisfaction. CRM technology provides sales personnel with access to order status, customer history, and product and customer information. Applications to assist the sales function include account/territory management, contact management, campaign management, and field sales communication and management. CRM technologies are available as SaaS, which typically uses cloud computing in its configuration. In addition to being a service that can be accessed immediately from anywhere upon paying the subscription fee, such services have benefits such as the ability to

access large segmented prospect lists, to network and chat with other sales professionals (either within the organization or outside it), or to download mobile device applications such as for inventory checking. Some systems integrate sales and marketing uses. In one SaaS product, the marketing view provides the marketing group with a complete customer view that is shared with sales and support. Sales will better understand which marketing campaigns are active, the rationale behind them, and the types of leads they attract. The package may include other tools: lead management, auto-response and trackable emails, workflow automation, a marketing encyclopedia, marketing analytics, and direct, mass, and ecommerce marketing. Exhibit 6-7 illustrates how various CRM technology tools can be used to support customer service, marketing, and sales. These tasks are divided into four areas: account management, sales force automation, business intelligence, and marketing automation.

Exhibit 6-7: CRM Technology Tools

Account Management Account management refers to managing and using customer information for the purposes of marketing and customer care. It includes such technology as call center automation (including automatic call distribution, interactive voice response, computertelephony integration, and internet call management). Account management applications are designed to provide detailed information about account data and sales activity that can be accessed instantly. These tools support marketing tasks like segmentation and promotion and also permit managers to match sales representatives and marketing teams to customer characteristics.

Sales Force Automation Sales force automation (SFA) is the core functionality of CRM technology because it collects customer data from transactions, customer service call centers, and marketing for use in customer acquisition and retention activities. Sales force automation allows salespersons and field sales agents to take ownership over maintaining and enhancing information on their customers, so it deepens relationships with customers. Salespersons can use it to schedule their next point of contact or collaborate with other salespersons. Sales force automation can increase customer retention. It promotes more open relationships with customers by providing Sales promotion and discount management, including impact on pipelines and existing customer accounts Dashboards listing customer analytics such as forecasts and profit margins Data synchronization with mobile devices Calendars and contact lists that can be merged with automated workflow programs Real-time data visibility Online networking when offered as SaaS or cloud computing. Sales force automation software usually includes the following tools:

Contact management enables the organization to prospect from customer data such as name, address, phone numbers, titles; to create organization charts; to maintain marketing information; to identify decision makers; to identify customers by value; and to link to supplementary databases. Account management provides on-demand, detailed information regarding account data and sales activity that allows matchups between salesperson capabilities and customer attributes. Sales activity management provides customizable sales process methods. Sales representatives are given individualized steps to follow at each point in the sales cycle. Event management provides active notifications of sales event priorities such as proposal deadlines, campaign openings, closing dates, or product demonstration appointments. Opportunity management or pipeline management applications help turn leads into sales, possibly by distributing leads among salespersons. They help to define the sales team, the specific opportunity, the company involved, and the proposed closing date. They can also track win/loss ratios. Quotation management helps salespersons write quotations for complex orders requiring product configuration. It includes

electronic reviews of proposals for capacity and feasibility. Knowledge management provides access to sources of information that are housed in each organization and are difficult to automate. This may include policy handbooks, sales and marketing presentation materials, forms and templates such as contracts, historical sales and marketing reports, and industry and competitor analysis. Knowledge management can act as a storehouse of all forms of information that can be easily added and referenced through online browsers.

Business Intelligence Business intelligence is “information collected by an organization on customers, competitors, products or services, and processes” (APICS Dictionary, 16th edition). This includes decision support systems (DSS) and data mining tools to generate customer segments and determine customer segment value.

Marketing Automation Marketing automation employs software applications to search, compile, and use customer databases to target customers and then generate a marketing campaign using mass media, direct marketing, the web, telephone, and other types of technology tools to reach customers. This is known as campaign management or enterprise

marketing automation (EMA). Campaign management automates the campaign process through tools such as customer intelligence and data extraction, campaign definition, detailed campaign planning and program launch, scheduling of activities, continuous performance measurement, and response management. It uses the internet to capture, extract, and analyze campaign information. By doing this, marketing groups are better equipped to design future campaigns that enhance customer relationships and ultimately increase profits. The following are the major components of marketing campaign management: Media-based marketing. Tools for launching, tracking, and budgeting for media-based advertising can help budget, manage, and time advertisement buys and track results. Direct marketing. Tools for telemarketing or sending direct mail or email can schedule and track prospect and customer contacts, responses, and success rates. E-commerce marketing. E-commerce marketing tools help organize online media advertising, sales, and catalog management. This technology manages websites or portals that allow customers to visit catalogs, enter orders, review pricing,

configure orders, send emails, and perform other self-service functions from order status to review to online learning. Marketing events. Marketing events can be communicated through online newsletters, seminars, and webcasts. (Traditionally, this approach was done through tradeshows and exhibitions.) With enhanced technology, customers can view new products and experience new services immediately. Campaign management by customer type. Marketing campaigns can be tailored to customer type: Prospecting campaigns. Prospecting campaign tools include segmented contact databases, automated personalized responses to prospects, and sales leads and data on prospects. Vulnerable customer campaigns (customer retention). It is estimated that businesses lose as much as 50 percent of their customers over a five-year period. By using campaign management tools, organizations can identify customers who are most likely to leave and weigh the possible impact of promotional efforts. Win-back campaigns. Win-back tools include prioritized lists of customers to contact based on their value to the organization and metrics based on customer value.

Loyalty campaigns (cross-selling and up-selling). Loyalty campaigns include loyalty reinforcement such as personalized automated thank-you messages or affinity card bonus point systems. Tools must also be in place to analyze the customers’ needs and offer cross-selling or up-selling alternatives that pique their interest. Promotions. Promotions include web-delivered giveaways, contests, or discounting that can immediately engage the customer. This eliminates the need for paper-based or telemarketing tools. Captured data can be directly input into the database and used for ongoing review and campaign modification. Response management. Response management uses marketing campaign information to determine the impact of the campaign by calculating actual customer profitability. Once this has been completed, the marketing automation tools can assist in refining and altering the course of the campaign, if necessary.

Keys to Successful CRM Implementation Why does CRM sometimes fail to provide the results a company needs? Often an organization is too focused on the CRM technology

itself and doesn’t spend sufficient time getting to know the customer. Organizations may also find it difficult to execute a paradigm shift from being focused on product marketing to being focused first on the needs, wants, and preferences of the customers who may buy those products. Sometimes even the metrics for measuring success are poorly chosen. Failures such as these may stem from poor, or nonexistent, testing of CRM software or applications. It could also be a culture or leadership failure. Company leaders and managers need to be on board and demonstrate their “customer-first” commitment to their employees to help the culture embrace CRM. CRM software may have robust features, but if such systems cannot be easily implemented within the limitations of the organization’s resources and culture, then the technology investment will add little value. Businesses implementing CRM technology should remember the following.

Architecture Needs to Be Determined Early. It is important to establish a thorough, well-thought-out information system infrastructure early rather than adding technology systems at random. Companies should assess their current level of infrastructure and plan ways to migrate toward higher levels of integration. If an SaaS (software as a service) solution is selected, the organization will still need to decide how to make use of its

existing customer data and how to interface with its larger transactional systems, such as ERP (enterprise resources planning). This may require an application programming interface from a supplier. There are several maturity levels of integration: Disconnected technology. The organization uses a variety of noninterfacing databases to house information. Data cannot be easily combined for deeper analysis or shared immediately throughout the organization. Interfacing technology. Various systems feed into each other, creating some capacity for integration of the data. Internally integrated technology. One main system captures and stores all the different data elements. Multi-enterprise integrated technology. Multiple business lines within a large, dynamic organization share captured and stored data centrally, allowing synergies to occur. CRM technology integrates data from different transaction points to anticipate customer needs and support CRM strategies. These integration points might include the following:

Online sales. Not only do online sales lower business costs, they provide an opportunity to capture valuable customer information. This information may include the compiling of user profiles, site navigation preferences such as visits to a particular tool or link, and information on product preferences. Order/provisioning system. Customer orders and service interactions, occurring through all channels, are logged and used to update customer profiles. Customers can be targeted with products and offers based on transaction history. Customer problem tracking. Problems are logged for analysis and to predict specific customer needs. Unresolved problems generate a notification to a customer service representative to help rectify the issue with the customer. Call center. Contacts with call centers generate information that immediately updates the customer information profiles and any predictive model scoring in the CRM system. Information from a call center can be tracked in the same manner as online contacts.

System Should Enhance Efficiency. The system should make CRM tasks easier and faster, not more involved and difficult to accomplish.

For example, a large commercial airline company makes the decision to use CRM technology as a way to create stronger customer relationships while making the system intuitive for the customer-facing staff. Working with its information technology group, the airline begins collecting data on incidents when customers are upset with the airline. According to the data, problems with delays affect 20 percent of the airline’s 100 million annual customers. In order to decrease that percentage, the organization develops a customer care system for gate agents that links a graphical seating chart to an airline reservation system and data warehouse. In this system, passengers can be tracked in real time to determine whether they are on board, reducing confirmation time for standby passengers. Additionally, when planes are delayed, the system links flight arrival times with the reservation system to identify, before they even arrive, which passengers might miss their connecting flights because of a delay. Agents rebook delayed passengers and send an agent to the arrival gate to tell passengers where to go for their new connecting flight.

Implementation Should Be Coordinated Throughout Organization. Implementation teams should contain employee representatives from every area that will be using the system.

Everyone Must Be Trained, and Some Will Need More In-Depth Training. Job processes must be redrawn to reflect the new CRM system. Training must be delivered to everyone according to his or her level of involvement. But remember also that CRM is not just a software system. Technology alone cannot solve the challenges that businesses and supply chains face. Training staff in the CRM methodologies can help them buy into the concept and anticipate challenges that may arise.

Implementation Is Measured Against Customer Needs/Expectations. Organizations should ask themselves the following questions: Will the customer use the technology as a common way of interacting with the organization? Is the customer ready to use the technology? How many customers have access to the internet based on their geographic location? How difficult will it be for the customer to learn the new technology? Does it build upon more familiar technologies or forms of interaction? This will make it easier for customers to migrate to automated CRM activities. Does the technology perform to customer expectations? Does it improve their experience or degrade it?

Does the technology allow personalization and customization? The successful use of personalization technology provides a better customer experience and does not clutter customers’ screens with irrelevant information.

Topic 3: Customer Service Metrics and Performance Customer service is the supply chain role that works to ensure that marketing promises can be met. Customer service metrics are discussed next from a strategic and operational perspective. Customer relationship management (CRM) performance relates to assessing how CRM is impacting customer service and customer satisfaction.

Customer Service Metrics Customer service is the supply chain role that has the goal of fulfilling marketing objectives. In other words, what matters to customers should be the organization’s top priority. What do they care about, and what happens when their expectations are not met? The basic customer satisfaction premise is that if customer expectations are met or exceeded, the customer will be satisfied.

Customers have expectations about product availability, performance, quality, and service reliability. Customer metrics need to measure what is important to the customer. Pinpointing exactly what they value and expect may require customer interviews, questionnaires, online feedback surveys, post-purchase follow-up calls, and so on. Customer service metrics can be presented at a strategic or operational level. Strategic-level metrics are long-term, aggregated, or summary assessments. Operational metrics are the daily details that need managing. In addition to customer satisfaction as is discussed as part of strategic metrics, fundamental measures of basic customer service include the customer service ratio (fill rate), lead time monitoring, and order status monitoring.

Strategic Metrics and Their Presentation Some strategic-level metrics that assess overall customer performance are discussed next, along with potential ways to present this information to executives. Perfect Orders Perfect order fulfillment is a total logistics service metric. It is a SCOR metric that basically measures every step of a customer’s experience, from order entry, credit checks, inventory availability and

picking, to on-time delivery, invoicing, and payment. Only an order that gets everything right counts as a perfect order. Perfect orders matter to profitability. According to AMR research, a three percent increase in perfect orders equates to a one percent increase in profits. However, since so many things can go wrong, it isn’t surprising that even the best logistics organizations have considerable room for improvement in this area. Another challenge with calculating this metric is that it could be difficult to collect necessary data, depending on the organization’s level of internal systems or partner integration. Customer Satisfaction Customers have underlying expectations about the quality and predictability of an experience, and these expectations can change over time. For example, if most of your competitors are improving their supply chain customer experience, even if your metrics are all the same as last year, customer satisfaction is likely to go down because the customers now have higher expectations. At a strategic level, organizations can use summarized and aggregated customer feedback. To determine relative levels of success, they can compare these results to benchmark organizations. They can also benchmark internal capabilities and the features, price, and quality of their offerings against competitors’

capabilities and offerings or against the best-in-class capabilities in any industry. The gaps that exist based on aggregated customer feedback and competitive benchmarking show areas for improvement. Using Real Numbers and Real-Time Data Some executives choose to view data on customer metrics in real numbers of persons affected rather than as an aggregate metric. In other words, while 99 percent may seem like you are doing well, if this is reported to the same executives as 9,000 customers getting late orders on a particular day, it can help motivate continued efforts toward improvement. Similar to the use of real numbers to put a face on customer-related data, many executives want to see data in real time or as near to real time as they can get. This also helps to reduce complacency.

Operational Customer Service Metrics Exhibit 6-8 provides a look at metrics that are important to keeping customer satisfied. Exhibit 6-8: Customer-Focused Metrics Attribute Availability

Metric Stockout frequency

Definition Probability of inventory not being available to meet customer demand

Attribute

Metric Fill rate

Measures impact of stockouts over time (For example, if a customer requests 100 items but there are only 92, the fill rate is 92 percent.)

Orders shipped complete

All items ordered are present in shipment

Backorders

Unfilled order or customer commitment

Time needed Speed of to deliver performance customer order

Product support

Definition

Elapsed time from when customer places order until product is delivered to customer and is ready for use (e.g., installation)

Supply chain cycle time

Time it would take to fill customer order if inventory levels were zero. Sum of longest lead times for each stage in supply chain.

Delivery consistency

Number of times cycles meet amount of time planned for completion

Flexibility

Ability to accommodate unexpected or unusual customer requests

Malfunction recovery

Having contingency plan in place for equipment malfunctions or service breakdowns; ability to source out-ofstock customer item from alternate facility

Response time to inquiries

Number of days it takes for customers to receive response regarding inquiry they have made

Response accuracy

Measure of whether response is on target and correct so that customer does not require additional follow-up

Attribute

Metric

Definition

Customer complaints Number of complaints or amount of negative feedback received from customers (usually within given time frame) Overall satisfaction

Repeat purchases

Measure of customer completing another purchase from same seller

Referrals to other potential customers

Number of names provided by previous purchaser as being potential customers

Customer Service Ratio (Fill Rate) The customer service ratio, also known as the fill rate, and a related measure, stockout frequency, can be used to measure availability of inventory when it is wanted by a customer. Orders shipped complete and backorders are other availability metrics. Traditionally, many organizations have stocked product in anticipation of customer orders based on demand forecasts. The goal is to achieve high levels of availability while keeping the investment in inventory and facilities to a minimum. Customer service ratio (fill rate) and stockout frequency can be defined as follows. Customer service ratio. The APICS Dictionary, 16th edition, defines customer service ratio as follows:

1) A measure of delivery performance of finished goods or other cargo, usually expressed as a percentage. In a make-to-stock company, this percentage usually represents the number of items or dollars (on one or more customer orders) that were shipped on schedule for a specific time period, compared with the total that were supposed to be shipped in that time period. 2) In a maketo-order company, it is usually some comparison of the number of jobs or dollars shipped in a given time period (e.g., a week) compared with the number of jobs or dollars that were supposed to be shipped in that time period. The customer service ratio measures customer service levels based on the percentage of product delivered compared to the amount ordered by the customer. The most basic calculation is full orders delivered complete and on time, which is called on-time delivery. The Dictionary defines on-time delivery as “a metric measuring the percent of receipts that were received on time by customers.” On-time in full (OTIF) is a metric for on-time delivery, and it is defined by the Dictionary as follows: A delivery scoring system in which a target delivery goal —usually expressed as a percentage—is set, and the

deliverer tries to meet that delivery goal fully and by the delivery date. Other variations include the following. Unit fill rate. Percentage of items delivered versus items ordered Line item fill rate. Percentage of line items delivered versus line items ordered Monetary value fill rate. Percentage of monetary value delivered versus monetary value ordered. Stockout frequency. Another method of measuring customer service evaluates the supplier’s management of stockouts. Some examples include Percentage of items that are in stockout Monetary value of items ordered that are in stockout Average age of stockout Average time to recover item from stockout.

Lead Time Monitoring Lead time monitoring involves measuring the time needed to deliver a customer order. Lead time monitoring can be broken down into speed of performance, consistency, flexibility, and malfunction recovery.

Speed of performance. Speed in terms of operational performance is the elapsed time from when a customer places an order until the product is delivered to the customer and is ready for use. Logistical system design determines elapsed time required for the performance cycle completion. Idle time may constitute a large percentage of production time, while work or run time makes up a small percentage. The entire time it takes to make a product is called cycle time, and cycle times that are too long are a key area for supply chain improvements. In the APICS Dictionary, 16th edition, cycle time is defined as follows: 1) In industrial engineering, the time between completion of two discrete units of production. 2) In materials management, it refers to the length of time from when material enters a production facility until it exits. Speeding up cycle time in production reduces work-in-process (WIP) inventory and meets supply chain management goals of reduced cost and improved customer service. The tradeoffs may be in the cost of equipment, facilities, training, or hiring that makes reduction of idle time possible. Faster speeds, which may result in higher costs to the consumer, may be justified if the value of speed

has perceived benefits to the consumer. Speed of performance can be measured using metrics such as Order delivery cycle time Time to process a customer-requested change Time to respond to a customer query Average wait time to be connected to an agent in a call or chat function Percentage of calls that encounter a busy signal Percentage of calls to customer service that are abandoned. Consistency. Consistency considers the number of times that cycles meet the planned amount of time for completion. Greater value is typically placed on consistency than on speed of service, because consistency has a direct impact on the customers’ ability to conduct their activities. For example, if cycles vary, then a customer must carry safety stock to ensure against possible late delivery, with the overall degree of variability directly impacting safety stock requirements. Early deliveries could also cause problems, such as an intermediate customer having too many trucks arriving at the same time or an end customer not being home for delivery. Consistency metrics could include Variance in lead times Percentage delivered in quoted lead time.

Flexibility. Flexibility describes an organization’s ability to accommodate unexpected or unusual customer requests. Examples requiring flexibility include support of customized sales or marketing initiatives, new product introductions or product recalls, or supply disruption. An organization’s logistical strength is closely tied to the ability to be flexible. Malfunction recovery. An effective customer service program knows that malfunctions and service breakdowns inevitably occur, and so the program will have a contingency plan in place. For example, if a stockout of a customer item occurs, an alternate facility may provide a replacement. The average number of days (or hours) from malfunction to recovery can be measured.

Order-Status Reporting Order-status reporting involves providing methods for customers to check on the status of their orders. For example, the status might be listed as received, executed, picked, packed, or out for delivery. Status could indicate whether the order is on schedule, or, if not, it could estimate a new arrival date. Intermediate customers and ultimate customers may need separate reporting systems so that each type of customer sees just what is relevant to their needs. For intermediate customers, this data could be automatically sent via

EDI (electronic data interchange) to their information systems. Measurements of success in this area could include the following: Functionality supplied versus requested (for service development purposes) Order status accuracy Percentage downtime of website or reporting system

CRM Performance Management The effectiveness of the CRM strategy must be measured to ensure that the strategy and related technology are establishing lifetime customers and increasing profitability. Here we’ll look at measuring customer service and customer satisfaction.

Customer Service Some areas in which customer service can be measured include response to inquiries, order processing, level of service, and product or service quality. Response to inquiries should be prompt and accurate. Responses related to supplying information can be measured by the delay between the initial contact and the response and the number of errors detected in responses. Another example of metrics in this area is executive complaints, complaints that are directed to higher-level managers and executives. (These

sometimes are forwarded to a group of higher-level complaint handlers.) Performance measures include tracking the volume, response time, and trends of such complaints. For telemarketing, metrics may include the percentage of calls getting a busy signal, the average answer time, the number of disconnected calls, or the percentage of repeat calls from a customer. Order processing should be fast and accurate. Delivery should be on time. Order processing metrics include order cycle time, the percentage of orders that were mechanically received, the percentage of orders with errors, and website ease of use. Level of service is measured by delivering the right product, in the right quantity, at the right time, to the right place, in the right condition, and with the right packaging and documentation. Levelof-service metrics may include the percentage of orders shipped complete and on time, the number of backordered items, the average age of backorders, and the value of backordered items. Product or service quality is measured by cost-of-quality issues. Product or service metrics may include the number of executive complaints, defect rates, warranty costs, product returns, and website downtime.

Customer service can also be measured using customer-facing SCOR® metrics, which assess supply chain reliability, responsiveness, and agility.

Customer Satisfaction The best source of customer metrics is the customers themselves. The SCOR customer-facing metrics and other metrics can be used to measure likely customer satisfaction, but even perfect scores measure only the absence of issues; they can’t guarantee customer satisfaction with products or services. A customer may get the correct product on time exactly as ordered and not return it, but this doesn’t mean that the customer is satisfied. Measuring how well the organization is doing in terms of order fulfillment is important, but customer perceptions are what matters. Customer satisfaction therefore hinges on how well customer expectations are established and then fulfilled. If customer expectations are met or exceeded, the customer will be satisfied. Organizations can go a long way toward customer satisfaction by setting realistic expectations with their customers. One phrase that sums this up is to under-promise and over-deliver. The airlines now do this by quoting very generous flight times and then typically arriving “early.”

Organizations have frequently used customer complaints as a proxy for measuring customer satisfaction. Although this method may bring to light some customer issues and complaints, it does not begin to accurately measure the satisfaction level of the customers. A study determined that manufacturers of large ticket goods or services hear less than five percent of the complaints of their unhappy customers. If organizations are going to move to a more customer-centric supply chain management model, they must measure more than customer complaints. The question is, who assesses customer satisfaction—the organization or the customer? Organizations can use internal data to measure performance against common customer expectations, but external review data—the customer’s own evaluation of the experience, such as the voice of the customer—are more meaningful. If an organization leverages partner relationship management (PRM), it can better control how a customer is treated throughout the customer experience. According to Ross in his text Introduction to Supply Chain Management Technologies, PRM is a business strategy that includes tools to increase the long-term value of a company’s channel network. PRM software enhances communications, processes, and transactions throughout the supply

chain system. It also assists companies in selecting the right sales partners and facilitates the communication between them. It searches for ways to improve not only sales but also the productivity and competitiveness of partners. The synergy created helps each trading partner to contribute to customer satisfaction. The quality of service in each delivery channel needs to be evaluated. One way is by evaluating the trustworthiness of the channel. Customers must trust the channel to deliver on time and in the way communicated. Next, customers should feel that they have been treated fairly, with respect, and in a competent, friendly manner. Finally, to evaluate the delivery channel, one must look at the effectiveness of problem resolution: Can customers quickly reach someone empowered to resolve the problem? Do customers feel that everything is being done to address the problem as quickly as possible? Are they satisfied with the solution? Customer Satisfaction Measurement Methods The general customer satisfaction measurement process is to poll customers on how you are doing relative to each customer-focused metric you are tracking. You can also ask them how your competitors are doing in regard to the same metrics. Tracking these results over time will show trends. Below are some possible methods that can be used to measure an organization’s customer satisfaction level:

Voice of the customer (VOC). VOC can be used to gather unscripted customer feedback from interviews, conversations, and focus groups. This information may help discover hidden areas of satisfaction or dissatisfaction. Organizations may use VOC with their most valuable customer segments to discover how their expectations and requirements have been changing and find gaps to focus on first. Transaction customer feedback questionnaires. A transactionbased questionnaire measures customer satisfaction at each transaction point. Assessment tools must be brief, but they can be simple to implement. For example, a leading car rental company asks every customer returning a car whether the rental experience was satisfactory, either in writing or verbally. If a customer indicates dissatisfaction, employees are trained to address the problem or concern immediately. Many quality certification systems such as ISO 9000 also require a documented closed-loop feedback system of customer improvement. Monthly/quarterly customer feedback questionnaires. This is a more detailed periodic questionnaire sent to customers regarding their overall experience over the last month/quarter. The technique can be expensive; however, the benefits can far outweigh the costs in terms of detailed customer information.

Participation in performance reviews. This technique may be especially useful in the B2B setting. Key customers are asked to evaluate their account manager’s or team’s performance. The customer perspective complements the internal company focus on quotas and numbers. Reviews solicited from external perspectives like these resemble the 360-degree feedback system used for internal peer reviews. Collecting and responding to negative comments on the internet and social networking sites. Organizations can actively search for and respond to negative comments on the internet or on social networking sites such as Twitter or Facebook. A 2021 article by Flori Needle that compiles social media statistics cites a Convince & Convert study that indicates that customer advocacy increases by 25 percent when a customer’s social media complaint is answered, but it also cites research by Sprout Social that indicates that while 79 percent of consumers expect brands to respond to social media posts within a day, average cross-industry brand response rates are less than 25 percent for any response at all. The feedback gained from these approaches can help improve customer service issues, order fill rates, etc., and will allow organizations to implement corrective action and improvement for

customer satisfaction. The goal must be to give customers an acceptable level of service the vast majority of the time so as to achieve the targeted customer satisfaction rate.

Section B: Supplier and Supply Chain Relationships This section is designed to Explain the factors used to select strategic partners List the benefits and requirements of strategic alliances Describe the steps required to implement a strategic alliance Indicate ways that supplier relationship management (SRM) can be measured, including use of supplier rating systems Illustrate functions performed by SRM technology Describe the roles of planners, buyers, and purchasing agents and how the interactions between these roles have changed in the SRM model Outline criteria and methods for measuring supplier performance Understand the process for certifying suppliers Explain how customer relationship management (CRM) and SRM interrelate Enumerate the building blocks of collaborative relationships Describe how to use collaboration skills to get the most out of relationship management Identify the features and benefits of collaboration Describe how to overcome obstacles to collaboration

Describe how communications must be tailored to fit the purpose, target audience, and communication channel Apply the basic communications model and express the importance of feedback Understand how different national cultures can impact relationships and communications. After introducing SRM and its process and technology components, this section compares and contrasts strategic sourcing and transactional buying, including how in an SRM relationship there are many more contact points between various functional areas of an organization. This is followed by a discussion of how to measure SRM and certify suppliers. This section concludes by showing how CRM and SRM are two sides of the same coin. It includes several case studies that illustrate the use of CRM and SRM in organizations. We also discuss how to establish collaborative relationships with supply chain partners.

Topic 1: Supplier Relationships and Segmentation Supplier relationship management (SRM) and supplier segmentation are introduced here, followed by SRM process and technology

discussions.

Supplier Relationships and Segmentation Road Map Supplier relationship management and supplier segmentation are introduced next.

Supplier Relationship Management The APICS Dictionary, 16th edition, defines supplier relationship management (SRM) as a comprehensive approach to managing an enterprise’s interactions with the organizations that supply the goods and services the enterprise uses. The goal of SRM is to streamline and make more effective the processes between an enterprise and its suppliers. SRM is often associated with automating procure-to-pay business processes, evaluating supplier performance, and exchanging information with suppliers. An e-procurement system often comes under the umbrella of a supplier relationship management family of applications. Supplier relationship management helps develop and maintain relationships with suppliers to meet the general goals of ensuring mutual profitability while also meeting marketplace needs.

SRM is a methodology to structure and support relationships with suppliers to Reduce procurement and inventory costs Support a customer-centric business that delivers product/service customization and quality in the desired time frame Continuously improve supply processes. We should note that SRM applies only to higher levels of buyersupplier relationships, except in the case of SRM technology enabling easier buy-on-the market transactions. SRM has its true strength in developing deeper relationships with suppliers that have been identified as key partners in the supply chain. These relationships entail a greater sharing of information, greater knowledge of suppliers and their needs, collaboration at certain points, and even integration of business processes. If we view the supply chain as a series of actions intended to add value to the final product or service (as shown in Exhibit 6-9), supplier relationship management relates to all those upstream activities prior to one’s own contact with the product or service. Note that Exhibit 6-9 assumes that the organization using SRM is a manufacturer; a distributor would use SRM to manage manufacturers, who are its suppliers.

Exhibit 6-9: Supply Chain Community

Supplier Segmentation Supplier segmentation is a part of a category strategy for suppliers. Segmentation is the process used to create these supplier categories. One traditional way of segmenting suppliers was to focus on those that did a lot of business with the organization. This may have prompted the organization to pursue strategic relationships with those suppliers. However, they might be supplying only commodities or could get a lot of orders due to inertia (e.g., established relationships or design specifications that would require redesigning other subcomponents) rather than because they deserved to have a strategic relationship. A more nuanced method of segmentation than total spend is often called for.

The rationale for segmenting suppliers is based on the importance of the supplier category to the organization. Just as treating all of your customers as if they were the same can lead to poor marketing and selling strategies, treating all suppliers as if they were the same can lead to inefficiencies or poor supply chain responsiveness. The Pareto rule applies to suppliers: 20 percent of the suppliers or so will deliver 80 percent of the value to the organization’s objectives or bottom line. The vital few suppliers who deliver significant value need more relationship management than the trivial many. Supplier segmentation is a key tool to move an organization toward having a responsive supply chain. While many organizations used to base supplier selection on finding suppliers who could minimize costs, such as by leveraging economies of scale and low wages in one country, today’s market is placing significant stress on responsiveness. For example, even when competing on cost, the country with the lowest labor cost may change quickly as the relative level of wealth in countries shifts. The result is that, instead of developing stable sources of lowest-cost, high-volume supply, organizations are faced with sources that may become less competitive sooner than expected. This means that even organizations with low-cost strategies need a certain level of responsiveness. However, since responsiveness has a cost, this

becomes a dilemma for cost-competitive models. Here is where supplier segmentation can come to the rescue. Supplier segmentation increases responsiveness without significantly increasing costs because it helps organizations with complex networks of suppliers manage their risks and responses. Cost and risk analyses can be simplified when suppliers with similar attributes can be analyzed together. Furthermore, a set of suppliers can be developed that can all be selected as a group when strategy needs to shift. For example, complexity may provide a competitive advantage in the early stages of a product’s life cycle, but, as a product matures, it may be better to shift to suppliers who can eliminate unnecessary complexity and provide a standardized product. Supplier segmentation is also ideal for organizations pursuing strategies other than low cost. For example, if quality will be the source of the organization’s competitive advantage, suppliers can be segmented based on their ability to provide consistent high quality. Organizations can devise unique methods of segmentation that benefit their industry and business model. The following are forms of supplier segmentation:

Product or service type. Segmenting suppliers by the general category of goods or services they supply can help when analyzing all suppliers in that category. Ideal relationship type. Segmenting suppliers by ideal relationship type involves analyzing what a supplier would bring to some form of partnership if one were to be pursued. The analysis might reveal that some suppliers should remain at arm’s length while others would make great strategic partners. It could also show where a supplier was in the wrong category. For example, a supplier could be mistakenly considered to be strategic even though your organization is contributing far more than it receives from the relationship. Supplier capabilities. Segmentation by supplier capabilities will help organizations that compete on a focus (i.e., niche audience) or differentiation (from competitor offerings) basis for their products/services, because here we are segmenting suppliers based their ability to deliver on the key business objectives at the core of these strategies. The complexity and quality examples above are segmenting by supplier capability. Another example is customer service. Suppliers who could impact customer service could be placed in one segment, suppliers who have marginal impact on customer service could be placed in another, and those

who are very unlikely to impact customer service could go in a third category. Suppliers in the first category could receive the largest amount of attention. There would be an emphasis on regular communication of problems and customer feedback, an early warning system for shipping delays, and supplier selection criteria based more on quality and responsiveness than on cost. Suppliers in lower tiers would receive less attention and could have selection criteria that kept cost as a primary decision factor. When an organization has several strategic priorities, suppliers could be segmented for each capability separately. Those suppliers ranking high in each list would be preferred suppliers; suppliers who failed to provide the needed capabilities would be identified and replaced. Customization versus standardization. Some suppliers will specialize in being responsive and able to provide custom solutions, while others will specialize in providing standardized solutions at economies of scale. Grouping suppliers in this way can help organizations when they are shifting strategies. The earlier description of reducing complexity to suit a product’s later life cycle stages is one example of how this type of segmentation could be used.

Level of innovation. Some suppliers are better partners than others when working to innovate a product’s design. Suppliers who contribute creative input to product designs can be given preferential early involvement in a product design. Lead times. Grouping suppliers by similar lead times might help organizations when scheduling orders for goods, when tracking supplier performance (it will highlight lead time consistency since they can be tracked against their peers in terms of average lead times), and possibly by allowing certain shipments to be grouped together (if feasible).

Segmenting Other Supply Chain Partners Who are the organization’s noncustomer/nonsupplier supply chain partners? Answering this question may result in some categories that can be used as segments. For example, these partners may include supply chains that produce complementary goods and services and that could be approached to pursue cross-selling opportunities. Other stakeholders may not count as supply chain partners but could still benefit from segmentation: regulatory bodies, auditors, the general public, specific communities, interest groups, unions, and so on. Segmentation could help the organization craft communications

that are targeted toward the group. Segmenting these stakeholders by relative importance can help the organization decide how much time and money to devote to maintaining each relationship.

Processes Enabled by SRM Supplier relationship management (SRM) enables any process that requires close, ongoing relationships between buyers and suppliers to succeed. These processes include a long list of supply chain management innovations: Collaborative design Collaborative planning, forecasting, and replenishment (CPFR) Lean and Just-in-Time 3PL/4PL partnerships Supplier- and vendor-managed inventory Quick response programs Distributor integration Collaborative transportation management Supplier co-location Most of these are addressed elsewhere. Only supplier co-location is discussed more here.

Supplier Co-Location

Supplier co-location is a term often used to describe the practice of locating a supplier or multiple suppliers within a single location. Consider the following examples. Example: An auto manufacturer invites multiple suppliers into a production plant. The suppliers put inventory and staff on site so that each one can perform an operation on vehicles as they move along the production line. In return, the manufacturer provides the suppliers with free space, shelving, office equipment, and telecommunications. Example: In the airline industry, all alliance partners operate in the terminal of the dominant carrier at an international airport to facilitate partner connections and product offerings. They offer combined check-in, member lounges, and ground services. When multiple entities are located in one facility or campus, a primary benefit to the organization is highly integrated operations. The benefit to the supplier is that they are on site and become an integral part of the business. In manufacturing applications, there is also the potential for the organization to reduce capital plant requirements, inventories, and lead times. The relationship between the organization and the supplier shapes the extent of the co-location. Highly integrated supplier co-location is characterized by internally co-located personnel with high levels of

team partnering. But there can be less integrated supplier colocation initiatives with physically separated teams. Broadband communications and SRM technologies make long-distance colocation between lead companies and suppliers a viable alternative to on-site co-location. However, suppliers with facilities located near their customers often have greater success. Supplier co-location also refers to bringing together people or groups in related roles for product and process innovation. Suppliers have been co-located in this manner to generate ideas and design new products. For example, organizations may use SRM to co-locate core team members on a design project to facilitate communication, develop trust, and promote and sustain team ownership for the project. This allows problems to be addressed quickly as they arise in the design, prototyping, and product qualification processes. Such collaboration usually reduces concept-to-customer time. Co-location initiatives may necessitate licensing agreements, ranging from traditional patent and software licenses to revenuesharing agreements.

SRM Technologies SRM software can streamline connections between purchasers and suppliers and between members of cross-functional teams. It

increases the efficiency of processes associated with acquiring goods and services, managing inventory, and processing materials. SRM technology can lead to lower production costs and a higherquality and more profitable end product. There are many reasons why companies that have seen the power of SRM technology are eager to spend the money necessary to get started. One is that transaction costs have decreased. In addition, SRM software tends to work well with most existing enterprise resources planning (ERP) systems and actually helps those systems to achieve their full, promised potential. SRM may even be a fully integrated ERP module. Companies using SRM software can improve the sourcing process. The software helps reduce the cycle time on sourcing projects. Instead of going through reams of RFPs and comparing a wide array of quotes, the software brings all of these data together for simplified presentation, analysis, and selection. Another way that SRM software reduces sourcing periods is that projects can be saved and then reposted. If the organization has frequently recurring needs, this can save a great deal of time. SRM software can help standardize purchasing decisions. Most organizations have no clear idea of why they choose their suppliers, but the software makes selection criteria more readily apparent.

Prices and total cost of ownership (TCO) or individual line item costs can be compared quickly so that TCO can be managed systematically, including tracking the past performance of suppliers so that poor performers (e.g., too much scrap) aren’t reselected. It can also enforce centrally made strategic sourcing decisions among decentralized buyers for consolidated purchasing, shipping, and quantity discounts. Persons actively involved in purchasing for major organizations have commented on the structure SRM software also brings to the ongoing supplier management process. After all, instead of their having to deal with hundreds of separate suppliers alone, the software does most of the organizing work for them. SRM technology also makes communication between the buyer and the seller faster. Since the transfer of information can be done in real time, the supplier can check the buyer’s inventory to determine whether new shipments are needed and the buyer can instantly submit orders over the internet without reducing overall productivity. Similarly, questions related to orders can be answered, perhaps by checking an extranet web page, so no human interaction or humanrelated delays have to interfere with the work. SRM system components may include both transactional and analytic systems:

Strategic sourcing and RFQ/ITT submission and analysis Procurement of goods and services through internet trade exchanges or auctions Collaborative product design and planning Purchasing and supplier scheduling using direct system links over the internet or electronic data interchange (EDI) or using portals Catalog management Category management and various methods of supplier segmentation Supplier databases and rating systems The internet is integral to SRM, so the following content looks at web-enabled SRM (which could include cloud-based SRM systems). Exhibit 6-10 highlights web-enabled SRM, which includes internal interfaces, external supplier interfaces, and SRM analytics, services, and procurement.

Exhibit 6-10: Web-Enabled SRM

Internal Interfaces Internal interfaces could refer to an ERP system and its data warehouse. They collect and provide a repository for internal information in order to guide the purchasing processes. ERP or other internal interfaces provide SRM systems with a wealth of information, including the following examples:

Procurement history. This area stores historical information, such as past transactions or preferred supplier lists, and dynamic information, such as open purchase order status and active supplier files. The accuracy and completeness of this information serves as the foundation for all internal and networked procurement functions. Open order file. The internal system tracks and controls all open orders with suppliers. Operations synchronization. Purchasing receives consolidated demand information from manufacturing planning systems and/or advanced planning systems to synchronize the replenishment requirements of individual plants, subsidiaries, and supply chain partners. Availability of parts, etc., is provided to such systems. Purchasing is similarly synchronized with other departments such as quality management, marketing and sales, inventory planning, and transportation. Accounting. Accounting feeds directly into the organization’s financial system for order and price matching, invoice entry and payables, credit management, early payment discounts, cost variance, and financial reconciliation.

Purchasing planning. Future purchasing is scheduled against anticipated demand and is available to partners on a planning calendar. Supplier performance measurement. Once the data history is compiled, organizations can generate specific reports and performance measurements using this function. This will enable them to determine the value of their supplier relationships and the degree of success of their continuous improvement initiatives. Supplier database. The system contains a data warehouse of all past and present suppliers as well as those who submitted RFPs/ITTs. There are usually subsets for approved or preferred suppliers. Supplier contracts are retained for reference.

External Supplier Interfaces External supplier interfaces automate transactional interactions with existing suppliers using internet or EDI links. These interfaces may be direct links between each party’s ERP systems, in which case the status of individual orders or logistics information is kept up to date in each system. The secure links allow for a full range of transactions between buyer and supplier, including requisitioning, purchase order generation and tracking, logistics, receiving goods, and paying suppliers. Suppliers can also post transactions, such as approving

the buyer for trade credit financing, issuing invoices, or issuing credits for defective products. External supplier interfaces include secure portals for use with SRM services such as messaging boards or collaborative product design. Portals can also be used to link with suppliers who do not have direct transaction system links (e.g., checking order status).

SRM Analytics Analytical technology allows the purchasing and supply chain management group to solve issues related to the management of materials, information, and finances in the supply chain through the following functions: Visibility and decision support systems (DSS). An analytical SRM solution helps facilitate the gathering, cleansing, and presentation of procurement information to allow organizations the visibility they need to support their business decisions. DSS analytical systems assist with optimizing suppliers, material quality, etc. Strategic sourcing/RFQ analysis. Purchasing and supply management have the information they need to negotiate the best contracts and support corporate goals.

Spend analysis. This strategic application allows the organization to identify who they are buying from, what they are purchasing from each supplier, and when and how it was purchased. These comparative data can assist in sourcing and developing strategic relationships and consolidating purchasing. Value analysis. This analysis finds the purchasing, financing, and delivery processes or activities that are value-added and seeks to eliminate what is non-value-added. For example, the analysis could recommend substitution strategies rather than paying expediting charges for a particular material, or it could recommend substituting a less expensive good or service when the price for quality received is too high. Performance analysis. Using the analytical approach enables the organization to measure its procurement performance in terms of cost savings, quality, delivery, price, and overall effectiveness. The analysis can monitor entire procurement programs, individual suppliers, and contract effectiveness. Let’s take a look at an example using the analytical SRM approach. Case Study: Electrical Systems/Components Manufacturer A manufacturer of electrical distribution systems and components with more than 70,000 employees in 130 countries lacks a global

view of purchasing. It also lacks the analytical capability to amend purchases and verify that supplier policies are being followed. To solve these problems and reduce costs, they implement an analytical SRM system. The technology provides them with a comprehensive, global view of purchasing, which allows SRM managers to focus on strategic procurement practice. They can also drill down into specific exceptions to rules so that they can amend proposed purchases prior to their final approval.

SRM Services SRM services allow organizations to initiate strategic sourcing searches or other supplier searches that go beyond arm’s length transactions. Some SRM systems may search the same sites for strategic sourcing and for SRM procurement, while others provide additional services for strategic sourcing. Value-added services may include more detailed search and analysis, comparison of RFQs or ITTs, contract negotiation tools and forms, online financial and billing services, comparison shopping functions, and transportation and logistics support to facilitate product fulfillment. SRM services may also include supplier development, collaborative design, and collaborative planning. Supplier development provides tools to help set up collaborative efforts, begin sharing data, and settle on pricing strategies. Collaborative design tools allow

organizations to collaborate in real time on design drawings and specifications; collaborative planning tools help orchestrate logistics. SRM services may provide member services, security, and workflow tools. Member services create personalized websites or portals for partners in the same way that CRM systems can create personalized pages for customers. Security is of great concern for organizations implementing and using online market transactions. The main goal of security is to protect individual files so that confidential information cannot be accessed without validation. Workflow tools process information in the background to ensure that all dependencies between procurement process steps occur correctly.

SRM Procurement The goal of SRM procurement applications is to streamline procurement of the goods and services necessary to produce products and run the organization. SRM procurement provides interfaces to online trade exchanges or auctions as well as additional features for transactional purchasing—such as shopping tools, special pricing, payment processing, order status and tracking, and after-sale support. Online technologies have made it possible to use B2B (business-to-business) service functions such as product search, supplier search, and custom searches by content (e.g., product description or type) or parameter (e.g., how the content is

organized). Product catalog management involves managing suppliers’ product catalogs online to ensure that they have current prices, inventory levels, and product specifications.

Topic 2: Strategic Sourcing and Alliances Strategic sourcing can be enabled by supplier relationship management. We differentiate between strategic sourcing and tactical or traditional buying and address generic sourcing methods such as sole sourcing. After that, we turn to the types of strategic alliances that strategic sourcing can help build.

Strategic Sourcing Using SRM Strategic sourcing involves identifying, evaluating, negotiating, and configuring supply across multiple geographies in order to reduce costs, maximize performance, and mitigate risks. It also involves periodically reassessing supply plans and strategic relationships so that the supply chain can be responsive to changing customer requirements, changing relative costs, and changing supplier capabilities. The APICS Dictionary, 16th edition, defines strategic sourcing as

a comprehensive approach for locating and sourcing key material suppliers, which often includes the business process of analyzing total-spend-for-material spend categories. There is a focus on the development of longterm relationships with trading partners who can help the purchaser meet profitability and customer satisfaction goals. From an IT applications perspective, strategic sourcing includes automation of request for quote (RFQ), request for proposal (RFP), electronic auctioning (e-auction or reverse auction), and contract management processes. Strategic sourcing can be contrasted with tactical buying , which is defined by the Dictionary as the purchasing process focused on transactions and nonstrategic material buying. It is closely aligned with the “ordering” portion of executing the purchasing transaction process. The characteristics for tactical buying include stable, limited fluctuations, defined standard specifications, noncritical to production, no delivery issues, and high reliability concerning quality-standard material with very little concern for rejects. While tactical buying could be buy-on-the-market transactions or could involve developing ongoing relationships to save money over the long term, strategic sourcing is for those critical materials or services that provide the characteristics to make the product into an order winner. Therefore, strategic sourcing requires finding and

building ongoing relationships with those trading partners that provide materials or services that differentiate the organization’s product or service from the competition. In other words, strategic sourcing in SRM helps align sourcing decisions with the organization’s strategic vision and goals. This could be lowest overall cost relative to the competition, perfect delivery lead time, or exacting quality for a critical part. The ultimate goal in strategic sourcing is controlling costs while providing essential goods and services across the supply chain network. Strategic sourcing can reduce costs by consolidating network demand. Multiple plants, supply chain partners, or divisions can allow SRM to consolidate purchasing power. Strategic sourcing could employ a single-source supplier or a small number of suppliers to gain volume discounts or could perform multisourcing to optimize supplier capacities and lead times while providing resilience against disruptions. However, there are sometimes situations when the organization has no choice but to use a sole-source supplier. The Dictionary defines these terms as follows: Single-source supplier : A company that is selected to have 100 percent of the business for a part although alternate suppliers are available. Multisourcing : Procurement of a good or service from more than one independent supplier.

Sole source : The situation where the supply of a product is available from only one organization [sole-source supplier]. Usually technical barriers such as patents preclude other suppliers from offering the product. Strategic sourcing differs in its focus and implementation from traditional purchasing, and it offers clear benefits. Traditional purchasing focuses on landed cost; strategic sourcing focuses on total cost of ownership. Landed cost is only a small component of total cost. For example, a manufacturer of computers may choose a component based on the lowest price, but that choice may translate into a very high cost if the low-priced components are not reliable and fail early. The savings in producing the computer will be offset by the costs of reverse logistics for returns and the loss of potential business and lifetime customers. Traditional purchasing is transactional; strategic sourcing is collaborative. Traditional purchasing sees each purchase as a discrete transaction, and adversarial relationships can occur as organizations fight over prices and other demands. Strategic sourcing involves ongoing relationships. There is opportunity for collaboration between the purchaser and the suppliers that can result in improving profitability for both parties and adding value to

the final product or service. Under the SRM methodology, a company shares information with its suppliers in real time, cutting material costs, minimizing inventory, reducing shortages, and regulating deliveries. More importantly, the suppliers can participate in improving the system, which will result in better product, customer satisfaction, and customer retention. Traditional purchasing never crosses the boundaries that distinguish the two business entities; strategic sourcing realigns processes, information flows, and workflows. Strategic sourcing redesigns workflow and information flow to eliminate redundancies and non-value-added work, often allowing purchasers or suppliers to focus on more strategic issues. For instance, one U.S. company used more than 140 classifications of temporary help positions. After a strategic sourcing review that simplified job specifications, the number of temporary help positions was just 19. Traditional purchasing does not increase the visibility of the entire supply chain the way strategic sourcing can. Collaboration brings increased amounts of information about all the points in the supply chain. When information from suppliers, manufacturers, distributors, retailers, and customers is available for analysis, there is enhanced visibility of the supply chain and

opportunities for improvement. Demand information, inventory status, capacity status, capacity plans, production schedules, promotion plans, and shipment and demand forecasts are all shared and ideally can be accessed by all parties on a real-time, online basis. Expanded information sharing can lessen the bullwhip effect and provide early problem detection, faster response, better contingency planning, and stronger relationships because of increased trust. While procurement may be a specific task for a purchasing department, today’s integrated plan, source, make, deliver, and return supply chains require collaboration on purchasing from marketers, engineers, and operations managers. Supply chain managers can help make connections between these interests both within the organization and with the extended supply chain. Does strategic sourcing in SRM work? Reports from mid-sized and large North American, European, and Asian companies that have adopted SRM strategic sourcing suggest that a business can reduce expenses by 10 to 30 percent. With strategic sourcing, major manufacturers, retailers, governments, and financial institutions are achieving significant savings while strengthening ties with suppliers that offer the best-quality products and customer service. Strategic

sourcing also allows small and medium-sized businesses to compete against larger companies for major contracts.

Strategic Alliances The APICS Dictionary, 16th edition, defines a strategic alliance as a relationship formed by two or more organizations that share information (proprietary), participate in joint investments, and develop linked and common processes to increase the performance of both companies. Many organizations form strategic alliances to increase the performance of their common supply chain. Over time there is alliance development , which “strengthen[s] the capabilities of a key supplier” (Dictionary). Strategic alliances can entail interaction between many functions, such as engineering, marketing, production planning, inventory, or quality management. Goals for these relationships may include cost reduction, quality improvement, better delivery performance, increased flexibility, or new product introduction. Alliances need to be flexible, and each partner must bring value to the relationship relative to the scope of collaboration.

Exhibit 6-11 emphasizes the difference between traditional purchaser-supplier relationships and strategic alliances. The butterfly shape depicts traditional relationships where there is one point of interaction between partners, typically those people making buying decisions and the supplier’s sales representative. The diamond represents the multiple points of interaction in a strategic alliance.

Exhibit 6-11: Traditional Purchaser-Supplier Relationship versus Strategic Alliance

Source: The Practice of Supply Chain Management, Terry P. Harrison, Hau L. Lee, and John J. Neale, editors.

Alliances should not be confused with joint ventures. A joint venture (JV) is “an agreement between two or more firms to risk equity

capital to attempt a specific business objective” (Dictionary). In joint ventures, the parties typically agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only or a continuing business relationship. In contrast, a strategic alliance involves no equity stake by the participants and is a much less rigid arrangement. This area covers some characteristics of successful strategic alliances. It also examines reasons to form alliances, factors that must be considered in deciding to form an alliance, and the commitment required for a successful alliance.

Characteristics of Successful Alliances Successful alliances are more than the exchange of goods and services—they are true relationships. And the relationship side of the alliance must be as carefully managed as its business objectives. Rosabeth Moss Kanter has compared effective alliances between organizations to successful family relationships. They both require flexibility, listening, and involvement. The most effective supplier relationships have similar characteristics: Individual excellence. Each partner has something to offer. The motive for the partnership is to pursue opportunity rather than to

escape a problem. Interdependence. The partners’ strengths are complementary. Although excellent individually, they are stronger as a partnership than they are individually. Importance. The alliance figures significantly into each partner’s business goals and strategies. Investment. The partners’ commitment to the relationship is evidenced by their investment of time, personnel, and resources. Information. Communications are open, and both sides are honest and generous in providing information. Partners actively listen to each other. Integration. The partners have many connections and shared operational procedures at different levels. Effective partners develop a strategy to help determine the appropriate level of supplier integration based on their situations. The integration provides supply chain visibility without sacrificing autonomy. Institutionalization. The alliance is given formal status, with clear objectives and procedures. Integrity. Trust is an intangible but vital element of an alliance. Partners in effective supplier relationships do not violate that trust.

Interpersonal skills. Even with technological advances that have changed the way we communicate in the workplace, basic interpersonal skills remain a critical component in building and sustaining a successful supplier relationship. People often get things done in teams—by working with each other. Without good interpersonal skills, relationships can falter and fail. Interpersonal skills are especially important in culturally dissimilar global supply chains where people have differing perspectives of what is an is not appropriate.

Reasons to Form Strategic Alliances Reasons to form strategic alliances include the following: To add value to products. When an alliance improves time to market, gets product into the hands of customers more quickly, or helps ensure quality, it increases customer satisfaction, which leads in turn to greater customer loyalty and more lifetime customers. For example, a key supply chain issue is the selection of appropriate suppliers for the components of a new product. In the past, suppliers were selected after the design and manufacturing engineers determined the final design for the product. However, organizations have realized significant benefits when involving suppliers in the design process, including a decline in purchased material costs, an increase in purchased material

quality, a decline in development and manufacturing time and cost, and an increase in final product technology levels. Similarly, a strategy for mass customization will give organizations a competitive advantage, but it requires the delivery of a wide variety of customized goods or services quickly and efficiently at a low cost. Early supplier involvement is critical to maximizing the potential of this strategy. To enable strategic growth. Alliances may enable organizations to combine resources to overcome barriers to entry and search for and develop new opportunities. Strategic alliances are common now in the pharmaceutical sector, where small biotech companies have the expertise to identify and develop innovative products but lack the resources to test and market new drugs. By partnering, the biotech companies help their own businesses grow and the larger companies gain new product to support their brand and their infrastructure of development, marketing, and sales personnel. To increase market access. Partnerships that lead to better advertising or increased access to new market channels can be beneficial. For example, an appliance manufacturer who previously specialized in residential kitchen appliances might team with a manufacturer of professional kitchen equipment to design new equipment. The residential company gains valuable design

input that helps it develop new and more profitable lines for serious home cooks. To strengthen operations. Building alliances between organizations can help improve operations by lowering system costs and using resources more effectively. For example, a summer garden tools manufacturer and a winter sporting goods manufacturer could share a warehouse to save on storage costs. To increase organizational expertise. Working with a partner that has expertise in a certain area can lead to increased knowledge and experience that will benefit the organization. To build organizational skills. Strategic alliances provide an excellent opportunity for learning within the organization. Not only will organizations learn from each other; they will also learn more about themselves and become more adaptable. To enhance financial strength. Alliances can help improve overall financial position by increasing revenue while sharing administrative costs. To better manage risk. Alliances can enable sharing of risks among those partners best equipped to mitigate or avoid the risk.

When searching for a sourcing relationship, organizations should consider the depth of suppliers’ competencies, their ability to deliver required services, product and service quality, capacity for innovation, willingness to collaborate, and, probably most important, customer focus. The ability to predict, appreciate, and deliver customer satisfaction drives the modern supply chain.

Factors to Consider in Deciding to Form Strategic Alliances Alliances may have limitations. The consolidation of the supplier base may decrease the economic effects of competition. Alliances that dominate the marketplace can dull the competitive edge. Some alliances dull their organizations’ core competencies. Not every relationship should be collaborative, and organizations will continue to keep some suppliers at arm’s length. Organizations seeking alliances with suppliers must consider the following. Strategic importance. While the organization should develop the in-house manufacturing capabilities for a component critical to competitive differentiation that may require proprietary knowledge or processes, manufacturing the component may call for expertise that lies outside its core competencies. In such cases, it should form a close alliance with a supplier who does have this core

competency. Strategic services can also be assessed for their importance and whether they are core competencies. Number of suppliers. How many suppliers can provide the component or service? If only one supplier is available, the organization may need to maintain a close relationship with that supplier to ensure availability. A strategic alliance may provide opportunities to co-develop new components that could provide competitive differentiation. Complexity. Complexity refers to the interfaces between the component procured and the final product as well as the complexity of the supply chain itself. The more complex the relationship between the component and the final product, the more value there will be in collaborative design. The more valueadded points in the supply channel, the greater the opportunities for efficient management of supply and demand and SRM. Uncertainty. Uncertainty in supply includes changes in raw material or component cost, quality, or availability that can block a business from meeting its goals. Managing uncertainty by purchasing in excess or gambling on quality can be costly strategies. If a sourcing relationship has the potential to jeopardize attaining business objectives, the buying company should develop

a closer relationship with that supplier (or find a different/alternate supplier). New relationships. If a supplier is new, especially one located in a region where the company is unfamiliar, the alliance must be managed carefully in the beginning until processes and working relationships are established.

Commitment Required for Successful Alliances Despite their benefits, many strategic alliances fail. One of the main reasons is that the organizations involved may not understand the true purpose of the alliance. An alliance is an interaction between two or more organizations, and, instead, the organizations may treat it like a merger or an acquisition. Although there may be similarities, a merger is an event and an alliance is a process that requires continual monitoring and attention. Organizations that view alliances as events focus too much on the contract or on making the deal. Once the deal has been made or sold, the focus fades and the alliance may suffer. Alliances may fail for other reasons: immature technology, uncertain marketplaces, shifts in corporate strategy, or external forces beyond the control of the alliance partners. Often, these reasons mask underlying problems in the alliance, such as ineffective

management, inadequate resources and staffing, and a failure to honor commitments. Alliances may also fail if companies are too quick to partner with global suppliers without understanding cultural and process differences, especially when working with suppliers in new regions of the world. Any supplier relationship will, in the normal course of events, undergo so many stresses, strains, and challenges that it is bound to fail unless each partner is thoroughly committed to its success. That general commitment to the success of the alliance must translate into specific kinds of commitment, each born of necessity. Commitment to Change The commitment to change begins by recognizing that several key developments have united to ensure that constant change is inevitable in today’s supply chain—for example, the high cost of inventory, shrinking margins due to online sellers and superstore discounters, shorter product life cycles, software that inundates trading partners with data, and the internet, which gives consumers a tremendous new array of choices. Pressure for and from change will grow more unyielding in the future. Technology aside, the customer will dictate how a company goes to market, and the winning supply chains will be those that can constantly reinvent themselves to match changing customer needs and wants.

Even without these forces at work, entering any alliance will result in changes in each partner organization. No two companies work the same way, so some adjustments are inevitable. The dynamics of today’s marketplace have made clear that no single restructuring of methodologies or processes will withstand the ongoing changes of the marketplace; rather it is a process requiring continuous improvement. What is needed, then, is mutual commitment to ongoing change and recognition that change can take place incrementally, not just in colossal jumps. Organizations are realizing that making adjustments in response to changes in the priorities and strategies of supply chain partners is essential to the long-term success of the alliance. Of course, getting people to change without a crisis driving it can be difficult. The key is to keep moving forward. Commitment to Relationship Relationship commitment refers to a supply chain partner believing that an ongoing relationship with another organization is so important that maximum efforts are warranted in maintaining it. In fact, anything less than that maximum commitment isn’t really cost-effective. Significant time and resources are necessary to establish any alliance with a supply chain partner. As with customer relationships, developing a new alliance is more costly than retaining

an existing one. Committing additional resources to foster a healthy, long-term commitment is thus well worth the ongoing investment. In order to ensure long-term success with supply chain partners, a systematic process for developing and maintaining the relationship is necessary. To ensure ongoing effective and efficient collaboration, organizations create Common models, techniques, and expectations for spotting, diagnosing, managing, and learning from conflict Structured methods for managing information flow Structure for decision making, including who will make decisions, who must be consulted versus just informed, and how the decisions will be communicated throughout the partnering organizations. Successful organizations conduct periodic tests to review the quality of their working relationships. This process allows them to gauge the strength of each alliance, spot and diagnose current or emerging issues, and identify potential opportunities to enhance the alliance. The tools used to assess the relationship may include online surveys and personal interviews. Those who interpret the responses follow guidelines for resolving the various types of interpersonal, strategic, structural, or organizational problems they uncover.

Commitment to Communication Open and continuous communication regarding joint objectives is vital to a successful supply chain relationship. Merely sharing data is not enough. What is necessary is a dynamic environment in which information flows in both directions on a real-time basis. Effective collaboration entails interaction at all points throughout the supply chain and well beyond the initial establishment of trading partnerships. It must involve everything from the design and introduction of new products to sales and marketing data management, order planning and fulfillment, and after-sales service. Successful organizations promote the free flow of information among trading partners. The ideal collaborative relationship consists of supply chain partners who mutually decide on the value of a piece of information, develop it jointly, measure their performance against it, and are paid accordingly.

Steps in Creating and Maintaining Alliances Commitment alone is not enough for an alliance to be successful. Successful alliances are able to channel that commitment into concrete steps that make ongoing success possible. The process

may differ by organization, but some essential steps (illustrated in Exhibit 6-12) can be isolated.

Exhibit 6-12: 10 Steps to Successful Alliances

Applying a systematic process like this to global sourcing also makes sense. Defined steps can help to overcome many of the differences that exist across locations such as language, culture, social norms, laws, and personnel skills. Having planned actions in place helps to align global participants and processes with broader supply chain interests. Let’s take a closer look at each of these steps. Note that this area uses some case study organizations: a clothing retailer, a leisure boat manufacturer, and a financial services provider.

Step 1: Align Internally. Before entering alliances, start by identifying key issues and decisions and involving key stakeholders. The benefits are twofold: fewer surprises and greater buy-in by your organization’s key people. For example, a case-study clothing retailer must recognize that its buyers will not be the only employees directly affected by each relationship it establishes with a clothing manufacturer. Its marketing decision makers will certainly want to raise issues about responsiveness and timing. Regional managers will want to know how flexible the supplier can be in responding to differences in local trends. Information technology will need to design or acquire methods for real-time sharing of information at all points in the supply chain, from placing purchase orders to tracking store deliveries and transfer of discounted goods. Other issues, such as quality control and shipping and delivery logistics, all need to be considered. In each case, the people most directly responsible—and those most directly affected—need to be brought into the process as early as possible.

Step 2: Select Proper Partners. When considering potential partners, look beyond strategic and financial fit. Evaluate differences in corporate culture, operating style,

and business practices as well. Assume a recreational boat manufacturer is entering into a partnership with an engine design company. By definition, this will be an ongoing and intimate relationship. Ideally, each partner will be providing ideas and making suggestions to the other and changing its own designs to meet the other’s needs. A high level of mutual trust will be required, since information shared has competitive implications. The partners must respect each other’s expertise and contributions. In such a relationship, corporate culture and operating style are not just abstract concerns. If these partners don’t share a common vision, their relationship won’t work.

Step 3: Negotiate Win/Win Deal. Negotiators must focus on their future working relationship as well as the immediate substance of their negotiations. A win/win proposal should be the goal, as this sets the tone for the future alliance. In working through their contract with the engine designer, the boat manufacturer’s immediate negotiation may be about the price of services, adherence to manufacturing goals such as cost and quality levels, and the proprietary nature of the design. But clearly, anything less than a win/win solution could lead to long-term conflicts. The manufacturer may recognize the involvement of the designer by

including a designer nameplate on the hull. This will strengthen the designer’s ability to attract new business. The need for win/win relationships is no less true for the clothing retailer. Inevitably, there will come a time when it will need a supplier to go the extra distance —to boost production to meet unexpected demand, for example. Negotiations will lay the groundwork for the supplier’s willingness to respond when the time comes.

Step 4: Establish Ground Rules. Guidelines, processes, and protocols must be developed for how the partners will work together, resolve conflict, and mutually manage the relationship. To keep its independent financial consultants, a case-study financial services company must have flexible and functional relationship management tools. By definition, the connection is in a constant state of tension: The consultants want greater support from the financial services company but also greater independence in their own client relationships. In a dynamic financial marketplace, a static consultant contract without clear and flexible guidelines and processes to manage the relationship may encourage consultants to break their connection with the company rather than redefine it. For example, the partnership must develop an agreement about what will happen when a client needs a product that may be available from

competitors but not from the financial services company. In that case, will the consultant be allowed to go outside the network of family products? And, if so, how will this other product be tracked within the broker and customer information systems?

Step 5: Appoint Dedicated Alliance Manager. If possible, top management should choose a dedicated relationship manager to oversee the alliance and implement a specific methodology for managing alliance relationships. The role of alliance manager may differ among organizations, but the objectives are to promote partner relationships, build joint initiatives, bring products/services to market quickly, and gain market share. This step is critical for the financial services company’s relations with its independent financial consultants, since the consultants’ own business is all about maintaining relationships. Like their own clients, they need to know that there is someone who values their relationship and works to maintain it—someone with real power and influence in the company who can relay their needs and ideas to the company’s strategic managers.

Step 6: Encourage Collaboration. Collaboration skills may not come naturally to everyone. Skills for resolving conflicts, negotiating, solving problems jointly, and

conducting difficult conversations must be developed in all allianceinvolved employees. The clothing retailer identifies and consults up front with every internal stakeholder who will need to work with the selected suppliers. For those relationships to succeed—especially in the company’s tight deadline environment—the stakeholders need to acquire skills that enable them to become true collaborators. For example, both buyers and suppliers need to become more aware of data mining opportunities in the company’s customer relationship management system and the wealth of information for predicting and crafting new trends that such information contains.

Step 7: Engage in Collaborative Corporate Mindset. For alliances to be successful, alliance managers must focus on joint goals and think in terms of the overall good of the alliance rather than that of the channel master (the dominant partner in the supply chain). For example, weekly web conferences that focus on collaboration and problem solving have helped the boat manufacturer develop a strong collaborative ethic among its own people and the suppliers. These sessions focus on redefining the larger goals and discovering short-term tactics that will help meet those goals. Collaboration is

always viewed in this strategic context—not simply as an abstract good.

Step 8: Manage Multifaceted Relationships. Many alliances occur between organizations that have other business relationships with one another. A partner may also be a competitor, a customer, or a supplier. To manage the complex interactions, companies need the ability to identify, discuss, and track all relationships with a given partner and understand their potential interactions. For example, the engine designer for the boat manufacturer designs engines for competitors as well. The partners must understand potential conflicts of interest and have agreements about patents and licensing.

Step 9: Conduct Pulse Checks. Auditing partner relationships is more than just ensuring that business objectives are met. It also includes formally monitoring the health and trust of the working relationship. The financial services company holds annual conventions for its independent consultants. While these began solely as sales promotion and morale-boosting sessions (“Here are our new financial products for you to offer”), they have grown into more

meaningful two-way communication opportunities. In small-group sessions, consultants and company representatives each get to report on what is and isn’t working and create collaborative solutions.

Step 10: Plan for Change. There are two aspects to planning for change. First, partners must anticipate and plan for business changes, such as executive moves, organizational restructuring, or shifts in the competitive or regulatory environment. Second, partners must build continuous incremental improvements into the relationship. The information shared between partners should enable them to work more efficiently with one another. The clothing retailer finds itself in an especially dynamic environment in which suppliers appear and disappear with startling frequency and in which key designers and purchasers often jump from one company to another. Its response includes finding ways to shift supply channels quickly when one supplier goes under. It also continually looks for ways to help each supplier succeed. Finally, it has been careful to strengthen relationships with the suppliers’ employees—not just with the organization itself.

Topic 3: Supplier Performance

Supplier performance can be assessed using performance measurement. Suppliers can also be subjected to a certification or rating process. When errors in performance are discovered, it is important to have an error correction process in place.

Supplier Performance Measurement The best organizations don’t monitor just the status of individual orders; they are compulsive about monitoring the overall performance of their suppliers in an ongoing manner. Consistent and continual measurement can help organizations focus on resources, determine performance missteps, develop strategies for supply chain improvement, and determine the overall cost of ownership of supply chain relationships and products. Effective SRM performance measurement systems Track the performance of all suppliers to some extent, with a focus on critical component suppliers or suppliers with prior quality issues Collaborate with suppliers on performance measurements, reporting, and improvements Automate key supplier performance measurement activities Standardize supplier performance measurement procedures across the organization.

Ongoing supplier performance measurement is a central feature of supplier evaluation programs. It is generally performed for a small number of critical data elements such as delivery, reliability, quality, technology, and cost reductions. These same measures are also often used to select and rate suppliers. When evaluating performance, businesses must check the supplier’s Promptness and flexibility of response to inquiries Ability to perform on a consistent schedule Commitment to quality assurance and the processes they have in place for enforcing this standard Financial stability Investment in technology, which includes ability to produce goods or services and also ability to integrate with an organization’s information systems. The reliability and quality of the supplier’s supply chain partners must also be checked. Some organizations set goals for their suppliers, for example, requiring cost reductions over a period of time, expecting collaboration with their suppliers to achieve the reduction, and then sharing in the savings.

The sophistication of a performance measurement process should correspond to the organization’s dependence on the supplier and the complexity of its interactions. All important desired results and key competitive factors should be regularly monitored.

SCOR Metrics SCOR metrics can be used to judge individual supplier performance.

Measuring Customer Satisfaction Since the organization is the customer, measuring customer satisfaction with specific suppliers can be accomplished by discussing the supplier’s products or services with internal persons who design, engineer, receive, handle, install, process, assemble, and ship the supplier’s product or service. Communicating the level of satisfaction with each supplier in addition to providing the results of quantitative analysis can help with continual improvement efforts. Tracking how issues were resolved or left unresolved can help when deciding whether to continue the relationship.

Supplier Certification Many organizations struggle to manage the supplier relationship systematically. Organizations tend to believe that their people skills are sufficient to generate and maintain relationships as well as react

to problems as they arise. Attempts to become more systematic are often resisted out of fear of rigidity and bureaucracy. But positive relationships don’t “just happen,” and relationship management can’t be left to “good chemistry,” “compatible corporate cultures,” or the talents of a single manager or dynamic leader. Rather, successful relationships arise from organizational commitments backed by a clearly defined process. One way to promote good relationships is to work with suppliers who are willing to be certified. The APICS Dictionary, 16th edition, defines supplier certification as certification procedures verifying that a supplier operates, maintains, improves, and documents effective procedures that relate to the customer’s requirements. Such requirements can include cost, quality, delivery, flexibility, maintenance, safety, and ISO quality and environmental standards. Certification is an extensive on-site evaluation of suppliers against agreed-upon performance levels in areas such as on-time delivery, quality, price reductions, and responsiveness. A certified supplier has shown a complete and thorough understanding of a third-party standard or of the organization’s needs. Certification may occur as a prerequisite to selecting suppliers for a strategic relationship, it may be implemented after the selection process, or it may occur

periodically. Certification is both a selection tool and a means to improve supplier performance, since the process of certification usually requires organizations to acquire new knowledge and abilities and improve existing performance.

Customer and Supplier Benefits Supplier certification accrues benefits to both customers and to suppliers. It is important for organizations working with suppliers to highlight the benefits suppliers can achieve so they can see that it is in their best interests to become certified. This approach is likely to be more effective than simply mandating certification. The value proposition for customers and for suppliers is shown in Exhibit 6-13. Exhibit 6-13: Customer and Supplier Benefits of Supplier Certification Benefits for Customers

Benefits for Suppliers

Benefits for Customers

Benefits for Suppliers

Helps to ensure the development, manufacture, and supply of products and services that are more efficient, safer, and cleaner. Safeguards consumers and users of products and services. Marketing assertions of corporate social responsibility can be extended to suppliers. Helps both with supplier selection and with ongoing performance evaluation. May be able to consolidate to fewer suppliers for significant savings. Helps organizations trust their suppliers and thus share information.

Provides access to wider market (organizations insisting on certification). Helps market existing capabilities. Higher quality can reduce overall costs (e.g., fewer defects, returns, lost customers). Suppliers can use the process to learn more about their intermediate customers’ needs. Best practices can improve throughput and reduce costs, increasing profits. Possible opportunity to be single-source provider with larger sales volumes. Demonstrates commitment to partnership.

Third-Party Supplier Certification The primary form of third-party certification is ISO certification. ISO stands for the International Organization for Standardization. ISO provides an internationally recognized and broad set of standards. ISO certification is voluntary, but, if it is obtained, it must be renewed every three years to remain valid. Whether an organization achieves

ISO registration (becomes certified) or merely implements and maintains ISO compliance, the results will be of benefit in supply chain management. Because of its worldwide recognition, the ISO certification has achieved great reach. However, there are other certifications. Social Accountability 8000 (SA8000) is an international standard for social accountability that cuts across multiple industries. The standard is a way for retailers, brand companies, suppliers, and other organizations to maintain just and decent working conditions throughout the supply chain. SA8000 sets basic standards for child labor, forced labor, health and safety, freedom of association and the right to collective bargaining, discrimination, disciplinary practices, working hours, compensation, and management systems. Some industries and nonprofit organizations have created their own certification programs that more narrowly reflect the capabilities of the potential supplier. These programs tend to have more depth than ISO certification but lack its breadth. For example, engineering standards for measurement, terminology, test methods, or product specifications are quite different than the ISO series of quality management system standards. General industry groups have also collaborated in an effort to standardize their individual requirements.

Automotive, telecommunications, and health care are examples of industries with unique regulations. Large organizations may also devise their own unique certification system if they have a sufficient suppler base and enough clout with those suppliers to get them to adopt the standards. Organizations need to justify the expense of creating such a system. Most certification bodies do not engage directly in registration or certification activities. Rather, they accredit third-party auditors, testing facilities, and laboratories to perform certification to a particular standard. The supplier (or possibly a customer) may contract with such a service to provide the proper level of testing. Organizations should verify that these services have proper accreditation. Organizations that have their own supplier certifications could do the certifying themselves or license third parties to perform the audits.

Supplier Certification Process In order to certify a supplier, a consistent process should be in place. The process can be organized into a booklet or flowchart to help inform and educate management and suppliers. This is important, because both parties need to know and understand the specific

requirements to complete certification. The certification process is illustrated in Exhibit 6-14.

Exhibit 6-14: Certification Process

Step 1: Define Requirements, Process, and Roles. Before the certification process begins, it is important to decide who will be carrying out each role. Third parties performing the testing or auditing should be identified. If the organization is performing some or all of the testing, the key players on the team must be identified and their tasks documented. For example, which functional areas will be included in the team that makes on-site visits to a supplier’s factory, warehouse, or transportation terminal? After the players and their roles have been identified, the next step in the documentation process is to establish a system of metrics, for example, an ISO standard or a custom scheme. Custom schemes should include tolerance ranges, number of tests run, number of

allowable flaws per unit or run, use of certain equipment, and so on. Procedures for documenting measurements must be established as well; these may include forms such as systems audit forms and process control detail forms. Once a documentation process is in place, the organization can implement orientation for managers to understand the process. Step 2: Evaluate Alternative Suppliers. Existing and/or potential suppliers are screened through conversations with the suppliers, additional background research, or requests for information. Step 3: Select Suppliers. The organization determines which suppliers (existing or new) to certify. It may be best to pilot the certification process by beginning with a few good (or local) suppliers and then expanding the system to develop other suppliers needing improvement. Step 4: Conduct Joint Quality Planning. The suppliers selected are clearly informed of the certification process and standards and measures. This can be communicated through supplier meetings, either in a group or individually. Step 5: Cooperate and Build Partnership with Supplier.

The supplier is asked to commit to a process defined in a formal agreement. The commitment agreement describes the certification parameters, methods, audits, process details, etc. To create a partnership with suppliers, an atmosphere of trust and commitment must be established. It must be made clear to suppliers that information arising from the certification process will be used for mutual benefits, not to place the supplier at a competitive disadvantage. Step 6: Conduct Measurements. Suppliers are measured against the chosen performance standards, which may include cost, quality, delivery, and other attributes such as technical support and attitude. The organization will obtain qualified individuals to measure the system against the standards. Step 7: Certify Suppliers. Typically, suppliers winning certification are either those that satisfy all objectives of the third-party standard or, for custom standards, those that are rated in the top five to ten percent in performance and stand out in all areas of the relationship. illustrates a certification award, one possible outcome of the certification process.

Exhibit 6-15: Certification Award

Step 8: Conduct Quality Improvement Programs. Organizations may implement programs to bring suppliers who have not achieved certification up to the desired standards. In addition, all suppliers should have continuous improvement processes in place. Step 9: Reevaluate Suppliers Periodically. The recertification process and/or a benchmarking system may be used to reevaluate suppliers. This will confirm if the organization is obtaining expected returns and identify ways to improve the process. As supplier reviews are conducted, organizations must ensure that

the supplier is maintaining the levels of performance expected and take corrective action if the supplier has fallen below certification standards. If a supplier is not performing at expected levels, a system must be in place to decertify the supplier or place them on probation. These are difficult steps to go through, and a well-thoughtout process will help ensure fairness and consideration to both parties. Supplier certification can be a long, winding process; however, there are rewards from both a management and human perspective. Organizations will see return on investment in improved quality, better customer satisfaction, and fewer returns/rejects. Suppliers will see the effect through recognition, longer-term and more profitable contracts, and improvement of their own organizations.

Supplier Rating Systems Supplier rating systems start by setting supplier performance measures and standards. Standards are target values against which to measure the supplier. Standards can help as a control for when they are not being met. They can also help with continual improvement; the standard can be increased as suppliers improve to keep the standard achievable but challenging.

When the supplier rating system is implemented with other operating functions, it can monitor quality costs, track the timeliness of incoming materials and outgoing shipments, identify areas for improvement, and ultimately contribute to the financial well-being of the organization. Supplier performance rating systems can incorporate data for continuous rating of suppliers from various sources: Conformation rates. Data from each inspection or test should be documented in the system. The data should include part number, lot size, number of parts accepted or rejected, reason for any rejections, and the quality disposition. Number of floor failure events. If a supplier-caused discrepancy is found after a part is shipped to stores or has been installed in an assembly, the organization needs to adjust the performance index accordingly. The performance index is the relationship of nonconforming costs to purchased costs. Levels or amounts of conditionally accepted materials. These are materials that do not conform to specifications but are accepted through the material review process. Time line performance. The system tracks the difference between purchase order schedule and actual receipt dates and

identifies undelivered and past-due items and unauthorized early deliveries.

Methods of Sharing Ratings with Suppliers It is critical to share supplier performance ratings, along with the measurements and standards used for the ratings, with the suppliers. Suppliers should understand when missed standards or overall ratings will initiate corrective action. Corrective action can improve future performance and thereby save costs and increase customer satisfaction. Measures and standards can also be automatically collected and disseminated to both the organization and to suppliers. The organization gets a picture of ongoing performance levels; suppliers can use the real-time information provided to immediately selfcorrect and avoid the need for formal corrective action. In other words, rating systems are not just a historical tool but a set of active controls. Supplier performance can be shared with suppliers in different ways: Scorecards. Scorecards capture quantitative and qualitative data and provide historical, plan (current), and predictive views of supplier performance. Suppliers have access to their own scorecard and can address specific areas of concern immediately.

Scorecards should be sent to strategic suppliers on a regular basis, at least quarterly. Deficiencies should be addressed by the supplier through a written corrective action plan. Performance alerts. Automated alerts on areas of concern related to supplier operational performance are delivered to supply chain managers on a real-time basis. Surveys. Standardized surveys are sent to supply chain managers in order to gather qualitative information on the performance of suppliers. The questions may address overall performance, reliability, cost, order accuracy, delivery/timeliness, quality, business relationships, personnel, customer support, responsiveness, etc. Other tools include supplier performance reports and supplier quality certification processes. Exhibit 6-16 is an example of a supplier performance report. Exhibit 6-16: Performance Report Date: January 20XX Supplier No. 100 Acme Mfg. Co.

Purchase Order No. 100 Product

Wheels

Rims

Spokes

Qty Ordered

250

250

5,000

Reliability

Qty Received

250

248

5,012

Reliability

Qty Rejected

0

2

0

Quality

UM

ea

ea

ea

Standard Cost

60.00

30.00

5.00

Cost

Purchase Price

62.00

29.00

5.00

Cost

Purchase Price Variance

2.00

0

Cost

Date Due

1/5

1/5

1/5

Lead time

Date Received

1/7

1/5

1/5

Lead time

Variance

+2

0

0

Lead time

Quality rating = A–

Controlling Errors Controlling errors in the supply chain is critical in the overall process of preventing future problems. To do this, some organizations are implementing online compliance scanning and labeling control systems with suppliers. These controls prevent suppliers from printing out package labels and shipping goods unless they comply with the purchase order (PO) or release order rules. Although each customer/supplier may specify the rules according to their supply contract, examples of these rules include “Do not ship unless it is included in the most recent version of PO release.” “Do not ship +/– days outside of delivery request date.” “Do not ship +/– amount outside of PO.”

“Do not ship +/– amount outside of PO total.” These control points help to minimize the number of shipments that are turned away at the receiving dock or arrive incomplete. Putting these rules in place will help document problems and resolve disputes and inventory discrepancies. However, when supply chain problems such as unplanned rush orders, canceled orders, delays in supply delivery, or slowdowns in customs or port clearances do occur, organizations are implementing processes and technology that guide decisions on recovery strategies.

Freight Claims A freight claim is a form submitted to the carrier requesting financial reimbursement for loss or damage. The contract specifies the time in which the claim must be filed in writing. The filing terms are governed by law and the original bill of lading. Domestic trade terms or Incoterms® trade terms will specify whether the buyer or seller should file freight claims. Freight claims can be submitted for visible damage, shortages, concealed damages that are discovered when the package is opened, and losses due to delays. When a claim is submitted, it can be supported by photographs of damage, notes on a delivery receipt,

and the invoice supporting the monetary value of the goods. Freight claims cannot be submitted for uncontrollable factors such as natural disasters, acts of war, government seizure, failure to appropriately package, and perishability. As filing freight claims is a routine matter in the transportation industry, many carriers post filing information and sample claims forms on their websites.

Topic 4: Supply Chain Relationship Management Customer and supplier relationship management are two sides of the same relationship, and so some common processes are discussed here. Several case studies are explored to illustrate these similarities. Tips for increasing collaboration and building collaborative relationships are also provided.

Customer and Supplier Relationship Management Customer relationship management (CRM) and supplier relationship management (SRM) are basically two sides of the coin—managing relationships with the buy side and the sell side. Therefore,

organizations often consider them together to determine the extent to which each is necessary. The key is to integrate CRM seamlessly with SRM and other processes such as logistics so that, for example, warehouses know and value their distribution customers and transportation suppliers, and so on. The goal is to have all parties consider not only their own intermediate customers’ needs but also the needs of their suppliers, their suppliers’ suppliers, their partners’ customers, and the ultimate customer. CRM and SRM are both important supply chain collaboration tools. Collaboration in CRM and SRM can involve Organizing one or more sets of suppliers in separate supply chains to suit the needs of specific customer segments Enabling some customers to collaborate with suppliers (or vice versa) to add value to the experience for all parties. CRM and SRM collaboration can also include getting customers or suppliers to participate in product development. When working with customers, this can involve focus groups for large customer segments and partnerships with larger clients or customers. For suppliers, this can involve including supplier representatives in product design.

Processes for Managing Relationships with Supply Chain Partners

Managing relationships begins as soon as the organization has customers and suppliers. Customer and supplier relationship management are important tools for maintaining any level of relationship, but they are very powerful tools to get a relationship to the next level and keep it on that path. These tools are vital for enacting supply chain strategy over the long term. The key processes that supply chain managers need to be able to perform related to managing the relationship with supply chain partners are Managing relationships with customers Managing relationships with suppliers. The following is a general overview of these processes. Managing Relationships with Customers The process of managing relationships with customers involves the following steps: Using change management to develop a culture, organizational structure, and philosophy of putting the customer first and deepening customer relationships whenever possible Acquiring customer relationship management software to capture data on every interaction with the customer regardless of point of contact

Grouping customers into meaningful segments to target communications and prioritize level of service toward the most profitable customers Understanding each segment’s needs and wants by Capturing data on customer interactions and preferences Analyzing data to design product/service packages for each customer segment Producing segment-tailored product/service packages Learning how wants and needs differ during the product life cycle Gathering feedback for a continuous improvement cycle Listening to and talking with customers to develop lifetime relationships Sharing information on customer constraints, priorities, and wants and needs with extended supply chain partners Eliminating non-value-added products, features, or services Tailoring messages to improve prospect conversion, vulnerable customer retention, customer win-back, and customer loyalty Capturing customer service measurements to measure overall program success Using metrics in a feedback loop to improve the CRM program Managing Relationships with Suppliers

The process of managing relationships with suppliers involves the following steps: Using change management to internally align the organization to promote information sharing, collaboration, and mutual profitability Acquiring SRM software to automate interactions, monitoring, measurement, and analysis with any level of supplier and information sharing with key suppliers Calculating total cost of ownership for key supplier materials Selecting the right partners for the given strategy Developing goals with suppliers for achieving a desired relationship type Negotiating mutually profitable contracts and ground rules Appointing managers for key supplier relationships or alliances Developing long-term relationships with key material suppliers Working with strategic allies to add value to products, reduce operational costs, enable strategic or market growth, and hone each party’s expertise Realigning processes, information flows, and workflows to eliminate your or your suppliers’ redundancies or non-value-added work Measuring or auditing supplier performance and compliance with voluntary requirements or certifications Conducting periodic course corrections based on performance Reevaluating selected suppliers periodically for strategic fit

Customer-Supplier Collaboration Case Studies You can appreciate the benefits of implementing customer relationship management (CRM) and supplier relationship management (SRM) in your own business through the following case studies of fictitious businesses. A collaboration between a furnace manufacturer and a company that makes furnace controls illustrates the importance of CRM and SRM to the relationship. Three case studies represent different types of business structures —a modern clothing retailer, a recreational boat manufacturer, and a financial services company. We’ll focus on how these case-study companies can use CRM and SRM strategies to fulfill a variety of business goals. A large multinational company uses organizational learning to meet the challenges of integrating SRM and CRM. This case study summarizes research by Uusitalo and Uuskoski.

Furnace Manufacturer and Furnace Control System Manufacturer A company that makes control systems for residential furnaces is given a design by a furnace manufacturer. The control system supplier must assemble parts from component manufacturers and

customize controls for different furnace models. While the furnace manufacturer is its customer, the control system firm’s primary concern is managing its relationship with its suppliers and ensuring that the parts are well integrated into the design, that the failure rate is low, and that there will be no delays and little need for extensive safety stock. So, SRM is a major issue for the control system firm. The furnaces are sold through distributors to furnace installers. For these installers, CRM is the major issue. They must understand how to present their products to homeowners, arrange installation and pickup of old furnaces, track when the customer will need regular maintenance, and ensure customer satisfaction with their purchases. They may rely heavily on the distributor and the manufacturer for support, but if they can’t manage the customer relationship, their reputation will suffer and the sales will fall. The furnace manufacturer is concerned with both CRM and SRM. It needs to stay current with what homeowners are looking for in new furnaces, so it conducts focus groups with consumers and works with engineers to ensure that current models reflect attention to current demands such as for sustainability. It also needs to supply technical and support information to customers after the sale and support regular maintenance or warranty work. For each furnace, the manufacturer works with 30 suppliers, who provide everything from

paint and plastic to control systems. The furnace manufacturer must manage relationships with its suppliers just as the control system firm does with its own suppliers.

Modern Clothing Retailer With each fashion cycle, a clothing retailer learns more and more about the preferences of its customers. It can tell its designers and manufacturers precisely what styles sell best in what areas, what colors are losing favor, and what sizes are selling best. In this way, it limits its losses from unsold inventory. The clothing company is also working to develop relationships with its end customers using CRM. To do this, it has set up kiosks in its retail stores for entry of email addresses, social media contact names, and other useful information. It offers an in-store discount for anyone volunteering this information. It uses email and social media to send willing customers information on promotions and suggestions for items the user might be interested in based on past purchases. It uses the social media connections to manage customer complaints, provides products for free to social media influencers, and also gives the customers an opportunity to provide ideas for new products.

As its online business has grown, the company has been able to consolidate its unsold inventory into a “bargain center”–branded website and alert its customers to newly received discounted merchandise. This has saved the retailer considerable costs in transporting unsold goods between its retail outlets. It uses SRM to let its suppliers know which styles have required liquidation so they can refine their demand data.

Leisure Boat Manufacturer In the product development phase, a boat manufacturer uses CRM and the voice of the customer (VOC) to learn more about what excites customers and what they aren’t satisfied with in the current marketplace. The manufacturer discovers that customers are particularly concerned about delays in delivery and in purchasing a watercraft that is distinctive and that has their personal mark in some way. The customers feel they are paying a premium price and want to be treated appropriately. The manufacturer begins by developing a system in which customers can “visit” their boats online as they are being assembled. This requires working with the engine suppliers closely to get them to set up cameras in the assembly area and perform some data entry regarding production stages. Not only can customers see precisely where their boats are in the production schedule from day to day, but

they can see the boats themselves as they are being assembled. The boats are designed to allow a considerable degree of customization, but the key ingredient here is that the manufacturer keeps track of what customizations are being ordered in each geographical area and provides this to suppliers using its SRM system. It also uses these data in its CRM system to advise customers on configurations and custom elements that are truly distinctive in their area. Data on customer orders are continually being fed from the front end at the marina into the back end of component and raw materials ordering and production scheduling. The production managers can more accurately order raw materials and parts and avoid the expenses of carrying an inventory of high-priced components. Suppliers are provided these data through SRM so they can minimize lead times and their own inventory. As boats enter service, calls to the customer care teams are carefully logged and tagged by specific concerns. When a pattern of concerns indicates a problem with a particular component, the manufacturer can quickly work with the supplier to correct the problem. When the problem is due to a design feature, the design team can begin immediately to build that customer response into the

design process for the next model. The CRM system helps capture and consolidate this data.

Financial Services Company When a broker in a financial services company enrolls a new customer, he or she completes a profile that indicates customer goals and key service interests. As the company develops new products and services, it integrates customized direct mailings with this information in the CRM customer database. The customer believes the contact is from the broker, which solves a problem related to broker dissatisfaction with the parent organization when it used to omit the broker from the loop. As the customer responds to offers, the customer’s actions are stored and used to analyze how well customer needs are being met by current products and how well promotional programs are performing. The company is able to create customer segments based on probable customer needs. This allows for promotional messages to be tailored to the segments’ values.

Multinational Corporation Using Organizational Learning A large multinational corporation (MNC) is a manufacturer, installer, and maintainer of escalators and elevators. It uses harmonized,

segmented SRM and CRM at both the global and local levels, with global spend category management and global customer focus. The company employs organizational learning to integrate these initiatives. Organizational learning can be defined as the ability of an organization to create, gather, and transfer knowledge and to modify behavior to assimilate the new knowledge into the organization’s practices. The organization Challenges people’s paradigms. A paradigm is how people see their environment and what they do not see. Examining paradigms helps people make sense of what SRM/CRM should look like and helps them envision the learning possibilities. Creates formal knowledge creation steps. Knowledge creation involves devising new options for learning and growth. Empowers people to make decisions. Decision making in this context is the application of created knowledge to find SRM and CRM improvements. Organizational learning needs practical application for the benefits to be seen and knowledge to become part of regular operations. The MNC’s approach is broad, but this case study focuses on just a few exemplary elements.

For paradigm setting, globally one idea is to benchmark how to support the needs of suppliers/customers. At the account level, they work to understand the pricing logic of suppliers/customers; at the local level, they look beyond price at what other factors motivate suppliers/customers. The company organizes presentations, workshops, and coffee-break discussions to get people to consider these new ways of thinking about customer or supplier motivations. For knowledge creation, the company decides to interrupt workers’ hectic routines. Globally, it has SRM and CRM decision makers challenge each other in relation to how they cope with similar situations between both disciplines; at the local level, it uses examples of real cases. It provides periods of reflection between meetings for idea generation. The focus of discussion is on transferring SRM success stories to CRM or vice versa and on finding the common ground between the two. Both focus on understanding the other party so that a deal can be created that appeals to those interests while also satisfying each one’s own interests. For example, one customer’s chief goal may be to minimize the delays that riders experience during peak elevator riding times. An offer on an innovative new system may be well received.

For decision making, the company requires decision-maker involvement to facilitate later incorporation of the best ideas. It creates some cross-functional roles and responsibilities between SRM and CRM, including an SRM/CRM management board. These roles have some decision-making authority for improving SRM/CRM. Change management is used to spread awareness, provide incentives, and show executive support. A debate between SRM and CRM decision makers focuses on similarities to help with global and decision-maker acceptance; specific case review helps with local acceptance. The results include a better understanding of when price increases are justified. Other insights include learning about specific negotiation situations based on the behavior of the other party. The company also devises joint training programs and job rotation between purchasing and sales and organizes a contact network between these two functions to improve ongoing organizational learning. Learning about the perspective of the other person in the transaction (i.e., the seller’s perspective for the purchaser and the buyer’s perspective for the salesperson) helps each become better at their jobs because they seek first to understand before attempting to be understood.

Developing Collaboration with Supply Chain Partners

Information technology has enabled collaborations among participants in supply chains, undreamed of in the past, that have become essential strategies for the present and future success of the organizations involved. These partnerships are being forged both with local and global suppliers, creating virtual organizations that extend beyond the physical boundaries of a company. Exhibit 6-17 summarizes the benefits to the supply chain of collaborative relationships.

Exhibit 6-17: Features and Benefits of Collaboration

The APICS Dictionary, 16th edition, defines virtual organizations as short-term alliances between independent organizations in a potentially long-term relationship to design, produce, and

distribute a product. Organizations cooperate based on mutual values and act as a single entity to third parties. Virtual organizations use point-of-sale data to replace make-to-stock (i.e., make-to-forecast, or push) with assemble- or make-to-order (pull) or go even further and provide these data to suppliers, who consult with the organization on product design and perform significant manufacturing tasks. Virtual organizations build trust between partners by sharing information. The more information each partner offers, the more robust the relationship becomes. And the faster the flow of information, the more efficient and agile the virtual organization becomes. For some chains, speed and accuracy become the competitive differentiators that allow the virtual organization to win customers. When sellers have access to greater detail about purchasing history and buyer preferences, they are able to enhance service levels. For example, a pharmaceutical wholesaler has designed a virtual organization by providing multiple independent pharmacies with an online system for ordering, accounting, and inventory control. The wholesaler gets a large set of captive accounts, information on actual customers, and a portion of the improved returns in exchange for its information technology investment. The independent

pharmacies improve customer satisfaction, and all partners reduce inventories. The speed at which virtual organizations can adapt to new business situations is the key to their success. Many virtual organizations have this speed because they are a constantly adapting network of informal relationships enabled by communications that are flexible and easy to set up. Some members of the network remain at a commodity level, while those who share better information or provide greater value for the whole gradually become partners. Virtual organizations may need to weaken their formal hierarchical organizational structures and instead empower individuals and even teams who represent a particular core competency. These individuals and teams informally work with others outside the organization as if they were employees. This enables them to make decisions and help develop strategies. By empowering individuals to act outside formal organizational structures, virtual organizations get benefits of both centralization and decentralization. A virtual organization has its risks. If the organization fails to design in informal controls, incentives, and training, individual decisions could cause the organization to revert to locally optimal but overall suboptimal decisions. Another risk is a backlash from organizational hierarchies, potentially leading to a return to functional silos.

However, technology that did not exist when traditional organizational hierarchies were formed can help these new disaggregated, informal control structures to survive and even thrive. What do these strategic partnerships look like in action? Suppliers, manufacturers, and customers all come together on design teams to create products that will not only satisfy customer demand but will be efficient to produce, assemble, transport, and store. Planners gather from all functional areas and from multiple supply chain partners to discuss anticipated demand, demand planning, forecasting methods, forecasts, and inventory goals. The operations teams collectively plan and manage manufacturing priorities, capacity, and inventory. The logistics teams determine the most effective and appropriate warehousing and transportation to optimize customer satisfaction and profits.

Requirements for Success But how does a business select its strategic partners? Jordan Lewis, author of Partnerships for Profit, has developed a comprehensive framework of criteria for evaluating potential partners for strategic alliances. Several factors need to be carefully researched and considered when forming a supply chain strategy.

Adding value. Can a company add value to your company’s existing products? Does the potential partner create products that are complementary to those of your organization? For example, Liberty Mutual sells auto insurance but a third-party auto glass company processes all glass-only claims. Liberty Mutual reduces its administrative costs, and the auto glass company gets significant new business (even after stating that the customer is free to choose a different auto glass company). Other examples of value-added benefits include shortening time to market, speeding up distribution times, or enhancing the product repair process; these all contribute to a higher perceived value of the company. Improving market access. Does the partner company have better, more effective advertising or provide access to new markets? Again here a company that has products that complement your organization’s offerings might make a good partner. A package deal with products from both companies could be a promotion. Strengthening operations. Will an alliance with this company improve your operations by lowering costs and cycle times? Companies with complementary seasonal products, for instance, can effectively share warehouses and trucks throughout the entire year.

Adding technological strength. Does the company use the same technology or is it willing to share new technology with your company? Does the potential partner have internal expertise to ease the transition between technologies? Is your organization prepared to handle those challenges? Enhancing strategic growth. Are there significant barriers to working with this company? Will its strategy align with your organization’s? Is the company heading in the same general direction? Pooling expertise and resources can provide new opportunities for growth. Sharing insights and learning. Is the company willing to share its insights and key learning with your company? Alliances yield a wealth of information that can be used by both organizations. This also encourages partners to learn more about themselves and increase their desire to be more flexible in the partnership. Increasing financial strength. Is the potential partner willing to share administrative costs for shared activities? Is the company willing to share in the risk? Sometimes administrative costs can be reduced due to the expertise of one or both partners, and strategic alliances can limit investment exposure if the other company will agree to share in the risk.

Every potential partner organization has its strengths or core competencies. These should not be diminished by the alliance with your organization; this can happen if the company’s resources are diverted from its strengths. It can also occur if the company’s strategic or technological strengths are compromised in the process of making the partnership successful. Trust and communication are also important components to a successful win/win relationship. Creating relationships that produce meaningful results requires commitment by both parties. Effective partnerships are a combination of shared risks, resources, rewards, vision, and values. Without these elements, strategic alliances often are unbalanced and unaligned. The more unbalanced a partnership is, the more likely that key objectives will not be met.

Building Collaborative Relationships Once the organization has analyzed potential partners according to its selection criteria and has chosen those that objectively match its needs, how does it go about building a collaborative relationship? How will it generate a supply chain strategy that can develop and grow trust, manage risks, overcome barriers, communicate, and collaborate effectively? Building these partnerships depends upon the following:

Auditable information exchange and technology for connectivity Deterrence-based arrangements such as formal contracts that make adherence to proper behavior a matter of self-interest Incentive-based arrangements such as aligning sales and management goals to collaborative objectives Process-based arrangements such as long-term trust building based on regular communications and feedback that spiral out into greater trust over time Assignment of leaders with the appropriate level of authority to enforce the relationship Focus on the entire supply chain Networkwide visibility and measurement of the bullwhip effect to assess the impact of collective management of inventory Sharing of knowledge, not just data Clear sharing of both the benefits and the burdens of the relationship Varied types of commitment, depending upon factors such as length of relationship, feedback, and amount of added value by each potential partner In order to build the foundation of the collaborative partnership, the partners must Initiate management tasks Overcome barriers to collaboration

Build levels of communication. Note that in addition to these steps, it is important to realize that different partnerships require different levels of collaborative intensity. While this is addressed elsewhere, it is based on the strategic importance versus the supply chain difficulty to obtain the supplied product or service (how much you need them) plus an assessment of how much the partner needs you (strategic fit). This results in a procurement product category strategy that guides the appropriate level of collaboration.

Initiate Management Tasks. Once the collaboration is official, it’s critical that top management demonstrate their commitment to the partnership. Since actions speak louder than words, management should publicly model relationship-building efforts. The managers of both organizations need to work together from the start: sharing information with external parties and with internal staff, modifying incentives to match collaborative goals, enforcing agreements by departments and staff, stabilizing pricing and ordering, and improving operations. They must develop good working relationships and strive for personal communication to develop mutual trust. They need to develop supportive relationships that foster team spirit between the partner companies.

Management can start by jointly discussing and designating relationship goals and planning next steps. This process begins with determining the specific contribution of each party and the criteria for measuring that contribution. Obviously, total profits should be one of the criteria, but there should be nonfinancial measures too. The criteria should be flexible enough to allow each party to use innovation to meet its goals. In the early stages, relationships should emphasize equity in profits among all parties. Equity will help motivate all parties to work toward the good of the whole. To facilitate collaboration, division managers are often asked to make major changes in how they operate. These division managers throughout the network must be given incentives to place the interests of the whole above their local interests. In addition to altering individual incentives, top management at each organization needs to go over the benefits of collaboration, consistently encourage division managers to make the required changes, and spell out the negative impact of any division managers not being on board with the required changes. Another task is to define roles for each party, taking care to avoid redundant efforts. Conflicts can occur if these roles make one party more dependent on another than they wish to be. To alleviate this common problem, networks should avoid sequential

interdependence. This is when the second party cannot begin work until the first party is done. Instead, they should establish reciprocal or mutual interdependence, in which the exchange of tasks and services occurs in both directions. An example of this is CPFR (collaborative planning, forecasting, and replenishment). Although mutual interdependence is more complex to manage, it can also yield much greater rewards. Since no contract can cover all contingencies, yet another task is to create a policy for resolving conflicts. If a conflict is serious enough to require amending the contract, negotiations should include all affected parties. Many organizations prefer to resolve differences through informal negotiation rather than by revisiting the contract. All parties to the contract should agree upon a plan to govern such negotiations to ensure that they aren’t too informal. The plan should call for regular meetings among key managers and cross-enterprise teams, and it should include guidelines for referring problems to the highest level necessary to resolve the conflict. Either the contract should specify how finance and information technology establish rules for transactions, or a policy and procedures guide should do so. Contracts, policies, procedures, and informal conflict resolution must be sensitive to cultural differences. In the United States, courts can resolve conflicts without detriment to long-term relationships

among parties to a contract. The opposite is true in most Asian countries. Finally, managers must stay involved. Without management commitment, each party tends to revert to its own self-interests. Weaker parties in the relationship may bear the brunt of problems; without an effort to maintain equity, the relationships may fall apart. The partnership’s benefits and areas needing improvement will be easier to identify and improvements can be made in a timely manner if the relationship is monitored and cared for. Top management must follow through on its responsibility for adhering to the collaborative arrangements.

Overcome Barriers to Collaboration Building successful collaborations requires overcoming predictable obstacles, including the following challenges. Suboptimization. Suboptimization refers to a solution to a problem that is best from a narrow point of view but not from a higher or overall company point of view. When supply chains are not truly connected at the planning level, each partner in the supply chain will work to maximize its own profits or to increase other measures at the expense of the other supply chain partners. When this occurs despite the recommendations of a holistic

optimization tool, it is a double loss because the investment in global planning is being wasted. For example, when a product is available in limited amounts, retail orders must be monitored across the supply chain. If each store is allowed to determine its own order quantity, the result might be overstocking of locations that order early and stockouts elsewhere. Transportation cost is another area commonly suboptimized. Individual incentives that conflict with organizational goals. Incentives such as sales force bonuses that are structured without consideration for supply chain strategy can often be counterproductive. For example, sales quotas for distributors or manufacturers are often based on monthly or quarterly targets for sales to retailers instead of on those retailers’ actual sales. While the distributor doesn’t actually control retail sales, this practice can lead to channel stuffing (intentionally selling too much inventory) and is aggravated by promotions intended to increase sales at the end of a period. These practices create a great deal of excess inventory as well as variability in demand that the manufacturer must deal with. Instead, sales goals must be aligned with actual demand. Many companies have stopped giving sales incentives and instead have turned to other metrics that more effectively align sales with company objectives.

Working with competitors. Supply chain management books tout the success of collaborations among competitors, but many of these ventures fail. This is partly due to lack of trust and cultural rigidity, but it also reflects the reality that one company is trying to win market share at the expense of the other. Such relationships should be kept at arm’s length to ensure fairness, and extra caution must be devoted to sharing information. Companies may pretend to embrace collaboration when they just want access to information for their own benefit. Bottlenecks caused by weak or slow partners. The slowest or least integrated partner in a network will often limit the technological collaboration level of a company as well as the level of trust that can be built. If the company is not willing to invest in a technical and social change process, the only alternative may be to find a more willing or able partner who can keep up with the network’s collaboration curve. Technology barriers. When potential partners have incompatible systems, it increases the difficulty of sharing data, especially when one or more companies use very old legacy or ERP systems that do not adapt well to the newer integration solutions. Incompatible and/or antiquated hardware infrastructures can also prove a barrier to collaboration.

Regulations and legal issues. There may be regulatory restrictions on sharing information, trade secrets, or products with partners in some countries. In another example, an organization may have legal rights to use certain assets or services that cannot be easily allocated to others. There may also be requirements to use arbitration in a conflict, and informal methods may be hard to enact. Power-based relationships. Rather than building relationships based upon trust and mutual benefit, the nucleus company may use its leverage to dictate the terms of relationships to the other members. While the profits of the nucleus company increase, other members of the network may suffer losses. When this occurs, the disadvantaged partners may rebel. Resistance may result in redundancy, loss of overall profitability for the supply chain, or an actual reversal of the power relationship with potential for vindictive behavior. Underestimated benefits. When collaboration is viewed as another type of process reengineering, the partners generally measure the results in reduced cost and cycle time rather than return on investment, which is a better long-term indicator. Simply measuring efficiency increases will fail to account for some of the true long-term benefits of collaboration. This may lead managers

to reject a collaborative venture based on a failure to see gains like removal of duplicated efforts, enhanced innovation, and better use of total system assets and processes. Culture conflicts. Cultures tend to be egocentric and thus tend to resist external collaboration. They feel that their ways are the best ways of doing things and will often reject a different way without even considering it. Culture conflicts are increased when each company relies on its own sources of information and is unable to see the impact of its choices on other areas of the network. When companies don’t see the negative results of their actions, they can’t learn from their mistakes. Another potential culture conflict can arise when managers delay or prevent collaboration. Such managers generally have safeguarded their positions by not sharing information so that they must be sought for their expertise. Others feel that collaboration is a fad or a bad idea altogether. Still others talk about collaboration but are only interested in receiving the benefits from a partner without reciprocating.

Build Levels of Communication. Communication between partners can take place on different levels; not all collaborations depend upon the same degree or intensity of

communication. We’ll consider four levels of communication. Transactional with information sharing. At this level of communication, each partner has access to a single source of data about matters such as workflow, forecasts, and transactions. Contracts are generally medium-term. Shared processes and partnership. At this level, partners collaborate in specific processes such as design. They share knowledge across the network. Contracts are longer-term. Linked competitive vision and strategic alliance. At this level, supply chain partners function as a virtual entity, working out even the highest level of strategy together. The partners develop considerable trust and achieve social and cultural understanding as well as information sharing. Strategic alliances may last for decades. Mergers and acquisitions (backward and forward integration). Outsourcing current functions isn’t the only way to forge links in a supply chain. Mergers or acquisitions may involve two companies in the same tier rather than horizontal supplier-customer partners. Although mergers would seem to provide the deepest level of trust and communication, the sudden clash of the business, regional,

and national cultures involved often requires years of work to align attitudes, technology, and business practices.

Collaboration with Customers Collaboration may take the form of a closer business relationship or an alliance between a supplier and one of its intermediate customers such as informal or formal inclusion in the product design process. In terms of end-customer collaboration, customers could provide their time and opinions to improve the organization’s offerings, such as in the voice of the customer technique. Collaboration with intermediate or end customers can take place when both parties find strategic value in the relationship and when there is enough trust and loyalty to encourage this higher level of commitment. Therefore, collaboration is a natural continuation of relationship building for some types of loyal customers. As Exhibit 6-18 suggests, if customer satisfaction and loyalty can be increased, the nature of that relationship will evolve past mere attention to price, to a growing recognition of the product’s or service’s value, and then to a dependency on the product or service that signals the creation of a win/win relationship between customer and business.

Exhibit 6-18: Evolving Relationship with Lifetime Customers

It is the potential value of lifetime customers that has driven the shift toward customer-centric organizations. Increased customer retention is the primary benefit of customer collaboration efforts, which, in turn, should lead to increased profits for the organization and the supply chain. The relationships can be improved from the perspectives of both the customer and the company. Customers get an improved experience—one tailored to their needs. Businesses get increased customer visibility (awareness of actions involving the customer). This increases the supplier’s ability to satisfy the customer, focus marketing to win new customers, create lifetime customers, and realize the profit potential of each customer.

Organizations also gain greater control over customer relationships and are better able to measure profitability and their own performance. Some customer-supplier relationships will become more transparent so that each party knows the motivations and requirements of the other, which can draw the partners into closer collaboration. Organizations can also turn dispute resolution into an opportunity to improve customer loyalty through innovative problem solving. The importance of developing relationships with customers has also led to two basic shifts in today’s business culture: Greater focus on the customer. This focus is on both internal customers (the recipients of another person’s or department’s output) and external customers. A shift to a customer-centric corporate culture is an opportunity for growth, but it requires extensive organizational change management. Greater integration. This integration occurs both internally (e.g., process reengineering to increase communication and collaboration among all departments) and externally (greater sharing of information and processes between parallel departments of supply chain partners). The movement is away from hierarchical organizational thinking to the involvement of multiple teams and their mutual involvement in the process.

How are these customer-centric businesses created? Exhibit 6-19 illustrates a five-step process that begins with redefining and redirecting the organization and ends with measuring the success of this corporate initiative. Note that part of this process involves implementing a customer relationship management (CRM) strategy.

Exhibit 6-19: Creating and Maintaining a Customer-Centric Business

Align mission statement, goals, organizational structure, and jobs to support a customer focus. Moving the organization from a product-focused to customer-centric orientation requires changes in the way companies manage everything from product design to customer service. This means that every customer contact point (e.g., where the customer learns about the product, where they purchase it, whom they contact with questions or when there are problems) must be analyzed to identify key players within the organization who can affect customer satisfaction and to determine what they can do to enhance the customer’s experience. This requires a high level of collaboration across

sections of the organization and a clear articulation throughout the organization, to every member, of this new priority. To achieve greater customer focus, some organizations have instituted the position of chief customer officer. This person is responsible for identifying customer touchpoints, defining and enforcing service standards, researching methods to enrich the customer experience, and helping customers navigate within the organization. From a high-level perspective, this position is responsible for integrating and leveraging customer information across the organization. Identify the customer’s perspective and needs. One of the goals and benefits of developing a distinct CRM strategy is increased customer visibility. Information about the customer’s desires, buying habits, and experiences are captured at every point of contact and can be analyzed to support decisions. To begin, an organization might compare the perspective of its customers with high lifetime value against those with low value. The gap in fulfilled expectations can suggest changes in products, services, or communication that can ultimately create customer loyalty by meeting and exceeding customer needs and wants. For example, a credit card company may discover that high-value cardholders use their cards heavily because of their frequent flier

partnerships but that many low-value cardholders are located in cities not served by those air carriers. The credit card company may consider creating other air carrier partnerships or other types of partnerships that would move the low-value group toward higher value. In this way, the organization can identify and leverage these competitive advantage factors. Create a map of customer segments. Customer-centric businesses recognize that they have more than one type of customer. They use quantitative and qualitative research to segment their customers and develop solutions to each segment’s distinctive needs. Businesses may prioritize their CRM efforts according to the value of these different segments. Different characteristics of the segments may also shape CRM programs. For example, a technologically proficient customer group may prefer that all contact points be electronic. A highly affluent, demanding segment may require human contact that is always available. Implement the most appropriate CRM strategy. Factors that influence the strategic shape of a CRM program include product position(s) in the product life cycle, value of the customer’s potential business, targeted customer needs, or preferred channels of communication or product/service acquisition. As

Exhibit 6-20 illustrates, a CRM strategy is cyclical. The process begins with targeting the desired customer and winning that customer’s business. For the relationship to continue, the promised product/service package terms must be fulfilled. Continued customer care promotes satisfaction. The company can then capitalize on its customer’s satisfaction by setting new goals for this customer. This may mean increasing the volume of the customer’s purchases, increasing the value of the purchases (upselling), or cross-selling additional products or services. Exhibit 6-20: CRM Cycle of Business

Monitor, measure, and report. This step in the process is iterative and is based on the organization’s selected customer key performance indicators. In the CRM model, the business is constantly learning more about its customers and the way they prefer to do business, and this information constantly reshapes CRM. The research provides data about buying patterns,

customer attitudes, and levels of customer satisfaction, and the information should be shared across all points of contact within the organization. It is also important for organizations to research continuously and document which CRM processes are working and which are not.

Communication Considerations Generally defined, communication is the two-way process of creating and sending messages and receiving feedback with the goal of influencing the opinions, actions, and decisions of the intended audience. Management of communications is a cornerstone of effective leadership and management. Managing communications involves collecting data and information from the various parts of the supply chain or supply chain project team members, creating discussion guidelines and formal reports, selecting communications media, and distributing the information to the right people at the right times. Stakeholders have different needs, preferences, styles, levels of expertise, and cultural backgrounds, so supply chain managers should adapt their communication styles appropriately. Customizing your communications shows respect and sensitivity, makes the message more effective, and encourages greater stakeholder

engagement and positivity. Well-planned and well-delivered communications therefore require gathering and using stakeholders’ communication requirements. The ability to communicate quickly, succinctly, and accurately can be helped or hindered by the abundance and diversity of available data or information. It is easy to overload your audience with too much information. The capability to develop is to know what information needs to be communicated for the given purpose and audience. Ask yourself: What does your audience need? How does the subject of your communication fulfill the audience’s need? How can you make the benefits of the presentation clear to the audience? We will examine how communication occurs as well as the importance of context in influencing the success of a communications management plan.

Communication Process and Dimensions A basic communication process occurs for all types of communications. This could be one-on-one talks, a presentation to multiple people, or technology-enabled communications. The intent

is always the accurate transfer of information between individuals or groups. Exhibit 6-21 shows the elements in the communication process.

Exhibit 6-21: Basic Communication Process

The following are the key elements in the communication process. Sender—The sender is the one with ideas, requests, or information to convey. Message—This is the subject matter that goes through an “encoding process” to translate the sender’s information into written, verbal, and/or nonverbal gestures. Medium—The medium is the pathway for the message. It could be oral (conversation, presentation), written (memo, newsletter), nonverbal (a stern look, sign language), and/or electronic (email,

video chat, social media). Some media are better for formal (i.e., expected level of decorum) and/or official (i.e., on the record) communications, and some are better for informal/nonofficial communications (e.g., text messages). Similarly, working horizontally with peers may require different media than when working vertically up or down in the organization. External parties like suppliers, customers, or regulators also fit into a formal or de facto horizontal/vertical communication hierarchy that will influence choice of media. In-person media tend to have both verbal and nonverbal information and so can convey a richer message than media that omit nonverbal information. Videoconferencing can somewhat compensate for this deficiency. Exhibit 6-22 illustrates these various dimensions of communication. Exhibit 6-22: Communication Dimensions

Source: Holmes Corporation. Used with permission.

Receiver—The receiver is the intended audience, who “decodes” or interprets the message in light of previous experiences or frames of reference. Filters—A filter is any factor influencing how the communication is received or interpreted. Filters include emotional states (mood), individual perceptions, experience, and culture. Because of filters, a message may not be received at all. “Noise”—Noise is anything that distorts a message. Noise includes background sounds, another person trying to interrupt, or distractions that prevent the receiver from paying attention or understanding the communication. It can also be electronic distortions that corrupt a phone line, file, or program. Acknowledgment—The receiver acknowledges receipt of the message in a medium, but this does not necessarily imply comprehension or agreement. Feedback—Feedback is the verbal or nonverbal reply or reaction to the message. It expresses the receiver’s understanding of the message. Feedback lets the sender assess whether or not the message has been received as intended.

Feedback is the key to this model. While filters and noise can get in the way of communication being successful, insisting on getting acknowledgment and especially feedback as appropriate is the communicator’s method of making messages fail-safe. Attention to the recipient’s feedback will signal if there is comprehension. If needed, the sender can revise the message and repeat the communication process.

Communication Management Plans The APICS Dictionary, 16th edition, defines a communication management plan as “a document that describes the communications needs and expectations within a project, including format, dates, locations, and responsibilities.” These plans are especially important in supply chain projects since stakeholders may come from diverse areas or organizations and using a plan can help encourage them to engage. In smaller projects, this plan could be brief, especially if few stakeholders are involved. The following describes the steps in creating a communication management plan. Identify Target Audience(s). Planning communications starts with determining the target audience. Due diligence regarding the who, what, when, why, where,

and how of communications can help avoid delayed communications, misinterpreted messages, or incorrect audiences. Efficient and effective communication will provide no more and no less information than the receiver needs to avoid the key points being buried in irrelevant data. Managing stakeholder relationships is crucial to a communications plan. The Dictionary defines stakeholder relationship management as addressing and managing the competing priorities, needs and concerns of internal and external stakeholders in a proactive and sustained manner resulting in decreased cost and enhanced stakeholder acceptance or buy-in. A kickoff meeting is a good time to gather communication preferences from stakeholders, including Preferred communication types, media, formality, and formats Information needs. Analyzing RACI (responsible, accountable, consult, and inform) and organizational charts can also provide information on how to structure your communications. RACI charts spell out who needs to do each task (responsible), which one person will answer to its success or failure (accountable), who needs to be given a chance to

review the information (consult), and who simply needs to be told about what’s going on (inform). Organization culture and policy can also influence communication strategies. There may be guidance on how to communicate with internal staff and for contractor, public, and media interactions. Good questions to ask regarding the level of information to present include Is the subject matter relevant for the person in this role? Is the level of technical detail appropriate? Is the level of complexity sufficient to succeed in the assigned activities? Is any confidential information being disclosed, and, if so, is it necessary and are appropriate precautions/approvals being taken? It is important not to underestimate informal communications, as these often motivate people and keep them informed. Identify Communication Channel(s). Communications channels refer to the number of potential two-way interactions that can occur between stakeholders. These are important because they indicate the relative complexity of communications. The greater the number of stakeholders, the higher

the number of possible lines of communication, and the more careful the manager and team must be to ensure thorough communication of issues. As complexity increases, so do the risks of communication failures. However, when the number of authorized representatives is reduced, complexity can also be reduced. (Each representative communicates with a subteam.) Create Message(s). A clear purpose is important. It addresses why you are communicating and what you want to accomplish. Are you hoping to influence attitudes or achieve consensus? Do you want the audience to make a decision or take action? Crafting an understandable message involves tailoring the message to the audience. With a clear picture of the intended audience, ask yourself questions such as Does the audience need background information and, if so, how much? What aspects of the topic matter to them? What information would be distracting, confusing (e.g., jargon), or irrelevant? Are there specific benefits for audience members? Why should the topic be of interest to the audience?

If the intention is to persuade, how difficult will that be for the given audience? How much does the audience already know about the topic? Different audiences may require different information, so vary your messages accordingly. For example, for a new supply chain process, financial information is useful to the board and senior management. Staff members need to know their own role and the roles of persons with whom they will need to interact. When selecting an appropriate delivery method, consider factors such as Physical constraints—size of the audience, how dispersed audience members are, time zones, and the technology and resources available Urgency—whether the message is routine, important, critical, or time-sensitive Cost—cost constraints, image and brand considerations Message distribution—the number and makeup of the receivers Security/privacy/sensitivity considerations—any legal, risk, professional, or proprietary aspects Preference—for example, a telephone call in lieu of an email or vice versa

Need for retention/retrieval—whether the information should be retained and for how long, plus the methods for storing, maintaining, and disposing of the data. An inappropriate medium choice or incorrect recipients can dilute the message’s intent, lead to indifference and confusion, or create many other problems. Good medium choices, on the other hand, can grab people’s attention and encourage conversation. Ensure Understanding/Gather Feedback. Feedback is essential in communication so you know whether the recipient has understood the message in the way you intended and whether he or she agrees with the message. Getting feedback from customers and suppliers regarding communications is essential to ensuring smooth supply chain operations. In face-to-face communication, observe nonverbal cues and respond to feedback. If not a face-to-face communication, follow up on queries and feedback received to help determine communication utility. Ask and answer questions to assess if the intended meaning equals the perceived meaning. Make clarifying points as needed; then repeat the feedback process to ensure understanding of the clarifications.

Do not neglect lessons learned through feedback. Consider what you will do differently next time, act on good feedback as feasible, and maintain an attitude of openness to feedback. Failure to do so may harm your credibility and give people a disincentive to provide constructive feedback in the future. Close the Loop. The final step in any communication plan is to ensure that communications are continually monitored for completeness, accuracy, and tone. It is also important to monitor the release and timing of messages. This may even include involving the legal department for any messages intended for consumption by the general public.

Cultural Issues To be effective in international business, organizations must understand the complexity of culture and the potential effect of cultural forces on the implementation of global strategies and local tactical supply chain practices. This applies as much to internal staff in multinational organizations as it does to customers and suppliers. Example: An American organization partners with organizations in Australia, China, Singapore, the Czech Republic, Germany, and Russia to develop and distribute

engineering components. The employees of all the organizations must be prepared for diverse communication, social, and work styles. Example: A Brazilian agricultural importer/exporter plans to open offices in Colombia and Costa Rica and establish new relationships with food packaging firms in both countries. The Brazilian businesspeople cannot assume that just because of their geographical proximity to these countries the Colombians and Costa Ricans will share the same attitudes toward business. They will have to learn each other’s expectations.

What Is Culture? In international business, it is not uncommon to hear cultural concepts such as “saving face” from Asian and Latin cultures, “ringi” from Japan, “guanxi” from China, and “speak your mind” in America. “Saving face” is finding a way to retain one’s good image or pride despite being wrong or losing in a conflict. “Ringi” refers to the Japanese decision-making process of building consensus from the ground up. “Guanxi” describes the Chinese tendency to build networks of close and informal relationships. “Speak your mind” equates to an expression of blunt honesty in American culture.

So how does culture influence these behaviors? A simple definition of culture is a shared system of values, beliefs, and attitudes. These shared patterns identify the members of a given culture and distinguish them from other culture groups. Culture affects our own actions and the way we perceive others. It shapes many aspects of human contact, including the give and take of negotiation, protocols, and other social and work conventions. Culture is learned through a process of socialization. It is not a product of an individual’s personality. Making assumptions about culture can result in inadvertently causing insult or embarrassment, such as speaking one’s mind when another culture requires much more ceremony before eventually getting to this level. (Or it may never be appropriate.)

Dimensions of Culture Studying cultural differences can help in understanding how employees in different cultures expect to be treated, which can help build teams and reduce the chances of conflict. Anthropologists, sociologists, and other learned professionals have developed various models and theories about characteristics that differ across cultures and their implications. Exhibit 6-23 is an overview of one: Geert Hofstede’s dimensions of culture. Exhibit 6-23: Hofstede’s Cultural Dimensions

Issue Power distance Extent to which less-powerful members of organizations and institutions accept unequal distribution of power.

High power distance: more separation of the average person from power and equality. Low power distance: more equality.

Examples of SCM Implications

High: Managers tell High: Malaysia, employees what should be Philippines, China, done. India, Panama, Mexico Low: Managers consult with employees about what should be done.

Individualism/collectivism

Individualist: Individuals Degree to which individuals are tend to define themselves by their job. integrated into groups.

Individualism: Ties are loose; self-reliance valued. Collectivism: Strong, cohesive groups in which protection is exchanged for loyalty to group.

Country Examples

Collectivist: Relationships are more important than one’s job; need for consensus-based decision making and involving the group in business activities to build a strong relationship.

Low: Austria, Israel, Scandinavian countries, U.K., U.S.

Individualist: U.S., France, Australia, U.K., Italy, Netherlands, Belgium Collectivist: Latin America, Japan, China, Pakistan, South Korea, Singapore

Issue Uncertainty avoidance Level of tolerance of uncertainty and ambiguity; extent to which individuals feel comfortable in unstructured, new, or unexpected situations.

Examples of SCM Implications High: Overall workplace culture cannot tolerate deviant people or diverse ideas; rules are set; may need to gather more data and apply a more structured decisionmaking process to gain idea acceptance.

Country Examples High: Greece, Portugal, Latin America, Belgium, Japan, France Low: Singapore, Denmark, Sweden, Hong Kong, U.K.

Low: Workplace culture has tolerance and selfcontrol; fewer rules, written or unwritten. Masculine/feminine Masculine traits: Ambitious, tendency to polarize, preference for speed and size, oriented toward work and achievement. Feminine traits: Nurturing, empathetic, oriented toward quality of life, striving for consensus, favoring small size and slow pace.

Masculine: Overall emphasis is on work more than family, particularly in terms of time. Feminine: Balance between work and family life, especially in time. Note: In masculine societies, gender roles are distinct; in feminine societies, roles may overlap.

Masculine: Japan, Hungary, Austria, Venezuela, Italy Feminine: Scandinavian countries, Netherlands, Chile, Thailand

Examples of SCM Implications

Issue Long-term/short-term Long-term orientation: Values thrift and perseverance; orders relationships by status and values. Short-term orientation: Values social traditions and fulfilling social obligations, being respected; expects reciprocation of greetings, favors, gifts.

Issue

Long-term: Traditions may Long-term: China, change and adjust to the Japan, South times. Korea, Brazil, India Short-term: Traditions must be honored and not changed.

Examples of SCM Implications

Language/ Miscommunication communication can impede working skills relationships and cause outsourcing Language problems. training or interpreters may be required.

Country Examples

May necessitate more reliance on e-mail and documentation so that partners can have written records to re-read and ensure understanding.

Short-term: West Africa, Philippines, Norway, U.K., U.S.

Country Examples The Chinese rely a great deal on nonverbal behavior and the context of the situation to decode the meaning of what is being communicated (as compared to Western cultures, which are much more direct and outspoken in their communication style). The English spoken in the United Kingdom may be different than English dialects spoken in other parts of the world.

Issue Attitudes

Examples of SCM Implications Requires an understanding or awareness that there are differing perspectives toward negotiation, conflict, disagreements, and other business and social exchanges.

Country Examples In India, progression in negotiations and agreements may take place only after people get to know each other at a personal level. Legalistic methods may be misconstrued. Respect, patience, and formality are among the main virtues for successful negotiations in China.

Americans express opinions freely, and they expect others to do the same; conflict situations may arise.

Issue Customs and business etiquette

Examples of SCM Implications Requires an understanding of appropriate behavior and what one can or cannot do or say in business as well as social settings.

Country Examples In Thailand, it is impolite to show the soles of your shoes; care should be taken when crossing your legs in a business meeting. In India, the person of power sits in the back seat of an automobile; in the U.S., that person would most likely ride in the front passenger seat.

In Germany, Spain, and China, first names are generally reserved for family and close friends. In Japan, when someone gives you their business card during a meeting, it’s considered an extension of themselves as a person. It would be an insult to put it in a briefcase or folder without looking at it. The proper way to accept the business card is to hold it in both hands, read it, and then place it right side up on the table in front of you until the meeting is over.

Issue Work values

Examples of SCM Implications Different approaches to completing tasks or problem solving can impede operations and the development of strong working relationships.

Country Examples In the U.S., the “get-down-to-business” mentality before forming relationships prevails, and finding the most practical solution drives most situations. In India, workers may have a group identity and expect that the head of the group will speak for them. Managers may be more likely to speak and act authoritatively than to use a more collegial Western approach.

This model was derived from Hofstede’s research during the 1970s into cultural differences at IBM subsidiaries in 64 countries. Hofstede’s dimensions have been subsequently researched in additional countries and in other occupations and industries. The Hofstede model can help to analyze a country’s culture in terms of its general population. However, it’s important to realize that not all individuals or even regions with subcultures fit any model’s characteristics all of the time. There will be exceptions to the Hofstede dimensions and other cultural models. Not all dimensions may be of the same importance in all cultures. Organizations’ mission and vision statements may also promote an internal culture that could differ in some ways from that of the local culture.

For more in-depth information about Geert Hofstede’s model, consult his book Cultures and Organizations, Software of the Mind. The Clearly Cultural website reports on cross-cultural news and research. It also features world maps showing the global distribution of Hofstede’s dimensions. Links to this information have been included in the online Resource Center.

Index A Account management [1]

B B2B (business-to-business) customers [1] BI [1] Business intelligence (BI) [1] Business systems [1] Business-to-business customers [1] Buyer-supplier relationships Strategic alliances [1] , [2]

C CDWs [1] Change management [1] Churn [1] Collaboration [1] , [5] , [9] , [13] See also: Collaborative design, Collaborative planning, Collaborative planning, forecasting, and replenishment (CPFR), Quick-response programs (QRPs), and replenishment (CPFR), forecasting

Communication [1] , [2] Communication channels [1] Communication management plans [1] Communication monitoring [1] Communication process [1] Culture [1] See also: Hofstede's cultural dimensions Customer care technologies [1] Customer data warehouses [1] Customer-driven marketing [1] Customer-focused marketing [1] Customer information [1] , [2] Customer metrics Customer service ratio [1] Customer needs segmentation [1] Customer satisfaction [1] , [2] , [3] Customer segmentation Customer needs segmentation [1] Customer value segmentation [1] , [2] Preferred channel segmentation [1] , [2] Customer segmentation technologies [1] Customer service [1] , [2] Customer service ratio [1] Customer types

B2B (business-to-business) customers [1] Lifetime customers [1] Loyal customers [1] Prospective customers [1] Retail customers [1] Service-minded customers [1] Vulnerable customers [1] Win-back customers [1] Customer value segmentation [1] , [2] Cycle times [1]

D Data warehouses [1] Delivery metrics On-time delivery [1] On-time in full (OTIF) [1]

E Environmental scanning Product life cycle analysis [1] Error control [1] External supplier interfaces [1]

F

Feedback [1] See also: Feedback loops Fill rate [1] Freight claims [1]

H Hofstede's cultural dimensions [1] See also: Culture

I Internal interfaces [1]

J Joint ventures (JVs) [1] JVs [1]

L Lead time [1] Lifetime customers [1] Logistics relationships Strategic alliances [1] , [2] Loyal customers [1]

M Marketing/sales technologies [1]

Marketing automation [1] Marketing research [1] Market research [1] Message creation [1] Metrics Customer metrics [1] Multisourcing [1]

O On-time delivery [1] On-time in full (OTIF) [1] Order fill rate [1] Orders Perfect orders [1] Order-status reporting [1] Organizational structures [1] OTIF [1]

P Perfect orders [1] Performance measurement Supplier performance measurement [1] , [2] Preferred channel segmentation [1] , [2] Product life cycle [1]

Product life cycle analysis [1] Prospective customers [1]

R Relationship building [1] , [2] Retail customers [1]

S SaaS [1] Sales force automation (SFA) [1] Sales operations [1] Segmentation Customer segmentation [1] , [2] , [3] , [4] Supplier segmentation [1] Service-minded customers [1] SFA [1] Single-source suppliers [1] Single-sourcing [1] Software as a service (Saas) [1] Sole-source suppliers [1] Sourcing Multisourcing [1] Single-sourcing [1] Strategic sourcing [1]

Stakeholder relationship management [1] Stockout frequency [1] Strategic alliances [1] , [2] Strategic partnerships [1] Strategic sourcing [1] Suboptimization [1] Supplier certification Third-party supplier certification [1] Supplier co-location [1] Supplier measurement [1] , [2] Supplier performance measurement [1] , [2] Supplier rating systems [1] Suppliers Single-source suppliers [1] Sole-source suppliers [1] Supplier segmentation [1]

T Tactical buying [1] Target audiences [1] Third-party supplier certification [1] Transportation documentation Freight claims [1]

V Virtual organizations [1] VOC [1] , [2] Voice of the customer (VOC) [1] , [2] Vulnerable customers [1]

W Web-enabled supplier relationship management (SRM) External supplier interfaces [1] Internal interfaces [1] Win-back customers [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

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Module 8: Optimization, Sustainability, and Technology The final module in this learning system is all about evaluating and optimizing the supply chain. Because it is so important to ensure that the supply chain strategy aligns with organizational strategy, this module starts with a deeper dive into various organizational strategies. From there it explores how to redesign strategy, supply chain networks, and processes to optimize them. A key area for supply chain redesign is to embed sustainability into all supply chain processes. We explore the triple bottom line (TBL) as well as United Nations guidelines and Global Reporting Initiative (GRI) standards. Other social, environmental, safety, and quality metrics are explored, and sustainability metrics are discussed. The final section of this module is about technology. We start with a review of emerging technology trends in supply chain management and then delve into how to succeed at selecting and implementing such technology. Since this often requires project management and change management, these methodologies are addressed here even though they can be applied to any type of project or change. Maintaining technology is also addressed.

Section A: Optimizing Supply Chain Strategy and Tactics This section is designed to Describe the relationship between the business strategy, the organizational strategy, and the supply chain strategy Define generic business strategies and describe how they are used Understand how a business strategy drives organizational strategy, which in turn drives functional area strategies, including those for supply chain management Explain how strategic decisions are made concerning customers and markets, technology, key processes, and sourcing Outline the key objectives and elements of supply chain strategy Identify specific ways in which supply chain management creates value for all stakeholders Address core competencies, cost structure, revenue model, and tax strategy in supply chain strategy Identify factors that can cause an organization to have misalignments or gaps in its strategy Discuss how to recognize when misalignments or gaps exist and how to resolve them

Use tools to redesign the supply chain, including network modeling and operations research. Developing a thorough understanding of organizational strategy is a prerequisite for supply chain managers in developing an aligned supply chain strategy. After addressing some generic strategies and related business models, this section addresses supply chain strategic value and how to optimize the supply chain. Part of this assessment includes financial modeling, network modeling, and operations research.

Topic 1: Business and Supply Chain Strategy Business strategy and supply chain strategy need to align with and support organizational strategy. The only way to make sure this happens is to develop a good understanding of the organization’s strategy. Learning about generic strategies can also help place a particular organization’s strategy into context. Here we start with an overview of business and supply chain strategy, and then we address the business model and strategy (generic strategies), organizational strategy (customer-driven, etc.), the business plan (value proposition and cost/revenue structure to

achieve the strategy), and supply chain strategic objectives (including increasing visibility and velocity and reducing variability).

Business and Supply Chain Strategy Road Map Before working to optimize an organization’s supply chain strategy, one must first learn about business strategy and the competitive advantage intended to be provided by a given organizational strategy. From there, the organization needs to develop or optimize a complementary supply chain strategy. This process needs to be ongoing so that misalignments or gaps are resolved on a regular basis.

Alignment of Strategies There’s a kind of magic in some words, “strategy” and “strategic” being key examples. Place “strategic” in front of the name of any business process, and it acquires an aura of great importance. Strategic objectives cry out to be achieved in a way that simple objectives do not. There’s a reason those words have such power. Strategy, originally a military term, is how generals marshal all available resources in pursuit of victory.

It’s really the same in the business world. Each company has a business strategy that paints a broad picture of how it will compete in the marketplace. According to the APICS Dictionary, 16th edition, a strategic plan describes how to marshal and determine actions to support the mission, goals, and objectives of an organization. [It] generally includes an organization’s explicit mission, goals, and objectives and the specific actions needed to achieve those goals and objectives. Since business strategy is like military strategy in that it requires the marshaling and organizing of all its resources, then it becomes clear that the business’s supply chain can be its most potent strategic resource. Designing and building the right supply chain, one that promotes the business strategies, can give the organization an edge on the competition and help it move faster, deliver more value, and be more flexible in the face of both steady change and surprises. The supply chain strategy is a complex and continually evolving plan to create value for customers and investors. Exhibit 8-1 shows how the direction of an organization is predicated on its business strategy, which includes its mission and vision statements that give clarity to the organization’s purpose.

Exhibit 8-1: Alignment of Strategies

If these strategies are not aligned, the direction and fit will be askew. All three strategies are linked and dependent. The Dictionary differentiates between business and organizational strategy (listed as “strategy” in the Dictionary) as follows: Business strategy . A plan for choosing how to compete. Three generic business strategies are (1) least cost, (2) differentiation, and (3) focus. Strategy [organizational]. For an enterprise, identifies how the company will function in its environment. Specifies how to satisfy customers, how to grow the business, how to compete in its environment, how to manage the organization and develop capabilities within the business, and how to achieve financial objectives. Supply chain strategy is then a strategy for how the supply chain will function in its environment to meet the goals of the organization’s business and organizational strategies. Competitive advantages are closely related to business strategy because they outline the advantages the organization should realize once it has decided how it will compete. A business model is the organization’s business and

organizational strategy formalized into a business plan. It specifies the details needed to achieve the strategy. Processes for developing the supply chain strategy and for designing or redesigning the supply chain follow.

Processes for Developing Supply Chain Strategy The key processes that supply chain managers need to be able to perform related to developing the supply chain strategy are Aligning with the business strategy Creating the supply chain strategy. The following is a general overview of these processes. Aligning with Business Strategy The process of aligning with the business strategy involves the following steps: Reviewing the organization’s business plan, financial statements, and other information and analyses related to business strategy to learn The organization’s overall strategic objectives, including its vision, key business policies, and cost and revenue objectives Its value proposition for customers and stakeholders, including its core competencies (and areas it chooses to avoid)

How it will differentiate itself in the marketplace to compete and grow in the face of change and uncertainty Gathering information on the external environment, including Customer requirements Competitor business and supply chain strategies Competitor supply chain maturity Market size and market share Overall, regional, local, and industry market conditions Global risks and opportunities Reviewing current supply chain capacity, resilience, sustainability, and adaptability to understand the current state of the supply chain (actualized strategy) Analyzing actual alignment to business strategy and the current environment Creating Supply Chain Strategy The process of creating a supply chain strategy that is complementary to the business model and the current environment involves the following steps: Defining customer service objectives for business-to-business and/or business-to-consumer

Selecting a revenue model, including direct and/or indirect and sales channels for each customer segment Mapping supply chain objectives to business objectives Aligning in-house versus contracted supply chain operating models and cost structure with organizational core competencies and strategy Aligning operating model (e.g., make-to-stock) Aligning cost structure or asset footprint (e.g., property, plant, and equipment and human resources for planning, sourcing, production, and logistics by region) Documenting the strategy, including Clarifying the supply chain value proposition Creating a network model Presenting and marketing the strategy to gain executive and supply chain partner support and approval Accepting feedback and making agreed-upon changes Gaining approval for the strategy Comparing supply chain strategy to actual supply chain capacity, resilience, sustainability, and adaptability

Creating action plans to resolve misalignments or gaps between desired and actual supply chain strategy Note that these action plans often involve supply chain design (or redesign).

Processes for Designing or Redesigning Supply Chain Supply chain design requirements are based on the types of products and services the organization is selling and how those products and services have been designed. The key here is to develop a sense of customer and business requirements to ensure that the products and services are designed to meet those requirements while also meeting the supply chain’s strategic goals, including for efficient and profitable operations. Every good supply chain design also needs to address collaborating with supply chain partners, delivering value using supply chain information systems, and specifying the proper methods of acquiring and managing data. Once a supply chain has an approved strategy for enabling and complementing the organizational strategy, it is time to get to specifics. Network and process design or redesign is about specifying who, what, where, when, and why for every detail of a supply chain, not only the location and number of facilities but also

how products will be designed to facilitate organizational strategy and how information systems will make the network transparent. The key processes that supply chain managers need to be able to perform related to designing the supply chain are Identifying customer and business requirements Identifying the current and future states Performing a gap analysis between the current and future states Developing an action plan to close gaps. The following is a general overview of these processes. Identifying Customer and Business Requirements The process of identifying customer and business requirements has these steps: Researching organizational and supply chain strategy for customer and business requirements Clarifying what degree of responsiveness and efficiency is required by stakeholders Performing market research Gathering information on customers’ product or service requirements Learning how customer and business requirements will change over the product’s life cycle

Understanding when customer and business requirements require development of reverse or specialized supply chains Determining when business requirements need to be satisfied through collaboration with supply chain partners Determining business requirements for technology, data, and communication channels internally and between partners Identifying Current and Future States The process of identifying the current and future states involves the following steps: Collecting historical data for several periods up to the present on Actual inventory levels per location and in transit Inventory ordering methods and communications Actual transit times and costs Facility costs Customer segments Efficiency, responsiveness, and other metrics and key performance indicators Technology usage, usefulness, and administrative costs Mapping process flow for manufacturing and logistics for current products Analyzing inventory trends and ordering methods

Modeling the supply chain in its as-is state using mathematical models, process flowcharts, and descriptive techniques Developing a future-state product or service design that will accommodate customer and business requirements and supply chain strategy Using supply chain network optimization tools such as network modeling and operations research to design a supply chain that meets strategic goals including responsiveness and efficiency Developing a technology model for desired information flows, analytic support, and electronic business Communicating the product/service and supply chain designs to stakeholders and gathering feedback Getting approval for the finalized designs Documenting the finalized designs Performing Gap Analysis Between Current and Future States The process of performing a gap analysis between the current and future states involves the following steps: Comparing the as-is to the to-be state to determine needed changes to Suppliers Supplier contracts and expectations Collaboration agreements and processes Customer segmentation

Facilities (e.g., opened, closed, modified, relocated) Product or service design Production process flows and production lines Processes, policies, and procedures that incorporate continuous improvement and other forms of responsiveness Transportation modes or providers Inventory policy and ordering methods Technologies (adding or retiring) Communications policies or procedures Metrics to provide incentives to align with strategy Estimating the scope of the changes and time and cost involved Performing a feasibility study and financial analysis to determine the return on investment Preparing a business plan and gaining executive approval for it Developing Action Plan to Close Gaps The process of developing an action plan to close gaps involves the following steps: Planning how to develop continuous improvement philosophies in ongoing operational processes, policies, and procedures Planning how to communicate and manage change initially and over the long term

Developing project charters for all changes to be implemented as projects Gaining approval and funding for each project charter, including the authority to plan projects and expend funds Planning each project to define the integration, scope, schedule, budget, quality, and how to manage human resources, communications, risks, procurements, and stakeholders Planning the execution, monitoring and controlling, and closing for each project Note that implementing action plans involve the following steps: Communicating and receiving feedback Using project management Using change management to change the culture and ensure that project results become standard operating procedure

Business Model and Strategy A business model is an organization’s plan to generate revenue and turn a profit based on its operations. It shows how the organization will differentiate itself from the competition and how it will function, including the expenses it expects to incur and how its components will work together. A business model is the

organization’s modus operandi, or way of doing things, and it consists of the following elements: Business strategy (what is the generic basis of competition) Organizational strategy (what is the specific basis of competition) Business plan (how to make the strategy happen) Value proposition Set of core competencies Cost structure Revenue model Typically, a business strategy will outline how to grow the business, how to distinguish the business from the competition and outperform them, how to achieve superior levels of financial and market performance, and how to create or maintain a sustainable competitive edge. Generic business strategies include least cost, differentiation, and focus. Least cost relates to a lower cost than the competition for an otherwise equivalent product or service. Differentiation relates to a product or service with more features, options, or models than the competition. Focus relates to whether the product or service is designed for a broad audience or a well-defined market segment or segments. There are many ways that these generic strategies can be combined or made into hybrids, for example:

Low cost—Focuses on delivering no-frills basics with low prices that are hard to match; cost is the basis for competition. Best cost—Focuses on delivering the best value at a relatively low price; both cost and quality are the bases for competition. Broad differentiation—Creates product/service attributes that appeal to many buyers looking for variety of goods; customer experience and/or quality are often the basis for competitive differentiation. Focused differentiation—Develops unique strategies for targeted niche markets to meet unique buyer needs; niche marketing and innovation are important examples of this type of competitive basis. Focused low cost—Designed to meet well-defined (niche market) buyer needs at a low cost; responsiveness can be the basis for competition. Competitive advantages mirror the strategies used to create them: A competitive advantage exists when an organization is able to provide the same benefits from a product or service at a lower cost than a competitor (low-cost advantage), deliver benefits that exceed those of a competitor’s product or service (differentiation advantage), or create a product or service that is better suited to a given customer segment than the competition can offer (focus advantage). The result of this competitive advantage is superior value creation for the

organization and its customers. If this advantage is successfully implemented and marketed, it should result in improved profits and market share. To see how low-cost-, differentiation-, and focus-based competitive advantages could be interpreted in an organization and its supply chain, we will explore each of these strategies in more detail next.

Low-Cost Advantage Strategies Strategies consistent with a low-cost approach to competition include a variety of methods to reduce cost in all areas of the supply chain, including resource extraction, transportation, warehousing, and location and design of retail facilities. A powerful nucleus company with a low-cost strategy and a large market share can exert great leverage on its suppliers. Such a company may be able to require suppliers to cut facility costs, relocate, adopt lean manufacturing (an approach that focuses on waste reduction and quality), change employment practices, and so forth. A low-cost strategy is adopted in supply chain strategy by emphasizing high operational efficiency, standardized products, and tight supplier inventory control. Supplier quality also needs to be high, or rework and returns will cut deeply into the thin profit margins of this model. Supply chain metrics need to measure efficiency from

many perspectives, including asset utilization, inventory turnover, and various direct, indirect, and total cost measures. A low-cost strategy should not be confused with target cost. Target costing is defined in the APICS Dictionary, 16th edition, as the process of designing a product to meet a specific cost objective. Target costing involves setting the planned selling price, subtracting the desired profit as well as marketing and distribution costs, thus leaving the required manufacturing or target cost. For example, this strategy includes numerous “dollar stores,” where the majority of the products cost only one dollar and the selection is huge. A variant on a low-cost strategy for multinational corporations is a global strategy , defined in the Dictionary as a strategy that focuses on improving worldwide performance through the sales and marketing of common goods and services with minimum product variation by country. Its competitive advantage grows through selecting the best locations for operations in other countries. In addition to selecting low-cost countries for operations, this strategy benefits from economies of scale by selling products with little variation in all markets. The items themselves may be cheap,

expensive, or a varying mix of products, but they can have a lower cost than the competition can offer because of these competitive advantages. Note that providing a product or service at the lowest price is generally not compatible with either the differentiation or focus (niche marketing) strategy. The lower profit margins provided by this approach are more consistent with mass marketing. However, even low-cost products have to meet some quality standards to remain competitive. Also, price competition can exist within a niche or differentiated market. One luxury automobile may undercut another in price, for example, if it maintains a level of quality and a sterling reputation.

Product or Service Differentiation Advantage Strategies Determining how to differentiate a product or service begins with a competitive analysis to see what the competition has to offer. According to the APICS Dictionary, 16th edition, competitive analysis is “an analysis of a competitor that includes its strategies, capabilities, prices, and costs.” Once a company has analyzed the offerings of competitors, it may differentiate its products and services in a number of ways. This is known as product differentiation , “a strategy of making a product

distinct from the competition on a nonprice basis such as availability, durability, quality, or reliability” (Dictionary). The following are some types of differentiation: High quality—durability, appearance, performance, type of materials, and so on (Quality is often an order qualifier, a necessary prerequisite for a purchase.) Diversity of the product line, offering customers many options (The opposite of this approach was Henry Ford’s alleged claim that people could have his cars in any color they wanted as long as they wanted black.) Greater reliability (which could be considered a type of quality) Special features not available from competing products or services Taking quality as a differentiation strategy example, the idea is to gain a reputation for reliability and consistency, which requires solid investment in product development and the processes of source, make (especially quality assurance), and return. Quality can be a differentiator for perishable or fragile goods. In this case, transportation and storage are key areas to focus on in the supply chain strategy. For example, Tropicana has not only invested in cutting-edge refrigerated trucks but has also developed a system to ensure that oranges are harvested at peak ripeness.

Supply chain strategies appropriate for product differentiation include the following: Modular design combined with postponement. Postponement is defined in the Dictionary as “a product design or supply chain strategy that deliberately delays final differentiation…until the latest possible time in the process.” Modular design with postponement allows last-minute customization to meet specific consumer demands. A base model with numerous options to reduce the risk of obsolescence (e.g., the same base could be used with upgraded subcomponents) while providing a large effective inventory (many configurations) with a small actual inventory. Collaboration with suppliers to develop innovative designs, numerous options appealing to different customer tastes, artistic design, and so on. Global track and trace technology to reduce the risk of counterfeit items or subcomponents. Another way to differentiate a product or service is to provide a superior customer experience. When customer experience is the organization’s primary competitive basis, the organization develops a thorough understanding of customer preferences to provide products

and services that are just right and are available where and when the customer needs them. This could be as simple as a convenience store that is always open. When customized services are offered, the organization’s supply chain needs to be sophisticated enough to measure the cost of offering these services to ensure that they remain profitable. From an inventory and logistics perspective, differentiation requires getting goods and services to customers based on their preferences while avoiding the need for expedited production or delivery. For example, Zappos.com is a shoe, jewelry, and clothing website that places customer service above all other priorities. Their customer service specialists are trained to take as much time as needed to help each customer, even calling them back after tracking down a difficult-to-find pair of shoes, rather than the standard call center philosophy of minimizing customer call time (and thus cost). Since they do not offer above-average pay to call center employees, to ensure that they get only employees who want to provide this high level of personalized service, they offer new employees a one-time cash offer to quit after the first week. This provides an incentive for less-committed employees to self-select out. In the business-to-business arena, customer experience may mean keeping the customer’s operations up and running without

interruption. For example, Sandvick Mining provides rock drilling equipment and parts for mining operations. In this industry, keeping the customer’s equipment going over all work shifts, day in and day out, is more important than the price of the equipment and spare parts. Providing this reliable customer experience is what the organization differentiates itself on.

Focus Advantage Strategies Ways to create a focus advantage include Niche marketing Responsiveness Innovation. Focus: Niche Marketing (Versus Mass Marketing) Companies can choose to develop products and services for a mass market or for a focused slice of a larger market—a niche market. As defined in the APICS Dictionary, 16th edition, mass marketing is “the strategy of sending the same message to all potential customers.” Mass marketing’s advantage is the ability to create a simple message and repeat it numerous times using mass media until the message enters the consciousness of consumers. Mass marketing is appropriate for products and services that have broad appeal across many market segments, either because they are

staples that everyone needs or because marketing can be used to create an apparent general need or desire. (Bottled water is an example of a product that marketing has developed into an apparent need.) Mass marketing is not just for standardized products. For example, it can be used to sell a customizable product such as a sandwich restaurant that allows customers to specify toppings. The point of mass marketing is to have a single message that can be broadly disseminated, not necessarily to restrict customers to a onesize-fits-all product or service. Niche marketing is used to design messages to be especially appealing to one or more market segments. It can also use less costly delivery channels because messages can be delivered over just the media the target segments (also known as channels) are likely to use. Internet advertising can even tailor marketing messages to a segment of just one person based on that person’s browsing or purchasing history. Some examples of niche market approaches include Catering to high-net-worth customers with products such as luxury automobiles, yachts, large homes, or specialized services such as estate planning, personal training, or expensive cruises Designing for a limited age group, such as children or senior citizens with special needs, instead of serving a broader

population Providing products or services for residents of a particular geographic area, such as growing vegetables for a neighborhood market rather than for packaging and shipping around the nation or world. Niche marketing shares some characteristics with product/service differentiation. In both cases, the product or service provided to customers has special features. Differentiation by quality, for example, can be the same thing as catering to high-net-worth customers. (Low-net-worth customers, or value shoppers, can also be a niche market.) Some supply chain strategies will work for both approaches. Collaboration to achieve distinctive design is one example. Depending upon the niche, sourcing may focus more on finding special expertise or high-quality materials than on low-cost labor or materials. An international variant on niche marketing is a multicountry strategy . The Dictionary defines this as a strategy in which each country market is self-contained. Customers have unique product expectations that are addressed by local production capabilities. Focus: Responsiveness

Perhaps the most obvious example of responsiveness is the fastfood industry that grew up in the last half of the 20th century, led by McDonald’s. Diners at fine restaurants will happily wait half an hour for their meal, but employees on short lunch breaks become impatient with even a few minutes in line. In the early days of the Toyota Prius automobile—a highly differentiated car—buyers were known to wait for months for a new vehicle. (The same phenomenon occurred when the Volkswagen “Beetle” first came to the United States, where it was both highly differentiated and a low-cost option.) But businesspeople or diplomats on assignment expect a rental car or limousine to be ready immediately when they arrive at the airport. Manufacturers of clothing prosper or go bankrupt by their ability to bring the latest seasonal designs to market rapidly. Perishable products, such as raw food items, must be delivered while fresh. Services may also compete on the basis of speed by cutting time spent waiting on the phone, standing in line, or processing paperwork. Supply chains designed for responsiveness may rely on substantial supplies of safety stock to avoid outages. Supply chains may have multiple warehouses to place products nearer to users. Another way to develop responsiveness is to invest in supply chain agility, which refers to the ability of sourcing and manufacturing to ramp up or down in production volume quickly without undue costs or hardship.

Setting up an agile supply chain can have a large initial cost, but over time it might be more cost-effective than relying on large safety stocks. Focus: Innovation A focus on innovation means ensuring that the organization’s products and services remain so cutting-edge that they become must-have items for the target market. Apple is a clear example of this competitive model. To succeed at innovation, an organization needs to not only invest heavily in research and development but also address changing customer desires related to functionality and style. Supply chains enable an innovation strategy by focusing on time to market and time to volume. Time to market creates the differentiation between the organization and its competitors. Products that get to market sooner can capture market share before the competition copies the innovation. Time to volume is critical because demand will peak in the early period of the release and then drop off relatively quickly. Failure to satisfy demand during the early period will severely impact profits. A supply chain that is fully integrated with product design will provide designers with materials and subcomponents that can be quickly and efficiently sourced and

produced. This requires close integration of information flows, processes, and physical plants and assets. Organizations also need to establish defined quality levels for all suppliers so that the right parts arrive on time with no delay. Since compressing design and innovation increases the risk of quality issues, this places more of the quality burden on suppliers, which may result in delays if they come up short. For example, on the verge of its initial release, the Apple Watch had a supply chain issue with a defective subcomponent. A part that made a gentle tapping sensation on the wrist was found to be defective. Since quality control found this issue before the watches were shipped to customers, rework but not recall was needed, and one of the two suppliers of this subcomponent needed to be abandoned. The remaining supplier needed extra time to ramp up to the increased demand. This created a bottleneck on time to volume at a critical time for the innovative technology.

Choosing Business Strategy It is important to focus primarily on one competitive strategy, at least within a given business unit. Most strategies have tradeoffs that make it difficult or impossible to pursue more than one at once. For example, providing high service at the lowest price is a challenge. The marketing messages will also become confusing. However, not

all the strategies are mutually exclusive; for example, product differentiation and niche marketing fit well together. That being said, trying to be all things will dilute the competitive advantage organizations gain from specialization. While a company that focuses on innovation needs to keep costs competitive and a low-cost strategy company still needs to pay attention to quality, these lower-priority considerations should not be allowed to drive strategic decisions. For example, Spirit Airlines has decided to be the “dollar store” of airlines. Since it is an airline, it obviously needs safe airplanes, but strategic decisions are based on the budget travel model. The number of seats per plane needs to be maximized even if this impacts customer comfort, so their seats don’t recline. They also charge for water and all other items and put advertisements all over the plane. Customer complaints are high with this airline, but they get many repeat customers—even many complaining customers—because the price of the flight is the driving factor behind their actual purchase decisions. Once an organization has decided on a business strategy, it uses these choices to drive the organizational strategy and eventually the supply chain strategy.

Organizational Strategy

Where do you start when building an organization’s strategy? Part of the APICS Dictionary,16th edition, definition of organizational strategy is that it “identifies how the organization will function in its environment.” The best place to start is to envision what the future should look like, or to begin with the end in mind. Setting clear goals will drive other decisions. After looking at the goals of organizational strategy, we will cover four examples of organizational strategy in detail: customer focus and alignment, the forecast-driven enterprise, the demand-driven enterprise, and product-type-driven supply chains.

Goals of Organizational Strategy and Impact on Supply Chain Strategy The goals of organizational strategy are provided in its definition. Goals are related to how the organization will satisfy customers; grow its vertical/horizontal footprint; thrive in its competitive environment and increase market share; identify, develop, and maintain core competencies; manage operations and partner relations; learn and grow; innovate; and make a profit. Whatever strategy the corporation adopts to satisfy customers, grow, compete, organize itself, and make money, the supply chain has to operate in a manner that furthers those goals. To give a simple example, if customers are demanding deeply discounted prices on

durable, high-volume goods with stable demand, a supply chain strategy that focuses on low-cost sourcing and/or capital expenditure with justified return on investment (ROI) would be on target to accomplish that goal. In the case of equipment investments, ROI would need to come in the form of lower labor costs, greater throughput, or increased economies of scale. Horizontal supply chains will contain a number of independent organizations, each with its own goals, processes, operations, technology, and strategy. So, when we refer to the necessity of aligning supply chain strategy with organizational strategy, we are referring to the strategies of a channel master or nucleus firm. Traditionally, that’s the manufacturer of a product—the company that sits right at the center of the supply chain (or network), with suppliers in tiers on one side and customers on the other. However, if a supply chain has a dominant company with a dominating strategy (one that is dictating its requirements to others), for example, a large retailer, then supplier and manufacturer strategies and goals must align with that retailer’s organizational and supply chain strategies. The suppliers of suppliers also have strategies to be brought into alignment. Finally, the strategies, once aligned, have to meet two broad goals: to serve the end customers’

needs and to be profitable for the supply chain as a whole and each company individually.

Strategy: Customer Focus and Alignment Organizations with a customer focus and alignment prioritize what’s good for the customer—not what’s good for the nucleus company or even what seems to be good for the supply chain itself. The matching supply chain strategy therefore needs to be focused on giving the final customer the right product at the right time and place for the right price. It isn’t necessarily about the most advanced product or service, nor is it always about the lowest price, the fastest time, or the most convenient place. It’s about the balance of quality, price, and availability (timing and place) that’s just right for the customer. How does one determine what is the right amount of each of these factors? Here are some basic premises that will help supply chain managers get started in determining the appropriate balance to enable this strategy: Serving the end-user customer is the primary driver of supply chain decisions. Organizations in the supply chain have to make a profit and stay in business to serve the customer.

Functional teams in the organization will provide their input and research on the optimal balance for the supply chain to meet customer needs. Design engineers—or, better yet, design teams from across the network—design products that are right for the end customer and can be sold profitably. Market research looks for the true, and not always obvious, needs in potential consumers that the supply chain can be engineered to satisfy profitably. Logistics strategy begins with data about customer demands for availability— of materials, components, service, or finished products, depending upon the customer—and then it looks for ways to move products in a cost-effective way with acceptable risk. That is, decisions are not just about product features or price or speedy delivery. They are about the right features at the right price on the right schedule. The term “customer” can be a complex concept in relation to supply chains because there may be multiple customers with different stakes in the process. When we talk about customer focus, we mean the end user, the consumer of the product. But perhaps only the retailer actually sees the end user and has a direct relationship with that person or entity. Everyone else in the supply chain has a more immediate customer just downstream before one gets to this ultimate customer. If the supply chain is completely aligned in its focus on the end customer, then, at least in theory, serving the customer just to an organization’s downstream side would automatically serve the end

user and also be in the supplying organization’s best interest as well as the interest of investors. Within each supply chain partner there are internal “customers” whose needs also must be aligned with corporate and supply chain strategies. Each manager must understand his or her role in making the supply chain profitable, and staff, too, must be rewarded, motivated, and trained in alignment with the needs of the supply chain’s end customer. Consider sustainable supply chain management, which is basically a supply chain that works to maximize the positive long-term social and environmental impact of its actions while remaining profitable. Successfully managing for sustainability requires a strategic mindset, involving numerous personnel and financial resources and a commitment from suppliers in multiple tiers as well as consumers further up the supply chain. Departments must cooperate with other departments in their organization (e.g., purchasing and environmental or design departments) and with their counterparts at suppliers. This type of collaboration between supply chain partners necessitates breaking down cultural barriers and building a culture of trust to ensure that the focus is on end-to-end supply chain activities.

Strategy: Forecast-Driven Enterprise

Another example of an organizational strategy is the forecast-driven enterprise. Simply put, this strategy is one in which the nucleus company, usually the manufacturer, uses a forecast, an estimate of future demand, as the basis of its organizational strategy. When a supply chain works in response to forecasts, it’s called a push system , and it entails the following (as described in the APICS Dictionary, 16th edition): 1) In production, the production of items at required times based on a given schedule planned in advance. 2) In material control, the issuing of material according to a given schedule or issuing material to a job order at its start time. 3) In distribution, a system for replenishing field warehouse inventories where replenishment decision making is centralized, usually at the manufacturing site or central supply facility. Everything in a push system is pushed downstream from one point to the next according to schedules based on the forecasts. The supplier delivers components in the amounts determined by the schedule to inventory, where they await use in manufacturing. The plant turns them into finished products and pushes the products to the distribution center or the retailer, where they await an order from downstream.

Here is the complicating factor: It is difficult to know what customer requirements will be from day to day, month to month, quarter to quarter, and so on. If a manufacturer knew its customers were going to need 1,000 SKUs (stock keeping units) every Wednesday afternoon, then getting those products to customers at the right time and place would be a matter of simple calculation based upon lead times for production and delivery. The manufacturer would look at the bill of material, determine the lead time for each item listed, and submit schedules to its suppliers. Unfortunately, it’s difficult to predict even the most stable demand— say, for a product like diapers. There is some variability in demand for diapers, even though they aren’t subject to seasonal changes and are in demand in all economic cycles. However, they are subject to the bullwhip effect. That’s why Procter & Gamble provides vendormanaged inventory (VMI) to Walmart to plan for demand and replenishment of diapers. In situations outside this kind of partnership, forecasting along the supply chain may work like this: The retailer forecasts demand from parents who purchase diapers. The wholesaler forecasts demand from all its retailers. The manufacturer forecasts demand from the wholesale distributors.

The component suppliers forecast demand from manufacturers. The raw materials suppliers forecast demand from the component manufacturers. How effective is this strategy? Here’s how forecasting error and the bullwhip effect can make this push strategy less effective: Parents vary their diaper-buying patterns in fairly small increments due to factors nobody fully understands. They may go to different stores for a change, shop on Tuesday instead of Wednesday, or buy two or three weeks’ worth at one time because the diapers are on sale. So, actual demand never quite meets the forecast. Meanwhile the retailer’s order includes a little extra safety stock. Or maybe the retailer runs a promotion that is not communicated to the distributor, thus resulting in needing a larger order than was previously forecasted. These fluctuations impact forecasting for the distributor. The wholesale distributor had forecasted demand based on past orders from its retailers. But now those demand patterns have wider variability than the demand pattern at the retailer’s checkout counters due to that safety stock or uncommunicated promotion. Sometimes inventory accumulates because demand is less than the forecast, and this means that the retailer’s next order shrinks

because it has a glut of diapers, so it becomes feast or famine up the chain. Up the supply chain, the manufacturer looks at the distributor’s order demand pattern and makes its own forecasts showing an even wider swing in variability. And this variability goes up the supply chain with ever-wider swings. This is the bullwhip effect , which the Dictionary defines as An extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply chain. Inventory can quickly move from being backordered to being excess. This is caused by the serial nature of communicating orders up the chain with the inherent transportation delays of moving product down the chain. The bullwhip effect can be eliminated by synchronizing the supply chain. The bullwhip effect is shown in Exhibit 8-2. It affects all manner of supply chains that are based on serial forecasting by each independent division or company that touches the product as it travels from raw material to finished good. Communication of little more than orders (failure to communicate actual demand) plus overreliance on forecasts are root causes of the bullwhip effect. One

solution to the bullwhip effect then is better visibility in both directions but especially of promotions, orders to replenish safety stock, and other information on actual demand. Another solution is to rely less on forecasting, which is the purpose of the next strategy discussed.

Exhibit 8-2: Bullwhip Effect

Strategy: Demand-Driven Enterprise Since the bullwhip effect is driven by demand forecasts, a solution is to replace the forecasts with actual demand information to the degree this is feasible. This isn’t necessarily a simple matter, but supply chain professionals have developed demand-driven techniques for letting actual orders (not forecasts) drive production and distribution while maintaining strategic buffers of inventory in key locations rather that spreading inventory throughout the system. Demand-driven planning (DDP) and its key ordering method, demand-driven material requirements planning (DDMRP) , are central elements of many of these models. DDMRP is defined as “a

method for planning material needs that enables a company to build more closely to actual market requirements” (APICS Dictionary, 16th edition). DDP and DDMRP are discussed more elsewhere. The demand-driven supply network is defined in the Dictionary as “a situation in which a customer purchase initiates real-time information flows through the supply chain that consequently cause movement of product through the network.” It is type of pull system , which the Dictionary defines as follows: 1) In production, the production of items only as demanded for use or to replace those taken for use. 2) In material control, the withdrawal of inventory as demanded by the using operations. Material is not issued until a signal comes from the user. 3) In distribution, a system for replenishing field warehouse inventories where replenishment decisions are made at the field warehouse itself, not at the central warehouse or plant. In the demand-driven supply chain, supply management is focused on customer demand. Instead of manufacturers planning their operations based on factory capacity and asset utilization, the demand-driven supply model uses a customer-centric approach that allows demand to drive supply chain planning and execution— moving the “push-pull frontier,” as it’s called, back up the supply chain at least to the factory but often to first-tier suppliers too.

Instead of producing to the forecast and sending finished products to inventory, the production process is based on actual demand information. There is, in other words, no fixed production schedule in a strictly demand-driven supply chain. Product is turned out only in response to actual orders, “on demand,” in other words. This often leads to a decrease in lead times due to the ability to better anticipate incoming orders from the retailer. Even deliveries of raw material are determined using actual demand information. (Note, however, that suppliers may still need to rely on forecasts to determine their production. The art of forecasting remains crucial, even in a demand-driven supply chain.) The challenge in changing from forecast-driven (push) systems to demand-driven (pull) systems is in reducing inventory without also lowering customer satisfaction. When a demand-driven system is set up and managed properly, it can actually enhance customer service while reducing costs. But stockouts are a risk. In the forecast-push process, the risk is related to the build-up of inventory all along the supply chain. Not only does inventory cost money while it sits in a retail stockroom, distribution center, or preproduction storage area; it runs the risk of becoming obsolete or irrelevant for a number of reasons. In a world of rapid innovation, inventory obsolescence is a real threat. Season close-

out sales and discount resellers are ways of clearing out overstock. Magazine distributors destroy huge quantities of monthly magazines when they came back from retail outlets. (Since magazines are inexpensive to produce and destroy compared to their retail price, the distributors would rather destroy ten copies than miss one sale.) Those are the results of producing to forecasts that no one trusts and purposely overstocking in case of unexpectedly high demand. In the demand-pull, make-to-order model, on the other hand, the risk is that orders will begin to come in above capacity and all along the supply chain there will be expensive activity to run the plant overtime, expedite more and faster transportation, or convince customers to wait or accept a substitute product. (Running short of stock is also a risk in the forecast-driven supply chain. Forecasts can be wrong in either direction.) Demand-driven enterprises therefore establish strategic inventory buffers and monitor the size of those buffers so that throughput can be kept high enough to satisfy most demand while keeping aggregate levels of inventory very low. They also rely more on maketo-order or assemble-to-order whenever feasible. In reality, most organizations pursue a push-pull strategy, and the point where push moves to pull is the key strategic decision. Once

that decision has been made, building a demand-driven enterprise can require significant changes in all supply chain processes. The following are some major steps: Provide access to real demand data along the supply chain for greater visibility of the end customer. The first requirement is to replace the forecasts with real data. The only supply chain partner with access to these data firsthand is the retailer, and retailers in the past have been no more willing to share business data than any other company. The other partners lack “visibility”— one of the main supply chain principles promoted by APICS. They simply cannot see what’s going on with the end customer. But visibility is required in a pull system. With point-of-sale scanning or radio frequency identification (RFID), a retailer can transfer customer activity data to its suppliers continuously. Instead of producing to a forecast, manufacturers with immediate signals from the front lines can plan one day’s production runs at the end of the prior day. They produce just enough to replace the sold items. Establish trust and promote collaboration among supply chain partners. Collaboration is implied in the sharing of information. But more is at stake than simply sharing sales information. Partners may have to invest in new technology and

develop new systems to be able to use the real-time data. With orders going out without a schedule, all processes will have to be altered—warehousing (less storage needed), packaging, shipping, and planning will all be handled differently in the new system. In return for the real-time data and subsequent reduction of inventory, suppliers and distributors have to agree to change their processes in whatever way necessary to make the new system function at the desired level of customer service. Increase agility of trade partners. Because the inventory buffers will be much reduced in this demand-driven supply chain, the trade partners need to develop agility—the ability to respond to the variability in the flow of orders based on sales. The plant, for example, may have to undergo considerable change if it has to produce several different kinds of products under the new circumstances. When making-to-forecast, a plant can run a larger volume of each product to send to inventory; when making-toorder, the plant may have to produce several different types of products in a day. There will be no room for long changeover times between runs of different products; therefore, equipment, processes, work center layouts, staffing, or siting—or all these things—may have to change to create the capacity required to handle the new system.

Gartner’s annual supply chain report (“The AMR Supply Chain Top 25 for 2021”) ranks the top 25 demand-driven supply chains, thereby underscoring the importance of this and other cutting-edge supply chain strategies. A link to this report is provided in the online Resource Center.

Strategy: Product-Type-Driven The last organizational strategy we’ll cover is based on a company having more than one supply chain, depending upon the types of products that are passing along the chain and other variables. For a product with a complex bill of material (many parts that combine into many components to make the final product), a manufacturer may be bringing in materials from many suppliers. And these materials might range from low-priced commodities to fragile or sophisticated materials that require special shipping and handling. Suppliers might range from small specialized organizations to raw materials giants larger than the manufacturer. Some are key accounts; some might be occasional buyers. The finished products may be sold through several different channels—e-commerce, printed catalogs, commercial, retail. These variables may combine in different ways, each suggesting its own type of supply chain strategy. In “What Is the Right Supply Chain for Your Product?” Marshall L. Fisher distinguished two types of products, functional versus

innovative, that require different supply chain strategies. Functional products “are mature products that tend to have a low profit margin and a predictable demand” (APICS Dictionary, 16th edition). Functional products change little from year to year and have longer life cycles, relatively low contribution margins, and little variety. Because demand for them is stable, they are fairly easy to forecast, with a low margin of forecasting error (perhaps around 10 percent), very few stockouts, and no end-of-season markdowns. The appropriate supply chain for these products should emphasize predictability and low cost with performance indicators such as High average utilization rate in manufacturing Minimal inventory with high inventory turns Short lead time (consistent with low cost) Suppliers chosen for cost and quality Product design that strives for maximum performance and minimal cost. However, make-to-order functional products, such as replacement parts for customized equipment, usually have long lead times (six months to a year). Innovative products have unpredictable demand, relatively short life cycles (three months for seasonal clothing), many variants in each category, and high contribution margins of 20 to 60 percent. They

have average stockout rates from 10 to 40 percent, end-of-season markdowns in the range of 10 to 25 percent of regular price, and a margin of error on forecasts of 40 to 100 percent. However, the lead time to make them to order may be as low as one day and generally is no more than two weeks. Maintaining fast lead times may require fast and more expensive modes of transportation. The supply chain for innovative products should emphasize market responsiveness rather than physical efficiency, with performance indicators such as Excess buffer capacity and significant safety stock of parts or finished items Aggressive reduction of lead times Suppliers chosen for agility: speed, volume and production run flexibility, and quality (rather than cost) Modular design that postpones differentiation as long as possible. Innovative products, with their high margins and unpredictable demand, justify the extra expense for holding costs. (Fisher also proposes, however, that manufacturers of innovative products can look for other solutions to the problem of unpredictable demand, such as aggressively reducing lead times and producing products to order rather than for inventory.)

What happens when a product can fall into either category? Fisher says that some products can be either innovative or functional. Automobiles fit that description, with a low-priced, no-frills car like a base model Chevrolet Spark representing the functional end of the spectrum and a Porsche representing the other end. Similarly, coffee can be functional or come from a high-end coffee shop, with the customer experience and the quality of the product being differentiators. Writing in Harvard Business School’s Working Knowledge, Jonathan Byrnes, a professor at MIT, asserts that one supply chain is not enough; two, three, or more would be preferable. “One size fits all” supply chains may have been sufficient in the past, he believes, when that was the competitive norm, but advancements in information technology make it possible to have multiple, dynamic supply chains that can accommodate different product and information flows. Byrnes breaks products into three categories: staples, seasonal products, and fashion products. Staples (which are much like Fisher’s functional products) have steady, year-round demand and low margins. White underwear is an example. Byrnes advises stocking staples only in retail outlets in small quantities and transporting them in truckload quantities. A

full truckload is more cost-effective for the shipper than a partially loaded vehicle. Seasonal products could include outdoor patio furniture, holiday décor, etc., for which the demand is more predictable since it is tied to the holiday or season. Fashion products are like Fisher’s innovative items, with unpredictable demand. Zara, the Spanish clothing brand, has two supply chains, one for staples and the other for fashion clothing. To get the fastest response time, Zara uses European suppliers for the fashion items. But for the more predictable demand items, it uses eastern European suppliers that are known to have poor response times (not a concern) and lower cost. In addition to varying the supply chain by product type, Fisher recommends several other variables to consider—store type, seasonality, and product life cycle. Demand varies considerably over the life cycle of many products. The same item might have infrequent demand at first, more stable demand in its maturity phase, and falling demand at the end of its life cycle. With more than one supply chain, the nucleus company can move its products from one chain to the other in response to changing variables, such as type of channel, seasonal needs, or life cycle stage.

Business Plan Business and organizational strategies are formalized and clearly specified within an organization’s business plan. A business plan is a written document that describes the overall direction of the company and what it wants to become in the future. The APICS Dictionary, 16th edition, defines a business plan in part as follows: A statement of long-range strategy and revenue, cost, and profit objectives usually accompanied by budgets, a projected balance sheet, and a cash flow (source and application of funds) statement. A business plan is usually stated in terms of dollars and grouped by product family. The business plan is then translated into synchronized tactical functional plans through the production planning process (or the sales and operations planning process). Although frequently stated in different terms (dollars versus units), these tactical plans should agree with each other and with the business plan. The business plan provides general direction regarding how the company plans on achieving its long-term objectives. Key functions such as finance, engineering, marketing, and operations typically have input into the plan. As illustrated in Exhibit 8-3, the overall business plan cascades down to those same functions.

Exhibit 8-3: Impact of Business Plan

The finance function manages and tracks the sources of funds, amounts available for use, cash flows, budgets, profits, product profit margins, and return on investment. Engineering is responsible for research and development and the design and redesign of products to meet requirements. Marketing’s focus is on analysis of the marketplace and how the company positions itself and its products. The goal of operations is to meet the demands of the marketplace via the organization’s products. Operations also manages the manufacturing facilities, machinery, equipment, labor, materials, and procurement as efficiently as possible. These functional roles collectively support the success of the supply chain. The business plan is based on and aligned with the business strategy and with market requirements. It provides a framework for the organization’s performance objectives that are tied to strategic goals. Formation of and changes to the business plan come from top management’s modifications to the business and organizational strategy. However, just because an organization invests time in developing and documenting a strategy, the selected strategy may or

may not be the best fit for an organization’s actual capabilities and actual business environment. One way to determine how well a strategy fits an organization is to use Porter’s five fundamental elements. After that the various components of the business plan are discussed: value proposition, core competencies, cost structure, and revenue model.

Porter’s Five Fundamental Elements Michael Porter, in his influential work on business strategy, Competitive Advantage, argued that an organization’s “fitness” for a given competitive strategy relied on choices related to five fundamental elements of any business. (Note that these are not Porter’s famous “five forces” but rather areas that need to be aligned to support a given strategy.) Customer service. The accuracy, flexibility, and speed of responses and deliveries. Sales channels. The allowed methods of placing an order for goods or services. Value system. The value-added activities that the organization— and the supply chain partners—will provide. This requires

specifying the core competencies the organization will pursue and that other supply chain partners will pursue to add value. Operating model. The way plan, make, source, deliver, and return operations are arranged to meet working capital and cost objectives at the proper level of customer service. Make-to-stock, make-to-order, assemble-to-order, and engineer-to-order are types of operating models. Asset footprint. The scope and location of owned and leased property, plant, and equipment; information systems and infrastructure; cost, distribution, and skill levels of human resources; and access to capital. The idea here is to put the proper emphasis on each element. Rather than isolating the decisions regarding each element, which could lead to suboptimization and conflicting goals, planning for all of these business elements should be integrated to develop a cohesive strategy.

Value Proposition The organization’s value proposition is the set of activities considered valuable by the organization’s customers. The value proposition may also explicitly discuss the value provided by supply chain partners.

The APICS Dictionary, 16th edition, defines value broadly as “the worth of an item, good, or service.” While this merely shifts the discussion from the meaning of value to the meaning of worth, note how value includes both goods and services. A related concept that is fundamental to supply chain management is value added. Adding value to a good or service is the responsibility of each entity and process in the supply chain. The Dictionary defines value added in manufacturing terms as the actual increase of utility from the viewpoint of the customer as a part is transformed from raw material to finished inventory; the contribution made by an operation or a plant to the final usefulness and value of a product, as seen by the customer. The objective is to eliminate all nonvalue-added activities in producing and providing a good or service. The value proposition shows how the organization plans to emphasize each of Porter’s five fundamental elements and thus provide the added value as defined by the customer in terms of customer service, quality, increase in utility for the price, and so on. The value proposition is a relative assessment of what is valueadded. An operation or process adds value if it does so better, faster, and/or at a lower cost than the available alternatives. Thus it is benchmarked against competitors and third-party service providers.

This analysis can help the organization validate its core competencies and the value of the products or services rendered by others.

Core Competencies An organization’s core competencies can be analyzed best by breaking the necessary functions and activities down into categories. (The subcategories shown leverage SCOR® processes.) Decision-making activities Planning Enabling Execution activities Sourcing Making Delivering Returning Some organizations choose to retain the decision-making activities and outsource some or all of the execution activities to organizations that can leverage lower-paid workers or other competitive advantages. Other organizations retain certain portions of execution activities to meet quality objectives. For example, an organization could do its own purchasing and get bulk discounts while controlling

quality levels but then outsource the final assembly of the product to a third party who is responsible for final quality and lead time at a lower manufacturing cost. Core competencies generally fall within one or more areas of competitive advantage: Economy-of-scale advantages allow high utilization of assets at a low per-unit cost. This can involve bulk purchasing, high-capacity production with long runs, large-quantity shipping, or a large customer base. Geographic expertise or capacity advantages take the form of regional networking, business associations, language and culture expertise, or regional economies of scale. Technology advantages include proprietary technologies that would be cost-prohibitive to develop or license. Resource advantages include currently available labor, expertise, materials, or financing that would take time and effort to develop.

Cost Structure An organization’s cost structure will be influenced by its operating model, asset footprint, capacity, customer service levels, technology investments, market labor prices, and so on. Of these, the operating model and the asset footprint most strongly influence cost structure.

The cost structure of various operating models differs significantly: Make-to-stock has low production costs but high inventory carrying costs. This model is best for standardized, high-volume products. Assemble-to-order (modules are made to stock but the final customer order is assembled only after being ordered) has moderate production costs and low inventory carrying and planning costs. This model is for moderate- to high-demand items with many options, such as computers. Make-to-order has high production costs but low inventory carrying costs and low planning costs. This model is for items that have sporadic demand patterns or that come in a wide variety of configurations or options. Configure-to-order (mass-producing items that can be configured after being ordered) is a short lead time extension of make-toorder that has moderate production and inventory carrying costs. It is used when it would take longer to assemble the item than the customer is willing to wait. Delivery times can be reduced and customer experiences tailored. Engineer-to-order (e.g., construction of a building) has production and inventory costs that can be initiated after payment is agreed upon.

The asset footprint is the number, location, and size of the organization’s property, plant, and equipment (PP&E) and the regions or countries in which the organization operates. While minimizing such assets is good for an organization’s balance sheet, the footprint needs to be large enough and capable enough to handle the required capacity of each type of activity in the supply chain. In addition to these physical assets, a supply chain asset footprint can also refer to soft assets, such as the location of various functional areas or teams such as a purchasing team. The goal of footprint optimization is to determine how much of each type of asset is needed in total and then to decide where to locate them to enable targeted customer service levels. There are several models for how these costs can be configured. With a global asset footprint, all production for a good or service takes place at one set of locations for distribution globally. This model increases economies of scale and minimizes unit production costs. It is best for items that require highly specialized expertise and are capital-intensive. There will also be a cost to address business interruption risk. With a regional asset footprint, production and sales are localized by region. This cost model is best when transportation costs or time are a significant part of the decision. Products can also be

produced to meet regional requirements. Different types of products can be made in different regions for some crossswapping of products. With a country-specific asset footprint, production and sales are localized by country. This model is best when transportation costs or time requirements are prohibitively high relative to the sale price/weight of the good. Avoidance of duties and tariffs or compliance with a country’s local sourcing regulations can be other reasons for using this model. The decisions regarding what to own and what to source through contracts will have a large impact on the organization’s cost structure. In addition, some areas have tax incentives to attract business while others have higher taxes. Tax optimization is an area for specialists who can provide valuable input to related cost discussions.

Revenue Model A revenue model is the organization’s plan for how it will earn more revenue than its expenses and thus earn a profit. A revenue model considers the sales channels that the organization will employ to sell the good or service. Channels can be direct or indirect, that is, from a dedicated sales force or web page or through intermediaries such

as distributors or retailers. Each sales channel will have different profit margins, depending on the cost of setting up and maintaining that channel and the amount of profit that each supply chain partner retains. Customer segmentation and customer profitability are the primary decision points regarding which channels to maintain and promote for which customers. Other decisions related to the revenue model include who receives goods or services when demand outstrips supply and whether to offer channels that directly compete with one another, such as a self-service vending machine or website versus a retail store.

Supply Chain Strategic Objectives With supply chain management, the functions of planning, buying, manufacturing, delivering products, and being paid have evolved from control of discrete business functions to an emphasis on business process excellence and the management of a network of relationships tied together by complex information flows. Achieving the benefits of supply chain management requires strategic planning to master the connected processes. The objectives of planning and implementing a sound strategy for supply chain management practices, systems, and technologies include

Improving market knowledge Implementing the three Vs—increased velocity, increased visibility, and reduced variability in the flows of goods and services, funds, and information Streamlining operations Improving risk management Increasing sustainability.

Improving Market Knowledge With supply chain management strategies in place, partners in the supply chain begin to share their knowledge about the marketplace and customers. It may take some time for the organizations to build trust before they share their account information. After the initial setup expense, data shared between partners can be an inexpensive and invaluable source of information on customer demand. There are myriad sources and documents containing valuable customer information that can be shared between supply chain partners, including transaction records, customer survey results, sales and service representative knowledge, and information from distribution points such as retailers, internet sites, or kiosks.

If this kind of market information is not forthcoming from a supply chain partner, another option is to purchase data from survey companies and database marketing companies. Service or finance bureaus can provide broad information about the customer pool. As opposed to data from partners, such data do not necessarily paint a picture of a business’s own customers. Purchased data may be more useful in acquiring new customers than in managing relationships with existing customers.

Implementing Three Vs Often called the three Vs of supply chain management, visibility, velocity, and variability are key elements of successful supply chain strategy. No matter what the competitive priority, the goal of supply chain management is to increase visibility and velocity while reducing variability, as seen in Exhibit 8-4. The future of supply chain management lies in continued pursuit of that goal.

Exhibit 8-4: Three Vs

Increased Visibility According to the APICS Dictionary, 16th edition, visibility is the ability to view important information throughout a facility or supply chain no matter where in the facility or supply chain the information is located. Increased visibility along the supply chain is a benefit for supply chain partners and the end customer. With better visibility, a supply chain manager or employee can see the results of activities occurring in the chain and is made aware of minor, incremental changes via technological processes. For example, point-of-sale data may be “visible” to computers in warehouses, the manufacturing plant, and suppliers’ facilities. Data about a sale can instantaneously trigger appropriate actions in all those places automatically. Shipments are scheduled from the warehouse to replenish the retailer’s shelves, manufacturing produces another unit, and suppliers release parts to the manufacturer. With all these actions prompted automatically and instantaneously by technology, the supply chain partners can realize savings in cost and time. Better visibility has resulted in greater velocity. Increased Velocity The flows of physical materials and services, cash, information, and returns (or the reverse flow) of products for repairs, recycling, or

disposal benefit from being increased in speed and efficiency. Supply chain management impacts the velocity of these four flows in a positive manner. According to the Dictionary, velocity is a term used to indicate the relative speed of all transactions, collectively, within a supply chain community. A maximum velocity is most desirable because it indicates a higher asset turnover for stockholders and faster orderto-delivery response for customers. Velocity, like visibility, is enhanced by good supply chain management. Methods of increasing the velocity of transactions along the supply chain include Relying on more rapid modes of transportation (if there is a net benefit after the increase in transportation costs) Reducing the time in which inventory is not moving (idle, queue, wait time, etc.) such as by using Just-in-Time delivery and lean manufacturing (The less time inventory spends at rest, the less likely it is to suffer damage or spoilage. Increased velocity reduces the expenses involved in warehousing inventory.) Eliminating activities that don’t add value, thus reducing the time required to accomplish supply chain activities Speeding up the flow of demand and cash as well as the velocity of inventory. (The more rapidly payments are received from customers, the sooner the money can be put to work in the

business or invested. Information about demand changes is crucial when the competitive strategy is responsiveness.) Reduced Variability Variability is the natural tendency of the results of all business activities to fluctuate above and below an average value, such as fluctuations around the average time to completion, the average number of defects, average daily sales, or average production yields. Supply chain management works to reduce variability in both supply and demand as much as possible. The traditional offset against variability is safety stock. If greater visibility along the chain results in greater velocity, supply chain managers should also be able to reduce the amounts of safety stock required to match supply to spikes in demand. As the demand signal speeds more rapidly up the supply chain, distribution and production can get off to a faster start to meet the demand. Demand variability has many causes, but a primary cause that can be minimized is the bullwhip effect (an extreme change in the supply position upstream that is generated by a small change in demand downstream in the supply chain). Inventory can quickly move from being backordered to being in excess due to the serial nature of communicating orders up the supply chain with the inherent transportation delays of moving product down the supply chain.

Supply variability typically increases in waves down the chain, starting with small amounts at the resource extraction sites and culminating in the largest amounts at the retail end of the chain. For example, any variability in the supply of a raw material, such as an agricultural product that is dependent upon fluctuating growing conditions, can result in even more widely fluctuating purchase orders for that raw material from buyers down the supply chain. A shortage in supply during one period may result in overpurchasing in the next period, with the excess accumulating in warehouses as safety stock. Buyers depending upon the supply will increase or decrease their purchase orders to reflect the variability of materials, parts, and products available to them, while variability increases at each point in the chain. The accumulating excesses can in turn trigger underpurchasing. Supply chain managers use visibility, velocity, and other supply chain tools such as strategic buffers to manage supply variability. Additional Vs Supply chain managers should attend to some other Vs, including vocalization, variety, and volume. Vocalization refers to the need to have good communications between supply chain partners as a vital way to prevent the bullwhip

effect rather than just assuming that current orders will form a reliable pattern. Variety refers to the mix of products and services in a portfolio that must alter to meet changes in customer demand. Too much or too little variety can both be bad. Volume is the amount of product being produced in a given time. A supply chain must be flexible enough to expand and contract volume to meet changes in demand for mass-customized products and services.

Streamlining Operations Achieving the benefits of supply chain management requires mastery of connected processes. As supply chains evolve, their ability to streamline key operational processes and flows also increases. With good supply chain management, the day-to-day functioning of the organization is smoother, with fewer process-related operational issues, because the organization is adept at Identifying each partner and step in the supply chain Identifying bottlenecks or problem areas in the supply chain Identifying and removing or simplifying unnecessary steps or those that do not add value for customers or partners

Knowing who is responsible for each substep or task within a larger process and how it impacts the supply chain’s performance and output Identifying processes that are interdependent and knowing how a change in one will affect another. The benefits of streamlined operations are felt enterprisewide and across functions in the form of increased velocity of cash, information, and physical materials and services in the supply chain.

Improving Risk Management With supply chain management, the organization develops a risk management strategy and plan in advance that describe how it will address supply chain vulnerabilities by avoiding, accepting, transferring, or mitigating risk. Managing risk proactively gives an organization an edge over its competition in a number of ways: It helps keep the supply chain flexible so that it can continue functioning despite disruptive events, which in turn helps balance the costs of contingency planning against the potential economic, facility, resources, and inventory losses. Risks are shared among supply chain partners who will be prepared to work in concert and play their parts responsibly. Risk planning arms employees and supply chain partners with valuable, actionable information and confidence to handle most

situations with a well-thought-out strategy driven by the risk data. With a risk strategy and plan in place, supply chains typically improve their chance of keeping material, information, and payments flowing through the network and arriving in the right number, time, and condition even if a risk event occurs.

Increasing Sustainability Sustainability goals can create corporate obligations that go beyond the traditional emphasis on bottom-line profits. Sustainability can include social and environmental goals, but all solutions also need to meet economic goals such as by being cost-effective. For a social example, improving working conditions and promoting a healthier working environment will help make the workforce more sustainable. Investments in this area can reduce related risks and costs, such as those from absenteeism. For an environmental example, organizational (and consumer) practices rely upon energy derived from fossil fuels that cannot be sustained beyond the availability of such energy resources. Supply chain management incorporates sustainability efforts such as replacement of resources as they are used (as in the planting of seedlings as part of forest management), upgrade of assets to more

efficient versions, and increased reliance on wind and solar energy to power manufacturing processes.

Topic 2: Supply Chain Strategic Value and Optimization Following a predetermined strategy-setting process can help ensure that the supply chain strategy aligns well with the organizational strategy. Creating a stakeholder value proposition is a critical way to set supply chain objectives. It can involve analysis of value chains and value stream mapping as well as analysis of different types of stakeholders to see what they value. Given clear objectives, the next steps are to assess the current state of the supply chain in terms of value propositions and core competencies and then set a complementary cost structure, revenue model, and tax strategy. To keep a supply chain strategy relevant, it is important to regularly identify and remove misalignments or gaps, so this is discussed last.

Alignment of Organization and Supply Chain Strategies A supply chain’s overarching goals are to provide customers with goods and services when and where they want them, at a competitive price, to remain consistent with the strategies of the

organization and the extended supply chain, and to ensure that the supply chain is globally competitive. Time, distance, and collaboration are the basic elements in modern supply chains that impact the chain’s ability to respond to competitive changes in the global marketplace. Exhibit 8-5 shows the strategic decision-making process flow that goes into aligning organizational and supply chain strategies.

Exhibit 8-5: Aligning Organizational and Supply Chain Strategies

This flowchart shows that The organization’s market and external environment analyses identify relevant customers, products, competition, and

socioeconomic environment issues. Management uses these analyses to derive the organization’s mission and overall goals to support those factors. The organization needs to identify and leverage its core competencies and note areas where it lacks expertise, since those capabilities might be outsourced. Organizational strategy drives the organization’s future direction and competitive priorities. These in turn drive functional area strategies, including those for the supply chain. Supply chain strategies drive the supply chain capabilities of the present, the immediate future, and the long term. These supply chain capabilities feed into a continuous loop and help the organization determine how to continuously adjust its competitive priorities of cost, quality, time, and price to support its dynamic organizational strategy. Once the supply chain strategy exists and there is confirmation that it is properly aligned with organizational strategy, the organization will monitor and control the strategy to ensure that it is still appropriate. Being flexible and changing the supply chain strategy when circumstances warrant taking a new direction keeps the strategy alive.

Supply chain strategies need the same elements as an organization’s business model, and these are explored in this general content area: value proposition, core competencies, cost structure, and revenue model.

Supply Chain Value Proposition Like the organization’s overall value proposition, a supply chain strategy needs to show how it will create value for the organization. Supply chain management, like any other type of business management, aims to create value through financial benefits and provide value to customers and other stakeholders by upholding the ethics of customers, stakeholders, and community. The goal is to add value at each step regardless of whether this is a service-oriented or manufacturing-oriented supply chain. This value can take the form of utility versus price, but other factors like availability or attractiveness also matter. A key way to determine what is and is not value-added is to use value chains and value stream mapping. After discussing these concepts, we address how different types of stakeholders have different types of things they value.

Value Chains and Value Stream Mapping

Although many would assume that a supply chain is, in fact, a value chain—at least if well managed—others may draw a distinction between the two. According to the APICS Dictionary, 16th edition, the value chain is made up of “the functions within a company that add value to the goods or services that the organization sells to customers and for which it receives payment.” A supply chain then strings the value chains of each entity together to satisfy market demands for specific products or services. Value chains integrate a variety of supply chain activities throughout the product/service life cycle, from determination of customer needs through product/service development, operations, and distribution. The intent of a value chain is to increase the value of a product or service as it passes through stages of development and distribution before reaching the end user. Not all value chain activities are technically part of the supply chain, and persons engaged in these activities may not understand their role in supporting the supply chain. Those activities might include engineering, marketing, finance, accounting, information technology, human resources, and legal. Managers from outside the supply chain often don’t understand the requirements of supply chain management, can’t distinguish a value chain from a supply chain,

and consequently don’t provide the supply chain management support required from their areas. Two closely related terms are value stream and value stream mapping. As defined in the Dictionary, a value stream is the processes of creating, producing, and delivering a good or service to the market. For a good, the value stream encompasses the raw material supplier, the manufacture and assembly of the good, and the distribution network. For a service, the value stream consists of suppliers, support personnel and technology, the service “producer,” and the distribution channel. The value stream may be controlled by a single business or a network of several businesses. A value stream encompasses all the primary actions required to bring a product or service from concept to placing it in the hands of the end user. It also includes timing. Mapping the stream aids in process improvement. Value stream mapping is defined in the Dictionary as a lean production tool to visually understand the flow of materials from supplier to customer that includes the current process and flow as well as the value-added and

non-value-added time of all the process steps. [It is] used to lead to reduction of waste, decrease flow time, and make the process flow more efficient and effective. Exhibit 8-6 shows a basic process flowchart for a supply chain used to show the as-is state of a process, and Exhibit 8-7 shows how an organization can apply value stream mapping to find the most effective production flow for that supply chain process in a to-be state for the process.

Exhibit 8-6: As-Is Process Flowchart Example

Exhibit 8-7: Value Stream Mapping Example: To-Be State

Stakeholders and Value When planning any new supply chain activity or monitoring continuing practices, it is important to identify all the stakeholder groups and determine the impact the activity will have on each one. The primary stakeholder in any business activity is the organization itself. It must be profitable to survive and create value for any other stakeholder group.

Customers are also significant stakeholders in supply chains. In addition to the consumer of the ultimate good or service, each downstream organization is a customer, who must create value for itself and its customers. Each intermediate customer has their own view of the potential value of any particular activity, though the ultimate customer is the true decider. For example, a supplier may decide to increase profits by raising the price of goods sold to its downstream supply chain partners. If this drives up the ultimate price to the consumer, a reduction in sales volume may reduce overall profit despite the higher profit margin. The end result of each partner’s activities must optimize value for the supply chain as a whole. There are also stakeholders that are external to the supply chain’s business partners and end customers. These include investors, lenders, communities, and governments. To investors and lenders, supply chain value may be defined as capital growth, dividend income, or interest payments and eventual return of invested capital. Investors expect returns to be equal to or greater than those that could be earned from a market investment of similar risk. Communities and local governments may also feel the impact of supply chain operations because they affect community members

and their environment. The location of a retail outlet, warehouse, or other supply chain facility will impact the community where it is built and maintained. The community, and its political leadership, may judge this impact to be a positive value (e.g., jobs) or a detriment (e.g., pollution or noise). Stakeholders usually have different views of what value a supply chain should create, and supply chain activities that are beneficial to one stakeholder group can be harmful to another. So managing a supply chain successfully sometimes requires balancing increases in value for one stakeholder with decreases for another. Everyone must be satisfied enough to continue participating. Customers have to keep buying, investors have to keep investing, workers have to keep showing up and giving their best, communities must be satisfied with each supply chain partner’s impact on social and environmental values, and so on. Exhibit 8-8 lists typical supply chain stakeholders and the types of things each typically values. Exhibit 8-8: Supply Chain Stakeholder Values Supply Chain Stakeholders Companies in supply chain

Stakeholder Values Profit margin, market share, revenues, expenses, image and reputation

Supply Chain Stakeholders

Stakeholder Values

End customers

Affordable, safe, attractive, useful products; affordable, timely, secure, easy, pleasant services; sustainable manufacturing practices

Investors

Return on investment (capital growth, dividend income), comprehensive and comprehensible communications

Lenders

Risk commensurate with reward, long-term stability, interest and return of principal

Communities/ environment

Tax base enhancement, sustainable manufacturing practices, environmental impact (safety, aesthetics, convenience, natural resources), attractive jobs

Governments

Legality, regulation, overall impact on community members and environment

Employees

Job security, wages and benefits, opportunity, good working conditions, sustainable and safe manufacturing processes

Types of Value Supply chains should create three types of value—financial, customer, and social—regardless of whether they are functioning within for-profit companies; nonprofit, charitable, or governmental organizations; or branches of the military. Financial Value Adding value that customers desire promotes increased sales, which can lead to an improved bottom line and more stable cash flows.

One method of increasing financial value is to reduce costs. Take these considerations into account when looking for opportunities to cut costs in a supply chain: Cut costs to yield net gains at the bottom line. One danger in pursuing cost reductions is the possibility that spending less in one area of the business will simply mean spending more elsewhere or even possibly creating a net loss. In the early stages of supply chain maturity, this sort of suboptimization happens often. The warehouse manager might, for example, eliminate one or more storage facilities to save warehousing costs without consulting with the traffic manager about the need for compensating changes in transportation. A more evolved supply chain management function (possibly outsourced) analyzes relevant data, including data on demand and transportation cost, to derive the appropriate size, location, and number of warehouses using inventory optimization software. (The APICS Dictionary, 16th edition, defines inventory optimization software as “a computer application having the capability of finding optimal inventory strategies and policies related to customer service and return on investment over several echelons of a supply chain.”)

Changes at any one point in the system will create changes elsewhere; therefore, change has to be viewed holistically. Supply chain management necessitates cross-functional teamwork for the internal change and cross-entity teamwork for the lateral chain. The guiding principle always has to be creation of value at the customer’s end of the chain. If a leaner supply chain can deliver the same customer satisfaction with a greater profit, then cost cutting is justified. It takes money to make money. Many of the improvements in supply chain performance require investments of money up front to realize greater revenues, profits, or both down the line—or simply to remain competitive on a global playing field. As always, the end result has to be a net gain. If an improvement in the supply chain brings in more revenue than the cost of the investment, then it’s justified. Purchasing automated machinery to improve warehousing, upgrading hardware and software, training managers in team building, and other investments may be necessary to build and maintain a competitive supply chain. Measures of financial success include return on investment (ROI) and return on assets (ROA) . ROI is defined in the Dictionary as “a relative measure of financial performance that provides a means for comparing various investments by

calculating the profits returned during a specified time period.” ROA is defined as “net income for the previous 12 months divided by total assets.” Gains should be equitably distributed. Be careful when pursuing increases in supply chain efficiency or effectiveness that are unevenly distributed to stakeholders. If cost cutting is used to cut prices for the consumer and the result is enough extra volume to more than compensate for the lower price per unit, then overall profits increase for the organization, other supply chain partners, and their investors. However, one can go too far in this regard. While most of these cost savings should be passed on when selling price-sensitive products and services in a market that has other low-cost competitors, even in this case, some of the savings should be shared with partners and/or reinvested in future supply chain improvements. Perhaps the most challenging task of all in a supply chain is agreeing on productive sharing of any financial gains. For instance, a powerful nucleus firm can rake in the benefits of an alteration in the location of inventory (or any other process change) at the expense of its suppliers. This can be self-defeating if it drives away quality suppliers. Teamwork among supply chain

entities can create improved value for customers for a net financial gain that is equitably shared by all stakeholders. Maintenance and upgrades to the supply chain’s infrastructure require continuous reinvestment. Equipment and technology need to be acquired and maintained. Employees have to be compensated at a competitive rate, trained in new processes and products, and recognized for their contributions. Research and development need support in identifying market needs and creating products and services to satisfy them. Customer Value In a competitive economy, making money depends upon responding to customers’ needs. The ultimate goal of market-driven supply chain management, therefore, must always be to deliver products and services that the customer values—and, of course, will pay for. Depending upon the market being served, a supply chain may be managed so that it delivers one or more of these values to its end customers: Quality of product or service. Quality applies to all products and services, from the production of a product like a bed mattress to the reliability and speed of cellular network services. Decisions all along the supply chain have to be coordinated to achieve the

appropriate level of quality through the right design, the right production, the right personnel, and the right materials. Affordability. Almost all products and services have an appropriate price level, one to which the market will react favorably. The supply chain has to invest in the processes, people, and technology conducive to creating a product at the right price. If a company’s marketing strategy is to provide the best everyday low price, this demands complete efficiency in the supply chain. Supply chain managers who are operating with those types of goals must develop collaborative design processes so that products are inexpensive to source, easy to ship, and have few quality issues. Availability. For some products or customers, availability is of paramount value and the supply chain has to be designed to deliver products and services right on time. This may affect not only the placement of inventories but also the selection of transportation modes (overnight delivery, refrigerated containers, etc.). Service. Product and service are inseparable. For example, the process of delivering a vehicle to a customer is intertwined with related services—transportation, financing, dealer preparation, sales, warranty agreements, and repair and replacement services

at the dealership. Collaborative design will include input from marketing, manufacturing, logistics, and supply to determine a product’s service requirements so it will be easy to maintain and can facilitate planned services. At the same time the team will implement an efficient reverse chain that takes products back for repair, replacement, or recycling. Sustainability. Consumers and customers are a driving force behind environmental and social supply chain innovation. For some individual consumer segments, sustainability is important enough that they will pay a premium for that good or service. (Estimating this premium can be difficult, however.) Opinions for or against a company’s environmental practices may be shaped by the media, community groups, environmental organizations, lobbyists, and others who exert social pressures. Boycotts or negative social media campaigns are examples of related reputation risks. There is no logic in making customers pay for a feature or service they don’t value or that isn’t required. If, for example, availability is a key value to customers, such as for critical maintenance parts, emphasis in the planning stage might be placed on fast and reliable delivery services, even if that requires cutting back elsewhere to stay within budget. Similarly, some perishable goods require special

handling by high-end carriers to reduce spoilage risk. However, if the customer doesn’t value immediate availability and the product doesn’t require it, then putting money into rapid delivery is not a rational supply chain decision. An international fashion clothing brand such as Zara succeeds by focusing its attention on its customers’ values—creativity, quality design, and rapid turnaround—to capture and quickly deliver the latest trends in taste for each new season. All their decisions about suppliers and distribution must serve those goals. Social Value Supply chains are also judged on their contribution to society. Delivering socially desirable and useful products or services. Supply chains deliver products and services that are embedded in a social and cultural environment. Businesses produce what society demands. Bullet trains in Asia and Europe exist because those societies value speedy public transportation. Supply chains also affect society in terms of the jobs and tax revenues they create. Avoiding or reducing negative environmental side effects from extraction, processing, and construction. The impact of business on the natural environment applies to supply chain

activities all the way from extraction of raw materials through manufacturing processes, logistics, and distribution. Through laws and regulations, society requires businesses to contribute to a healthy environment. Conformance to these regulations has become an increasingly significant part of supply chain management, including accepting back sensitive materials at end of their life cycles using a reverse supply chain. Integrating sustainability into the supply chain. Investment analysts often reward forward-looking environmental and social policies and supply chain practices.

Existing Network and Process Evaluation Information gathered about organizational strategy and about the supply chain’s value proposition are inputs into the next step in generating a supply chain strategy: evaluation of the existing network and its processes. You need to know where you are and what you are actually good at before determining what needs to be improved. We’ll look at the general capabilities needed in a supply chain and at supply chain core competencies.

General Capabilities

A supply chain strategy needs to specify how it will arrange and prioritize its various capabilities. Every supply chain is made up of organizations, people, processes, and information. Each supply chain’s capabilities are based on its Organizational design Processes Systems and technology Human resources Metrics (measurement techniques). Evaluating the existing network and processes in these areas involves determining how much priority the supply chain currently places on each of these elements and how mature each area is relative to internal goals or external benchmarks. Organizational Design According to the APICS Dictionary, 16th edition, organizational design refers to the creation of an organizational structure to support the strategic business plans and goals of an enterprise (e.g., for-profit and not-for-profit companies). Given the mission and business strategy, the organizational structure design provides the framework within which the business operational and management activities will be performed.

Organizational design also encompasses how the organization communicates internally and externally, the chains of authority and responsibility, financial management, and job hierarchy and descriptions. The key question to ask is the degree to which the organizational structure enables or hinders supply chain management. Supply Chain Processes Supply chain management covers a series of linked processes. Although management of any one activity or link in the chain may be straightforward, effective supply chain management requires mastery of these connected processes. It is important to assess the maturity level of these interconnections since they are hard to form and keep. Systems and Technology Being able to integrate, implement, and manage sophisticated software that can automate complex and numerous transactions involved in supply chain management is a critical capability. Information systems may enable organizations or supply chains to integrate operations at various levels: integrating one plant, partial or full cross-company functionality, or multiple supply chain partner integration.

Many organizations use an enterprise resources planning (ERP) system to provide transactional support for multiple business processes. It is important to assess whether the ERP system enables critical links between strategy and operations and supports the specific supply chain capabilities that a company desires. When assessing existing levels of partner integration, explore what technologies the organization is using to transfer data between parties, how much automatic identification and data capture technologies are being used to automate the process, and whether the information is being put to use, such as for marketing analysis to gain insight into customer behavior. When making these assessments, review information on each supplier category related to how much you need them and how much they need you to place the current level of integration into context. Some suppliers may need better integration than they currently have. Making technological advances has challenges, however. Hurdles may include incompatibility of programming languages and different software applications and network protocols. There are also human and organizational barriers that can prevent taking full advantage of available technology. Despite the steady moderation of price and increase in user-friendly electronic linkages, some departments or users may question the usefulness and related costs of technology.

New users of this technology have to be trained, and, in some cases, they also have to be converted from a skeptical to an accepting attitude toward new technologies. Change management is therefore critical in implementing technology design. The most significant assessment to make with partners is to determine the degree to which you trust them and vice versa. Lack of trust among companies along the supply chain and even across functional areas or teams within organizations can undermine integration goals. Trust is built in small increments, so assess what steps each party has taken or plans to take to build trust. Steps that prove effective with one party might be used with other parties. Human Resources An organization is significantly impacted by the manner in which it creates and organizes its functions and how the people within the departments manage the business operations and key processes. Horizontally organized supply chains typically have no unified ownership or management structures (unlike vertically integrated supply chains), but more mature chains may develop crossfunctional planning and implementation teams that have executive sponsorship from each organization. It is also important to assess how much the supply chain management mindset has been embraced at the organization and at

partner organizations. Development of supply chain strategy and the control of supply chain processes depend entirely on having the right people in place—people educated in supply chain thinking rather than functional silo thinking, Of necessity, supply chain management sometimes draws upon personnel attached to multiple functions, yet they may be available only part-time to the supply chain team. These functions also need to understand the benefits of supply chain and functional area integration. The hiring and training programs of the organization and supply chain partner organizations should be assessed to see whether the organizations are acquiring and developing properly skilled, processoriented, and knowledgeable supply chain specialists to design and monitor supply chain processes. An assessment should also be made as to whether other functions receive some basic level of training on supply chains to sell them on the benefits of supply chain management. Change management may also be needed. Unlike specialists in traditional functions—production, logistics, procurement, etc.—an organization needs supply chain personnel with expertise that extends beyond deep knowledge of one area or functional discipline. These personnel need to be broadly knowledgeable about the enterprise as a whole and trained in the art of inspiring people to work harmoniously in pursuit of a common

goal. People on supply chain teams may represent every function, from procurement to marketing. On occasion, the supply chain manager may need to work as a diplomatic go-between when mistrust and misunderstanding prevent team members from cooperating with one another. In addition to the multidisciplinary, communication-savvy, holistically oriented supply chain manager, the organization and the supply chain need people with specialized skills to contribute to the success of supply chain initiatives. For instance, a team member with cost accounting or technology expertise comes in handy when planning an initiative. With so much pressure to keep costs low, upgrade initiatives must be skillfully managed to keep costs in line and avoid driving up product prices. Modeling the process in advance with data from supply chain partners can help prove feasibility and speed later implementation. Finding and developing the level of talent required to manage supply chains requires skilled and knowledgeable human resources management staff. The degree to which human resources policies support and enable or hinder the integration efforts required of a supply chain need to be assessed. In large organizations with complex bureaucratic structures, the key to improving such policies is to find an executive-level champion.

Supply chain professionals should be able to do the following: See the supply chain as one continuous entity made up of linked processes. Manage relationships among and between teams to coordinate different temperaments and visions. Understand the business model and its alignment with the supply chain. Manage costs skillfully for the chain as a whole. (Understand net value.) Identify technology requirements such as to provide the entire supply chain with visibility at the required level of velocity (e.g., real-time updates). Supply Chain Metrics An organization should have the right set of metrics in place and be capable of measuring these key performance indicators efficiently. To answer questions such as “How well is the supply chain performing?” or “Is our supply chain helping or hurting corporate objectives?” the answer should include a data-driven component. Here are some ways to benchmark an organization’s past performance: Desired performance (to show how close or distant from goals) Competitor performance

Industry average performance (“We’re better than average!”) World-class, or best-in-class, performance from any industry for the same activity or process you’re assessing Quantitative data generally provide the most convincing evidence. When discussing your cash-to-cash cycle, for instance, you might say “We’ve got it down from 50 days to 20, and that’s better than the industry average.” Organizations can also use a checklist to measure performance. This could include certain activities, types of equipment, technologies, etc. One example is the Oliver Wight supply chain excellence checklist. (Refer to the Resource Center for more information.) Summing Up Taken together, the elements just discussed determine the capabilities of organizations within a supply chain. The assessment of existing networks and processes should look for Integrated organizational design with a process orientation Key supply chain processes in place and functioning at competitive velocity Systems and technology sufficiently advanced to tie all processes together and allow the supply network to operate from the same, simultaneously available data

Educated and skilled employees who have a process focus, can see the end-to-end supply chain as a single entity, and manage accordingly Metrics that are in place to assess performance against a relevant standard and locate areas for improvement. All of these supply chain capabilities should be aligned with one another and with the supply chain strategy. One major international petroleum company, for example, instituted advanced information technology to convert from a forecast-driven to a demand-driven enterprise. Demand data from filling stations and large industrial customers became available throughout the supply and distribution networks for use in marketing, logistics, planning, and refining. These shared demand data fed into virtually every decision made along the supply chain, from spot-market purchases to scheduling of refill runs. When all supply chain processes operated from the same base of data, the partners functioned as seamlessly as a “virtual network” (as if they were one company).

Supply Chain Core Competencies An organization’s supply chain management function may excel in certain areas, and these may be core competencies if the function does them better than the competition or third parties could do them.

By contrast, things that are not core competencies are things that others can do better, faster, or more efficiently. Core competencies can include tangible elements, such as having a fleet of trucks of the right size plus great truck-routing software, and intangible elements, such as excellent management skills or a high-service supply chain brand image. Determining core competencies involves considering how an organization’s internal capabilities differentiate it from its competition in each of the following key items: Adding value to products, such as shorter time to market Improving market access, such as providing new market channels Building financial strength through increased income and shared costs Adding technological strength if there is internal expertise in the use of more advanced software and systems Strengthening operations by lowering system costs and cycle times Enhancing strategic growth to break through barriers to new industries and opportunities Improving organizational skills that facilitate shared learning and insights among management and employees (internally and/or among other partners) Assessing the current state of what the organization considers to be core competencies can reveal gaps that can be the focus of change

initiatives, or research might reveal that more major changes are needed, such as if new service providers now exist who can outmatch the organization’s capabilities. Organizations leverage their and others’ core competencies in order to achieve defined goals and objectives. The following supply chain management objectives are key areas to assess when implementing a business strategy and determining where to invest: Excellence in customer service Effective and efficient use of systemwide resources Effective and efficient leveraging of partner core competencies Excellence in Customer Service Customer service , according to the APICS Dictionary, 16th edition, is “the ability of a company to address the needs, inquiries, and requests from customers.” It can also be explained as a “measure of the delivery of a product to the customer at the time the customer specified.” Organizations with a customer service core competency will develop and use their customer service strategy to identify and prioritize all activities required to fulfill customers’ logistical requirements at least as well, or better, than the competition does. The strategy should address the fundamental attributes of basic customer service: availability, operational performance, and customer satisfaction. The

organization may consider one or more of these areas to be a core competency. The organization may also target the measures that are weak if it wants the overall customer service area to be a core competency. Let’s take a closer look at each of these attributes. Availability is having the product where and when it is wanted by a customer. Great supply chain management organizations can achieve high levels of availability while keeping investment in inventory and facilities to a minimum. Such an organization is less likely to have products out of stock over time and is more able to ship complete orders. (If a customer order is missing only one item out of several, the order is considered incomplete.) Measures tied to availability include stockout frequency, fill rate, and orders shipped complete. Operational performance deals with the time needed to deliver a customer order. Great supply chain management reduces the elapsed time from when the customer places an order until the product is delivered and ready for use. Well-designed supply chain management systems might focus on facilitating speedy and reliable delivery at a higher costs; facilitating slow, steady, and inexpensive delivery; or maintaining both as competencies by having multiple supply chains. Another operational performance competency to assess is whether the supply chain is flexible

enough to accommodate unexpected or unusual customer requests or shifts in demand. It should also be determined whether there is a sound system for responding to service failures and whether there are contingency plans in place for disruptions. Customer satisfaction takes into account customer perceptions, expectations, and opinions based on the customer’s experience and knowledge. Mature processes include discussing and clarifying customer expectations for an order in terms of quality, price, and delivery. Increases in customer satisfaction can be evidenced by seeing how many successful long-term customer relationships exist. Effective and Efficient Use of Systemwide Resources Effectiveness is doing the right things, and efficiency is doing the things right. Both are needed for an organization or supply chain to have a core competency in its use of resources, and both need to be balanced for the organization to thrive, as illustrated in .

Exhibit 8-9: Balancing Effectiveness with Efficiency

Use of supply chain resources is effective when it helps the organization achieve its business objectives. Resources can be in the form of workers, raw materials, equipment, etc. Being effective means that the supply chain gets the right product and the right amount to the right customer at the right time and price. Effectiveness is measured against the customer’s needs and wants —while still meeting cost objectives. For instance, if a supplier encounters a glitch in its normal mode of over-the-road transport of the car parts that it makes for an auto manufacturer, it could still get the order to the customer on time if it sends the parts via air. Air is far more costly, but it contributes to the company’s effectiveness in meeting its customer needs, in this case, for a plant that doesn’t need to shut down due to lack of parts.

Companies use a variety of tools and metrics to measure effectiveness, such as benchmarking and comparing the company’s actual performance against its organizational strategies for growth, increased sales, increased customer satisfaction ratings, or improvements in the metrics of the SCOR framework. Supply chain management enables an organization to be more effective in reaching these types of strategic goals. Efficiency is defined in the Dictionary as a measurement (usually expressed as a percentage) of the actual output to the standard output expected. [It] measures how well something is performing relative to existing standards. Efficiency is inward-focused, in that an organization or its extended supply chain looks to its internal processes to determine how the processes can be done less expensively, in less time, and with fewer resources without missing customer service targets. Efficiency is one of the measures of capacity in a supply chain. Capacity is all about what can be accomplished by employing all the resources in the supply chain network. That includes work centers, storage sites, people, and equipment. An efficient system will have greater capacity than the same system would have with poor efficiency. According to the Dictionary, capacity has two meanings:

1) The capability of a system to perform its expected function. 2) The capability of a worker, machine, work center, plant, or organization to produce output per time period. Supply chain management can increase the efficiency of any mix of manufacturers (or service providers), suppliers, and customers in a supply chain. When a supply chain is operating at high efficiency, it means that it’s using its resources well to produce the level of output in a production plan within the time allowed. If it does so while meeting customer service objectives and other key performance indicators, then it is also effective. Effective and Efficient Leveraging of Partner Core Competencies If the organization is able to recognize when another organization is stronger in certain core competencies, at least in certain specialized areas or regions of the world, then it will be in a position to leverage these competitive advantages. If the organization and its partners can achieve more together than they could have individually, then mutual strengths are being effectively leveraged. The selection of the “right” partners means that their corporate cultures, operating styles, and business practices are

similar enough for the benefits of an alliance to outweigh the negatives. Well-chosen partners will benefit from a high level of mutual trust, respect of each other’s expertise and contributions, and a shared common vision. In order to leverage a partner’s strengths, the organization must identify the partner’s core strengths or competencies and reassess them over time. Supply chain management technologies and practices can help a company select the appropriate partners and support them by Providing and receiving timely and accurate information Helping them deal successfully with channel customers and marketing Aiding them in leveraging their strengths, such as innovation, speed, high quality, low cost, etc.

Cost Structure, Revenue Model, and Tax Strategy A supply chain strategy needs to build off of its value proposition and core competencies to show how it will add financial value. Here we look at how supply chain strategy needs to specify a cost structure, a revenue model, and tax strategy.

Cost Structure

A supply chain’s cost structure (or at least one organization’s portion of it) consists of spending priorities for customer service, sales channels, value system, operating model, and asset footprint. Note that what you own or lease will carry a different cost structure from what you contract out, but both methods have related costs. Outsourcing or partnering costs include supervision costs and a reduced share of total revenues as benefits are shared with more partners and service providers. Like other areas of supply chain strategy, a supply chain’s cost structure needs to support the organization’s overall cost structure. For example, if the organization chooses low cost as its basis of competition, then the supply chain strategy will tend toward efficiency as its cost structure. An efficient supply chain will have economies of scale, will use third parties whenever the total cost is the lowest, and will minimize more expensive forms of customer service such as expensive sales channels. Even in a make-to-stock operating model, inventory levels will be minimized. This model will not be able to emphasize responsiveness, such as ensuring delivery during an emergency, as high levels of responsiveness come at a high cost. On the other hand, if the organization has innovation or customer experience as a basis of competition, its supply chain will likely

pursue this focus or differentiation competitive basis by investing in responsiveness, so that it can respond quickly to changes in market conditions, transformative technologies, the need to increase capacity (i.e., agility), new competitors, or the incorporation of newly acquired organizations. In this case, the cost structure will not be able to also maximize efficiency in all areas, as some redundancy and scalable capacity may be needed. Regardless of the strategy, costs will need to be tracked and controlled so that they can be minimized to the extent possible given the strategic goals. Depending upon the type of industry, supply chain costs can be as high as 50 percent of a company’s revenues. According to research done by A. T. Kearney, a global consulting firm, inefficiencies in the supply chain can total 25 percent of a company’s operating costs, so there is often significant room for improvement. Spend management is one tool that organizations employ to ensure that outgoing funds are appropriate and authorized. The APICS Dictionary, 16th edition, defines spend management as managing the outflow of funds in order to buy goods and services. The term is intended to encompass such processes as outsourcing, procurement, e-procurement, and supply chain management.

Spend management often deals with consolidating internal demand across business functions, divisions, or extended partners and/or consolidating suppliers in a given category to find areas for purchasing and transportation quantity rate discounts. Relative to financial performance, spend management involves managing the outflow of funds in order to buy goods and services. Spend management may also need to coordinate closely with accounts payable, because payment timing is vital to spend management execution. If supply chain management can reduce the amount spent on inventory or increase the speed with which inventory is converted into cash without reducing customer service or revenue, then it contributes directly to the company’s financial performance. Saving money will always be a priority; organizations realize a more direct gain when costs go down than when revenues go up. This is because when revenues go up all variable expenses also go up. When sales increase, variable costs, such as direct material and labor costs, increase along with the revenue increases. However, cutting, say, one dollar per unit from a cost increases the profit margin by one dollar per unit, so the entire gain is leveraged.

Revenue Model

A supply chain’s revenue model will parallel its organizational equivalent. However, a supply chain doesn’t directly produce revenue unless the sales channels are included in what is defined as the supply chain. Supply chain strategy can include establishment of sales channels (e.g., warehouses, transportation networks, network partnerships) that do generate revenue. In the past, a supply chain was perceived as a cost center. This mentality led to cost-cutting measures that often compromised value. More modern supply chain revenue models consider the supply chain as a value-added service that earns the organization a share of the revenue it is producing. Supply chain managers need to play a role in justifying supply chain management by promoting it with executives as a value-added function.

Tax Strategy Supply chain management strategies have an impact on tax planning because multinational organizations often work to reduce the global tax liability of the extended enterprise. Paying less in taxes around the world translates into increased earnings per share. Organizations that operate internationally can design their supply chains to take advantage of tax regulations in various regions that are designed to lure business to a specific country, region, or local area. This will be just one factor in the decision to move some part of

operations to a given area, so the goal will be to find areas with the minimum total supply chain cost. As taxes increase, these advantages tend to play a greater role in the decision. In many cases, the headquarters of an organization may move to one location to minimize income taxes while other supply chain operations move elsewhere to take advantage of operational tax advantages. A tax-aligned supply chain (TASC) is one that weighs taxation among other supply chain costs and challenges. By aligning tax planning with supply chain efficiency initiatives, an organization might find a location that increases both efficiency and tax savings. This strategy applies for the most part to large, multinational organizations that are in the midst of modifying their supply chains, giving them the opportunity to locate assets and operations in low-tax countries. The World Bank’s “Doing Business 2020” includes an indicator for tax policies by country. A link to this index has been included in the online Resource Center. Types of Taxes Various types of taxes might be used as incentives, including property, income, and value-added taxes (VAT). The taxes might be lowered for an area for an indefinite period through a change in tax policy. For example, Ireland was granted a tax advantage for VAT. The tax on the value added in that country is 10 to 12 percent rather

than the 20 percent assessed in the rest of the European Union. If considering moving there to save a net of 5 to 10 percent in taxes, supply chain managers need to weigh this savings against other costs, including labor and transportation infrastructure. Certain taxes can also be eliminated using a tax holiday, which waives taxes on specific inventory, property, plant, or equipment for a temporary or indefinite period. Procurement and Taxes When rethinking procurement strategy, multinational corporations may decide to set up a central, global procurement and sourcing center to create efficiencies from consolidation of staff and equipment. If, in addition, the company locates the facility in a lowtax region, the tax savings will magnify the savings from efficiencies of scale. If a centralized procurement facility is created, it could also reduce tariffs, another type of tax. Taxes and Logistics Networks Some organizations review their logistics networks every five years or so to see if they can find ways to improve the efficiency or effectiveness of product flows. While they’re cutting lead times, reducing manufacturing costs, and shaving transportation outlays, they can also reduce their global tax liability by closing facilities in

high-tax jurisdictions and moving them to countries with lower tax rates. Taxes and Information Technology One tax-saving strategy is the purchase of supply chain software to improve planning and responsiveness. This could be an enterprise resources planning (ERP) system that automatically determines the right tax payment for the company and locates all justifiable tax credits and deductions. Such systems can also be useful in complying with corporate governance regulations, such as the U.S. Sarbanes-Oxley Act.

Reasons Misalignments or Gaps Occur A strategy that works today may not be as effective in the future. Supply chains are dynamic in nature, and those that focus on responsiveness are especially so. What drives these changes? There are several important factors that can cause an organization to need to alter its supply chain strategy: Change in market conditions Change in business direction Disruptive technology Anticipated change in market

Business combination or merger Product life cycle changes

Change in Market Conditions Changes in market conditions can happen with stunning rapidity. But they can also evolve steadily and incrementally over time. The key is for supply chains to spot these changes early and adapt quickly. Some examples follow. COVID-19–Related Supply Shortages COVID-19 disrupted many businesses’ ability to operate. Not only did some factories need to shut down for certain periods, but some materials faced new export restrictions and once reliable international sources of supply were completely halted. The need for domestic production of many materials suddenly had great importance. For example, many of the precursor materials for mRNA-based COVID-19 vaccines and other DNA-based therapies could be found only in China and South Korea. Since so many organizations rely heavily on supplier expertise, such as an automobile manufacturer relying on a touch-screen supplier, many organizations found that they were reliant on small suppliers who were high risk because they operated in only one country and/or one plant.

These supply shocks forced many organizations to reexamine their supply chains. According to an article by Willy C. Shih in the Harvard Business Review, organizations need to find ways to add resilience without weakening their competitive position (e.g., failing to be pricecompetitive). A key way to do this is to take a deeper dive into one’s suppliers and their suppliers. This process is expensive and timeconsuming, so traditionally organizations have focused on their major suppliers or areas with the most room for bottom-line improvements. The article includes suggestions by supply-chain executive Tom Linton and MIT professor David Simchi-Levi to perform a mapping process on suppliers that determines their relative risk of creating disruptions. Suppliers with less geographic diversification or no presence in the home country and whose products have few alternate sources would be high-risk. Suppliers who would have the most impact on revenue if the source is lost would also be high-risk. Suppliers with metrics proving great disruption recovery time (e.g., SCOR model measures such as supply chain flexibility and supply chain adaptability) would be lowerrisk. Other ways to reduce supply risk suggested by the article include the following: Diversify the supply base. Some organizations are adding a “China plus one” strategy, meaning that they still source from

China but add at least one supplier in a different country as well, such as Vietnam, Indonesia, or Thailand. Use cost of disruption as a factor for setting safety stock levels. Use the need to relocate or to add redundant capacity as a way to build in new process efficiencies and lessons learned from other plants. Invest in automation not only as a way to reduce variable costs but as a way to help increase social distancing and reduce risks of disease spread. Rationalize the number of product families or products. Toilet paper producers, for example, contributed to the shortages of this product because they had so many varieties to produce (least expensive single-ply for businesses and hotel chains and multi-ply in many package sizes for consumers) that they could not meet demand for any particular variety. An article from Business Wire related to the impact of COVID-19 cites an opinion by Gabriel Smith, a pricing expert at Pricefx, who believes that the Just-in Time revolution’s focus on cost cutting through inventory reduction has gone too far, since it expects every supply chain element to be perfect. He recommends putting a premium on availability into inventory cost calculations and simplifying one’s pricing models so that pricing is more transparent

and more based on actual profit drivers. The latter changes can keep costs low despite having more suppliers and/or more inventory. Nestlé and Demand Disruptions Retailers selling goods in brick-and-mortar stores in China, including Unilever and Nestlé SA, were hit hard by a fast and sharp drop in retail demand. Overestimated retail demand forced Unilever to post 20 percent drops in both third and fourth quarter 2014 China sales, while, according to a Wall Street Journal article from June 2015, Nestlé was burning instant coffee it couldn’t sell. The article goes on to state that while Unilever claimed the slowing economy played a role, the trend had much to do with the rapid increase in consumer online shopping. The story highlights how difficult it is to keep a supply chain flowing smoothly when something minor, such as delivery patterns, shifts. Online purchasing has high competition, so not all online sales will be through one organization, even if it does have well-developed ecommerce. While large organizations were once able to negotiate with retailers for preferential display space, as Nestlé’s China food and beverage director Reinhold Jacobi says, “If you go online, everyone gets the same screen space.” Zara and Mango

In the market for fashionable apparel, change is a given rather than a surprise. Every season can bring a shift in taste that makes all processes, designs, and materials outmoded. So Zara, Mango, and other fashion-conscious clothing companies and brands have found ways to begin the seasonal design process early. By paying careful attention to trends on the street, they can get a head start in ordering materials and developing prototypes of designs that seem likely to appeal to their target customers in the upcoming season. But they delay final design decisions and the start of manufacturing until real data come in.

Change in Business Direction Another reason to modify a supply chain strategy arises when a company comes to market in a new way. It may be entering uncharted territory with no real data to use in making decisions and little ability to forecast demand and set production schedules. A new product line may require complete recasting of the supply chain— new raw material suppliers, new manufacturing processes, logistics changes to reach new markets, and new strategies for reaching the end customer. Toyota faced those challenges when it introduced the Prius, its first gasoline-electric hybrid car. There were no comparable vehicles in the market at the time, so there was no demand history to use in

forecasting sales in the aggregate or for segmenting the potential market. Toyota dealt with the challenge of forecasting by changing its logistics network in the United States to reflect its uncertainty about where it would be delivering the new models and what sort of buyers might be interested in them. They suspected that new market segments might be attracted to the offbeat styling, technical inventiveness, and “green” characteristics of the Prius. Instead of allocating cars to dealers based on past performance, they sent Priuses from the production line to central distribution centers for shipping to dealers only in response to customer orders. With the larger pool of cars in central locations, they reduced the risk of stockouts caused by unexpectedly large consumer demand in any one region. Toyota also allowed for customization of cars at the distribution centers in response to requests for specific features—a postponement strategy made possible by modular design. The system was more expensive, but it provided the required flexibility in delivery. The percentage of the new model sold in northern California far exceeded the usual percentage allocated there, while sales in the southeast were far less than demand patterns for other Toyota models would have predicted. Without the centralized logistics setup,

the Prius would no doubt have gone immediately out of stock on the west coast while sitting unsold on car lots in the southeast. So the investment in a new supply chain strategy provided net value when compared with the probable costs of redirecting cars from the southeast all the way across the country to California and risking the loss of customers due to the resulting delays.

Disruptive Technology New technologies can change the rules of the game and allow new competitors to quickly take market share from an organization if it doesn’t recognize the implications of the technology quickly and also adopt it. For example, when Netflix announced that its primary business model would be electronic delivery of movies, its competitor Blockbuster and many others may have scratched their heads, since DVD delivery was the business model Netflix had used to grow so large in the first place. However, their move proved to be prophetic, as their rivals were too late to adopt a similar model and went out of business.

Anticipated Change in Market Innovation is the key to strategic flexibility when there is time to implement changes in advance of an anticipated market change. Innovation in product design, supply chain design, and organizational design plays a major role in keeping supply chains

flexible enough to respond to rapid changes in supply or demand as well as more gradual evolution of markets and technologies. As the case of the Prius indicates—and to a degree the strategies of Zara and Mango—supply chain strategies can be modified in anticipation of changes in demand rather than waiting until they come as a surprise. This might be considered an advanced form of forecasting, and since forecasts are always wrong, a very risky strategy. A clothing design operation has no choice but to forecast, since it has to anticipate trends in fashion on a continuous basis. If a new look will depend on natural fabrics instead of synthetics (or vice versa), new suppliers will be necessary, and they will have to be under contract before the season begins. Zara and Mango are effective because they are committed to creating a design process that allows for revamping supply strategies at the last possible minute when real data are beginning to replace forecasts. Toyota’s success was due to its innovative approach to the marketplace; in anticipation of new demand patterns resulting from environmental consciousness and the potential impact of rising petroleum prices, the Prius was created. The company was additionally successful because they were proactive in setting up a new supply chain in advance of Prius sales that was suited to an innovative product.

Sometimes it’s an organization’s strengths that make it most vulnerable. Trust in other supply chain partners can cause problems when they are not up-front with changes to their strategies. In addition, supply chain efficiency can become a serious liability if the chain loses its flexibility because they have removed all the buffer from inventories or pared process times down to the Just-in-Time delivery velocity. A supply chain that has become fast and lean may just keep right on running in a given direction until it starves to death for lack of a market.

Business Combination or Merger When an organization acquires or merges with another organization, their supply chains may also need to merge and reconfigure. Some redundancies can be minimized, while other redundancies might be maintained to improve flexibility and reduce risk. A careful review of each function will be needed to see what can be integrated, what is best kept separate, and what needs to be eliminated. Another consideration is customer experience and perception. While some supply chain changes can be made without any impact on the customer, special consideration is required before making changes that impact customer delivery times, costs, or even the persons with whom customers are accustomed to working.

Product Life Cycle Changes

A product’s location in its product life cycle may require different supply chain strategies as it is introduced, as it grows in demand, as it matures in demand, and as it declines in popularity and other products start taking its place.

Resolving Misalignments or Gaps When working to resolve misalignments between supply chain strategy and overall organizational strategy or to resolve gaps in a strategy, the first step is to recognize when such issues exist. Another prerequisite is to study the past so that the highest-impact improvements can be identified and prioritized. Since there are many areas of alignment, the discussion here focuses on alignment with complexity requirements, with supply chain partners, and with financial requirements. Organizations can use tools such as network modeling or operations research to determine how to structure a new network. Does the organization’s culture reward or punish failure? When failure is punished and only success is celebrated, managers of all sorts will fear being critics. Unfortunately, critics are just the sort of persons who are needed to point out when a strategy has misalignments or gaps. These gaps will eventually become so obvious that everyone will recognize that they exist. However, by

then the impact on organizational market share and other factors will likely be difficult or impossible to repair. An organization can start on the path to becoming a culture that rewards critics for speaking up by using tools such as anonymous surveys or brainstorming meetings where everyone is asked to give reasons why a given strategy might fail. Change management will also likely be needed. A third-party consultant or organization may also be in a good position to provide an objective analysis of the organization and its gaps. Such an organization, or the organization itself, can use tools such as a SWOT analysis to discover the organization’s gaps. Of course, making the decision to act on difficult news takes courage as well, but this is a change that may need to start at the executive level. If supply chains are to be able to respond in advance of market changes, they will have to play by different rules than many have followed in the past. Here are some of the lessons supply chains have learned: Pursue cost efficiencies and increased velocity but not at the exclusion of flexibility. The strategy of shipping only in full truckloads or full containers cuts transportation costs, but it can also leave a partial load of product waiting at the dock when it should be on the road to a stocked-out facility downstream.

Develop multiple supply chains that are appropriate to each product line. To achieve those full truckload shipments, some companies will mix products. While that’s a good strategy for speeding up delivery of some products in the mix, it may be highly inefficient for others. The high-dollar, lightweight items could be flown to their destination rather than staying in the truck, train, or container. One can customize suppliers to provide whatever each product line needs—speed to market, quality at a higher price, or ability to change rapidly. Watch trends in demand at the consumer end of the chain, not just at the next stop downstream. Visibility to the end of the supply chain can speed up response to changes in the market. Watch the larger trends in global markets—changes in demographics, political changes, patterns in rules and regulations, access to raw materials, and so on. Get local assistance for advice on supply chain strategies when you enter an unfamiliar foreign market. Design products for maximum supply chain flexibility. Put suppliers on the design team to offer help in creating modular designs, allowing fewer components to be assembled into more products. Time the assembly to happen as close to actual orders as possible.

Aligning with Complexity Requirements A way to address misalignments or gaps is to evaluate the complexity of the supply chain. A supply chain should be only as complex as it needs to be. Complex supply chains take more time and money to establish, monitor, and control, and they become more difficult to keep agile and responsive to changes in demand. Sources of supply chain complexity include maintaining multiple supply chains for different goods or services, maintaining an extensive asset footprint for production or distribution, the variety of products sold, the amount of configuration needed for products and at what stage, and the number of customization options available to customers. Limiting product and service offerings is a key way to minimize complexity while maintaining flexibility, since reducing asset footprints or reducing the number of different supply chains will severely impact flexibility and customer experience factors. The Performance Measurement Group (PMG), an internal PwC organization, consists of supply chain performance experts who collect data and perform benchmarking analyses of companies across the globe to assess supply chain performance. Their research indicates that best-in-class supply chains have a similar number of customers and production and distribution assets as their

average peer group but roughly 50 percent fewer distinct items for sale (fewer SKU [stock keeping unit] groups). Maintaining only variety that is actually in demand increases flexibility because there will be lower risk of unsold inventory and stockouts. The question to ask (and related metrics to develop) relate to whether the additional options actually increase profits or just increase revenue while increasing expenses such as inventory holding costs even more.

Aligning with Supply Chain Partners When gaps or misalignments exist between supply chain partners, often this requires determining who the channel master is and how much influence the organization has. If it is the channel master, how sensitively has it used its clout in the past with partners? Are they treated as respected partners, or have they been pummeled for price concessions? The latter group may be resisting full alignment with the strategy. Non-dominant players may have more influence with some customers and suppliers than others. The key to segmenting customers and suppliers is understanding if you are in a buyer’s or a seller’s market. If there are multiple suppliers for a customer, each supplier will have relatively less clout, as is true in the automotive

industry. If you make a key component that few suppliers can duplicate, you will have more influence with your customers, as is often true for innovative technologies. The idea is to use that influence to promote collaboration over control.

Aligning with Financial Requirements Using Supply Chain Financial Modeling Financial modeling involves determining the financial feasibility and return on investment (ROI) of a product/service strategy or supply chain strategy. Optimized network models supply cost estimates for financial modeling. Since it is just the increase in costs and the increase in benefits that are important to a decision to create, change, or improve a product and/or supply chain, financial experts use marginal analysis to study the marginal costs and benefits of the option being considered. Marginal costs include constructing, leasing, or contracting out all of the parts of the supply chain that need to be improved, reworked, or developed. They will compare these to the marginal benefits received from new or increased demand and the resulting increases in sales revenues or profit margin. For the benefit side of a benefit-cost analysis, market research provides information on projected demand for the products and services that will be produced as well as target pricing. This

information can then be used to estimate revenues for future periods. Financial modeling has more nuance than just taking the benefits and dividing them by the costs, though this is the basic formula for ROI. Since money that is borrowed requires interest payments and money that is earned can be invested to earn interest, financial analysts factor in the time value of money. Briefly stated, money to be received in the future is discounted to the value it would be worth if received today at current interest rates, called the present value. If you will get US$100 a year from now and interest rates are 10 percent per year, and if someone gives you US$90.91 now, the principal plus interest is calculated as US$90.91 x 1.1 = US$100, so getting US$90.91 now is the same thing to a financial analyst as getting US$100 a year from now at that interest rate. This concept is used in a number of financial metrics, including net present value (NPV) and discounted payback period. With net present value, each year’s future cash inflows are discounted back to their present values, and the present values of all cash outflows are also calculated. The difference between these amounts is a measure of profit in today’s money. Any NPV equal to or greater than zero is a positive sign, but, obviously, the higher it is, the better.

Discounted payback period determines how long it will take to recoup the initial investment or break even. It also discounts the future cash flows to the present value before applying them. A supply chain investment that will take three years to break even is far less risky than one that will take six years. This was a key reason that Target decided to close its operations in Canada in 2015. An analysis determined that the Canadian operations would not become profitable until 2021, and apparently this six-year payback period was not acceptable. What constitutes an acceptable payback period may have to do with alternative investment opportunities and the product being offered. For example, if a product will be obsolete quickly, it will need a fast payback period or the capital investments will need alternate uses such as a follow-on model that can be produced with minimal further investment. There are a large number of other metrics that financial analysts can compile and help interpret. One of these is economic value added. The APICS Dictionary, 16th edition, defines economic value added (EVA) as follows: “In managerial accounting, the net operating profit earned above the cost of capital for a profit center.” EVA is useful because it specifically accounts for the capital investment cost before it calculates profit.

The results of financial modeling will indicate what level of capital investment will be possible. This can help supply chain managers propose product, service, or supply chain designs that are likely to meet business requirements for profitability.

Network Modeling and Operations Research Network modeling (also called network design) and operations research are tools that can be used to revise strategic plans and network designs for a supply chain. Supply chain network modeling involves developing the capabilities to find and enact the least-cost solution for the entire network (efficient) or the ability to manage demand and respond to actual demand (responsive) through some combination of customer focus and/or agility. While network modeling is a large subject, we will restrict the discussion here to the subset of network modeling in which expert analysts create a mathematical model of the supply chain for supply chain managers. A good model will represent the supply chain in all of its necessary complexity but be no more complex than it needs to be (avoiding being needlessly complex and thus error-prone). It is a representation of a supply chain, not a supply chain itself, and so is

complex enough when it can reliably help decision makers choose between available options. Mathematical models have inputs, processes, and outputs. A model’s input parameters can be adjusted to account for where facilities might be located, the number of these facilities, their function, their costs and related transportation costs, and so on. The model will have processes (mathematical relationships and formulas) that automatically translate the inputs into outputs. The outputs will indicate total network costs as well as any other key performance indicators related to strategy that the model developers include. These models are often developed in a spreadsheet such as Microsoft Excel, but more sophisticated modeling tools also exist. Modeling expertise is needed to develop, check, and validate such models. Model errors are easy to create, and there is a risk that the wrong decision will be made based on invalid outputs. The Dictionary defines operations research (OR) (called operational research in the U.K.) as 1) The development and application of quantitative techniques to the solution of problems. More specifically, theory and methodology in mathematics, statistics, and computing are adapted and applied to the identification, formulation, solution, validation, implementation, and control of decision-making problems. 2) An academic field

of study concerned with the development and application of quantitative analysis to the solution of problems faced by management in public and private organizations. Operations research is typically concerned with finding the minimum (e.g., minimum cost or risk) or the maximum (e.g., maximum profit, yield, or performance). The mathematical models developed with network modeling use operations research to solve for optimal network design. Since the problems to solve in an international supply chain are very complex and have many tradeoffs, finding an optimum level for parameters that cannot all be simultaneously maximized or minimized requires computer science. The benefit of harnessing this is that decision makers have some assurance that the choices they are making in regard to expensive capital investments are likely to be wise in the long run. Operations research uses a number of tools to find the best number and location of suppliers, manufacturing and assembly facilities, warehouses and distribution centers, and retail locations. The best solution depends on supply chain strategy. Some networks will minimize total supply chain cost while others will provide best value in terms of the most flexible, the highest quality, or the fastest flow of products through the network. Current best practices promote finding a solution that maximizes flexibility while minimizing cost so that the supply chain can both be resilient to frequent changes in the

environment and provide the maximum potential for organizational profit. Operations research relies on mathematical modeling, statistical analysis, simulation and optimization, economic methods, queuing theory, expert systems, decision analysis, and other tools. While it is beyond the scope of this text to describe these tools, let’s look briefly at one common method: the Monte Carlo simulation. A Monte Carlo simulation randomizes each variable within its available range and runs thousands of simulations, and then it generates statistics to summarize the average results as well as other statistics such as the minimum and maximum. This frames the solution in terms of its possible range of results rather than just being a point estimate. A model that makes risks and opportunities obvious helps decision makers design both resilience and cost efficiency into the model.

Section B: Sustainability This section is designed to Define sustainability and corporate social responsibility Describe what is meant by the triple bottom line and its three aspects—economic, environmental, and social Discuss micro- and macroeconomic considerations for sustainability Explain how to balance short- and long-term economic performance Understand the compliance requirements of mandatory versus voluntary programs Outline the principles of the United Nations Global Compact Describe the Organization for Economic Co-operation and Development’s Guidelines for Multinational Enterprises Describe the Global Reporting Initiative and its reporting standard Define conflict minerals and related reporting requirements Define accreditation and certification Show how accreditations and certifications can improve the efficiency of business operations, productivity, and the bottom line Describe ISO

Describe ISO 9000 and ISO 14000 Series Standards, ISO 26000, SA8000, and ANSI Z.10 and their respective roles. The section addresses the triple bottom line of economic, environmental, and social sustainability along with sustainability guidelines and standards, including some methods of reporting or aligning organizational policies and procedures to international expectations in these areas.

Topic 1: Sustainable Supply Chains Sustainable supply chains can use the triple bottom line concept to redesign their business model to reflect economic, environmental, and social value. Sustainability can be required by law or regulation or be voluntary.

Triple Bottom Line According to the APICS Dictionary, 16th edition, sustainability involves the “activities that provide present benefit without compromising the needs of future generations.” The triple bottom line (TBL) concept has three components that create a sustainable business model, as shown in Exhibit 8-10.

Exhibit 8-10: Triple Bottom Line

The TBL links a company’s ability to keep operating (economic sustainability) with the two other key measures, environmental and social contributions. Originally coined in 1987 by the Bruntland Commission in Europe, this term was popularized by John Elkington in his book Cannibals with Forks: Triple Bottom Line of 21st Century Business. Elkington believes that for an organization to be economically viable over time, it must reinvest some of its profits in market growth. One area of reinvestment is in improving the organization’s reputation. Today’s customers and societies are demanding that organizations make a positive impact on the environment and society. Organizations that listen to these demands and make the required

investments should see more market growth than those that ignore such demands. Making all three of these components into “bottom lines,” or top-level organizational success indicators, usually requires a company to modify or change its business model. It cannot be an afterthought. Integrating triple bottom line thinking into the various aspects of the business involves creating a business plan that reflects the organization’s commitment to conservation and stewardship. Such a plan spells out the company’s mission, marketing, operations, pricing, and growth strategies and explains how it will integrate environmental and social elements into its business strategy. If the business plan determines ways to satisfy all three of these bottom lines at once, this is what Elkington calls the sustainability “sweet spot.” This is represented as the center of the Venn diagram in Exhibit 8-10. These strategies should cascade into the planning, goal setting, and processes of key functions within the company. Once this occurs, the organization should have a truly comprehensive accounting and performance reporting mechanism to measure its progress on multiple levels.

Economic Performance In order to design and operate a sustainable business and supply chain, we need to build a foundation of knowledge about sustainable

business practices and how they contribute to the financial wellbeing of a company and impact its supply chain. Economic, or financial, performance is tangible and can be viewed from both short-term and long-term perspectives, but there is an incentive to promote the short-term over the long-term in today’s business culture. The TBL provides incentives to balance short- and long-term perspectives. Since economic performance is the traditional bottom line for an organization, in the TBL, economic performance is the first bottom line. So how will you balance the financial needs of the organization in the immediate future as well as in one, five, or ten years? What is the right mix of metrics and incentives for the organization and its supply chain? Are the critical players on board and in agreement? Oftentimes in organizations with sustainability initiatives already underway, there is no alignment of the financial-related goals of the different functions involved in the supply chain, which results in tradeoffs between short- and long-term performance. For instance, in “Fudging the Supply Chain to Hit the Number,” authors Godsell and van Hoek found that sales managers and financial managers were too eager to make their short-term targets and would consequently sacrifice best practices of supply chain management in order to make the numbers look better. There is often a gap between these

two functions and the supply chain team, which is quick to offer examples of their integrated supply chain efforts being derailed by sales and marketing’s activities. Here are some examples of the tradeoffs companies sometimes make between short- and long-term performance: In order to meet its end-of-month or reporting period targets, the sales department moves orders to periods about to end by giving the customer incentives to order “now,” such as discounts or competitive payment terms. This impacts the supply chain by putting a crunch in the capacity at the end of the period to fulfill these artificially inflated customer orders and leaves little demand for the beginning of the next period. One way to resolve this is to provide incentives to the sales departments on margin as well as revenue, because these last-minute orders carry a lower margin. Lower margins are not good for short- and especially long-term performance. Sometimes the wrong metrics are being used to make short-term customer service appear better than it actually is. Instead of tracking orders that are delivered by the customer’s requested due date, companies often track delivery by a promise date that it sets. What needs to be done is to track customer service using both request date and promised date, because the request date

originates with the customer and directly impacts customer satisfaction. Customers can take their business to a company that will meet their request date. However, since the request date may not be reasonable or feasible, also tracking a promised date can show that the organization was working to set realistic expectations. Many customers will happily accept a different date than requested if it is explained up front and then fulfilled as promised. Creating a large anticipation inventory, particularly of seasonal products, is another frequent occurrence that looks like it is beneficial but can actually require increased warehouse capacity and raise short-term inventory holding costs. For example, a manufacturer usually must place its orders with suppliers in February for the following Christmas or Hanukkah season, ten months before the event. However, there are inevitably shortages of popular products and too much stock of others. A more effective approach is to segment product lines into two types: shorter cycle times for higher variability items versus longer cycle times for products with more stable demand. Manipulating customer orders or inventory on a balance sheet is called window dressing (when it is done in legal ways), but it harms long-term sustainability. When it comes to manipulating

orders, this is one way it happens: A fairly conservative forecast is made for the following quarter’s sales reported to the stock market. When those sales targets are met before the end of the quarter, new shipments of customer orders are held until after sales results have been reported to the market so as not to overperform. Then customer shipments resume again, resulting in reports that show sales peaks at the start of each reporting period. However, these “faux” sales peaks increase supply chain variability, which in turn requires additional capacity being added, thereby increasing costs and decreasing shareholder value. The tactics can harm customer service too, because delays just for revenue recognition purposes do not have the customer’s needs in mind.

Environmental Performance The following terms from the APICS Dictionary, 16th edition, help illustrate the various ways organizations can define themselves as environmentally responsible: Environmentally responsible business : A firm that operates in such a way as to minimize deleterious impacts to society. Environmentally responsible manufacturing : A collection of manufacturing activities that includes design of

the product, facility, manufacturing processes, logistics, and supplier relationships that reduce or eliminate environmental waste through innovation and improvements. Environmentally sensitive engineering : Designing with consideration of how a product or its packaging will ultimately be disposed. Environmental issues and efforts include sustainable and safe products and services (including packaging), resource use, production processes, and reverse logistics. Improvements in these areas are tangible and can be measured, usually over a period of a few years. An environmentally responsible supply chain manager must think of the overall functions that are included in the entire supply chain and look for causes and effects related to environmental impact. Examples of linked supply chain decisions that can benefit environmental sustainability follow. Procurement Can you select vendors who use ISO 14000 (standards that help companies improve environmental performance) or who can be certified by the organization? Is it possible to use recycled materials instead of new?

Do we need to use nonrenewable resources, or can we find substitutions? Manufacturing Is the product designed for the supply chain? How might the manufacturing process be made more environmentally friendly? Can the use of toxic, dangerous, or hazardous materials be reduced or eliminated? What environmental risks might arise during the production process? Will they impact the safety of employees or cause an accident that would damage the environment? Warehousing and Transportation Can we use existing facilities or rent facilities that are environmentally designed? How will inbound or outbound traffic impact the local environment? Can we use recyclable packaging and shipping materials? What type of carrier choice would be best environmentally as well as economically? Is the carrier licensed, certified, or trained, as needed, to handle our products? Which transportation mode or modes would leave the smallest carbon footprint?

Reverse Logistics How will we set up a process for gathering products for recycling, reuse, etc.? Where will we store any toxic, hazardous, or dangerous materials or components? What industrial processes will be used to separate or dissassemble products? How will these products or components be stored safely? How will the public view this opportunity for recycling? How can we take it one step further environmentally? You can also use the environmental SCOR® model component called Green SCOR. Its performance attributes focus on environmental concerns. Research sponsored by the U.S. Office of the Deputy Under Secretary of Defense (Installations and Environment) resulted in the following environmental definitions: Reliability. Reliability is the ability to deliver the correct product to the customer. Reliability reduces waste from product discards and reduces air emissions and fuel use from extra transportation for returned products. Proper documentation enables all players in the supply chain to keep better track of hazardous materials or toxins that are embedded in certain products, thus allowing them to arrange for proper storage, handling, and disposal.

Responsiveness. The environmental definition of responsiveness relates to measuring the changes in material movement velocity caused by processes intended to mitigate environmental impacts, such as pollution control or other regulatory steps in a process. Flexibility. Flexibility is the degree to which a company can meet the environmental demands of its customers. This pertains to the company’s products and their production, transportation, recyclability, etc. Costs. These expenses include the costs of environmental compliance and cleanup as well as energy costs. Asset management. Sustainable asset management practices take governance, environmental, and social aspects into consideration when making asset and investment decisions.

Social Performance Social performance, sometimes called corporate social responsibility (CSR), involves respecting and supporting the needs and rights of employees, communities, and indigenous peoples. For employees it can involve nondiscriminatory hiring and labor management, providing living wages to employees matched to the cost of living in a region, providing reasonable benefits and accommodations, abiding by health and safety regulations, and respecting the rights of

persons to form unions when allowed under the law. Community support can take the form of hiring local workers and reinvesting in local businesses by getting local supply when feasible. Charity efforts can also be directed to local causes. For indigenous peoples, this involves fairly compensating these groups for any organizational impact on them and respecting treaties. Commitments to social performance often also need to be extended to supply chain partners, especially when manufacturing is primarily outsourced. Social performance can also involve encouraging employees to get involved in sustainability efforts. For instance, Intel did this by motivating their employees in several ways related to the environmental portion of their sustainability efforts. (While the subject is on the environment, the employee participation and request accommodating portions are the social part.) A system was established to measure green progress on three fronts: product efficiency, business operations efficiency, and stewardship. Intel asked its employees for suggestions on energy-saving and efficient products, software, and commuting options. They offered employees monetary bonuses for their efforts. Intel accommodated employee demands by installing solar panels and buying carbon offsets. (A carbon offset is an investment in a

renewable energy, forest protection, or reforestation project that can be used to offset the carbon dioxide–producing activities of an organization or individual.) A true commitment to social responsibility can influence competitive advantage, the organization’s global and local reputation, employee morale and commitment, the opinions of its many stakeholders, and relationships with customers, suppliers, the media, the community, and other companies. In Vachani and Smith’s article “Socially Responsible Distribution: Distribution Strategies for Reaching the Bottom of the Pyramid,” the authors explain that “socially responsible distribution” encompasses efforts and activities to give market access to poor producers and consumers in less-developed nations. These efforts help make up for their minimal physical links to markets, marginal buying power, and lack of information and communication infrastructure. Vachani and Smith identified three means of aiding these producers and consumers: lowering the costs of distribution, identifying different routes or means of reaching rural producers and consumers, and encouraging private-sector businesses and communities to invest in their future and to be socially active and partially responsible for that success.

Implementing Sustainability

Many organizations talk about sustainability, but not many are translating their words into action. In “Corporate Social Responsibility in Global Supply Chains,” Mette Andersen notes how despite environmental annual reports, voluntary efforts, and sustainability strategies, many companies are still not able—or not committed—to implementing sustainability in their own supply chains. One of the companies that is taking action is IKEA, a Swedish home furnishings retailer established in 1943. According to IKEA’s supplier portal, as of 2021, IKEA had 1,600 suppliers in 55 countries with an 11-year average length of supplier relationship. IKEA’s strategy is to engage in long-term relationships with fewer suppliers, and the company is committed to helping these suppliers do their best environmentally. The company has developed a code of conduct that the suppliers must adhere to in order to work with IKEA. The code delineates the requirements for the outside environment and the social and working conditions in an initiative IKEA calls IWAY. If a supplier is not able to meet those standards in an ongoing manner, they are asked to develop an improvement plan that they will implement. Follow-up audits are conducted at later dates. As long as there are signs of improvement, IKEA and the supplier will continue to work together.

The IKEA culture has long been known as one that trains its employees well on production-related environmental and social issues. Its employees thrive on being empowered with this knowledge, which helps them perform better and in a more green approach, but this also then carries over to IKEA’s suppliers. They term this transfer or sharing of knowledge as a “knowledge enhancing mechanism.” Here are a few brief tips to get your organization and supply chain to become more sustainable: Start with things that fit in the “sweet spot” of solutions that simultaneously provide economic, environmental, and social benefits. (Elkington’s book has examples of this, such as CocaCola working to use less water in India to reduce the stress on the community and environment while saving money on water.) In online ordering systems, place the more sustainable choices as the first options in lists. Make requests for proposal/invitations to tender and contracts specify sustainability as a criteria. Use service contracts to provide vendors with an incentive to reduce materials (e.g., buying treated lumber rather than lumber treatment chemicals gives the supplier an incentive to minimize the amount of the chemical or make the product environmentally friendly.)

Do an audit on what composes the waste in the supply chain and determine if some parts of it could be prevented from entering the waste stream in the first place. Get an environmental, safety, or quality certification from an accredited third party.

Sustainable Supply Chains and Compliance When sustainability regulations exist, they may take the form of voluntary partnerships, formal regulations with required compliance, or individual organizational initiatives. For voluntary programs or individual initiatives, the organization will need to weigh the costs of implementing compliance programs against their benefits. From a risk perspective, this could include lower reputation risk and lower risk of lawsuits for environmental or community impact of the operations of the business. For mandatory laws and regulations, the same costs apply, but the cost of noncompliance such as fines or legal liability may outweigh other considerations.

Voluntary Program Compliance Examples of voluntary programs include programs to encourage reuse, recycling, and recovery of industrial materials and responsible handling of products at the end of their useful life. Material content

reporting is part of such efforts. One example is the Global Reporting Initiative (GRI), which disseminates globally applicable sustainability guidelines for voluntary use. One benefit of voluntary compliance is the ability to implement sustainability at a measured, cost-effective pace rather than waiting until mandatory compliance requires frantic effort. Another benefit could be an improved and less costly reverse logistics infrastructure in the long run. The costs could include infrastructure investments such as more-efficient or less-polluting equipment, more-expensive contracts with local suppliers, and new report preparation and disclosure costs. Another potential cost or benefit is that with increased disclosure comes increased scrutiny by the press or activists, which may or may not be positive. Nokia provides one example of a company that has developed its own reporting system by applying GRI guidelines. This reporting system is accessible in our online Resource Center. It includes a summary of Nokia’s extensive sustainability report, which includes disclosure of energy consumption, carbon dioxide emissions, water consumption, waste, and ozone-depleting substances. Organization-Specific Sustainability Programs Sustainability can also be implemented through independent programs. For example, the U.S. shoe manufacturer Timberland

developed the following set of “EcoMetrics” to assess the environmental impact of its products: Energy to produce Global warming contribution Material efficiency (weight of product in relation to weight of material used in making it) Additional attributes (for example, use of renewable energy in manufacturing the product) The organization has made sustainability into a market differentiator, and a clear benefit is loyalty from market segments that value sustainability. For another example, Nike has made a commitment to sustainability even though it does not call its products “green” per se. There is a link to a video on this example in the Resource Center.

Government and Regulatory Compliance Business organizations are subject to regulations developed and enforced or monitored by governments and their regulatory agencies. A common area of regulation is vehicle emissions, which impacts vehicle manufacturers directly but may also impact other organizations if they or their 3PLs need to update their fleets. These

standards often effectively require vehicles to meet the most stringent laws in a major market (e.g., California) to avoid needing to produce multiple product types. A positive outcome of these regulations is that technology has improved. For example, diesel engines for on-road and marine applications are now more efficient and produce less pollution. Regulations can also create some supply chain expenses, such as when local communities restrict the hours in which trucks can make deliveries in a community, which can restrict routing efficiency. In another example, regulations that balance when ships can come in can cause the same issues, but this may prompt the ports to become more efficient over time. Other areas of government and regulatory compliance include material content reporting and handling of dangerous or hazardous goods. Material Content Reporting Reporting of material content is part of a larger movement toward sustainable trade practices that promote a clean, safe, healthy environment, including reuse, recycling, and recovery of industrial materials and responsible handling of products at the end of their useful life. Dangerous and Hazardous Goods

According to the U.S. Department of Transportation (DOT), items or goods are called hazardous materials (hazmat) or dangerous goods (DG) internationally when they are “capable of posing an unreasonable risk when transported in commerce to health, to safety, and to property.” For such goods, both the shipper and the carrier bear legal responsibility for compliance with related regulations. Many governments require organizations to have contingency and disaster preparation plans in place to mitigate both the environmental and economic consequences of a disaster. Organizations that store or process hazardous materials also need to keep hazmat logs. The U.S. DOT identifies ignitability, corrosivity, reactivity, and toxicity as four characteristics of concern due to health and U.S. Environmental Protection Agency (EPA) requirements. The level of danger is also rated. provides a list of specific dangerous goods that has wide international acceptance. Note that these are United Nations classifications (UN Class). Exhibit 8-11: Dangerous Goods UN Class 1

Dangerous Goods Explosives

Classification Explosive

UN Class 2

Dangerous Goods Gases

Classification Flammable gas Nonflammable, nontoxic gas Toxic gas

3

Flammable liquids

Flammable liquid

4

Flammable solids

Flammable solid Spontaneously combustible substance Substance that in contact with water emits flammable gas

5

Oxidizing substances

Oxidizing substance Organic peroxide

6

Toxic substances

Toxic substance Infectious substance

7

Radioactive material

Radioactive material

8

Corrosive substances

Corrosive substance

9

Miscellaneous dangerous goods

Miscellaneous dangerous goods

Items on the dangerous goods classification list have different handling requirements. A toxic substance, for instance, requires very different handling than a toxic gas. Proper communications of material risks is a key regulatory area. Hazard symbols are an example. Hazard symbols are internationally recognized icons that are more important than text, since they can be understood by people who speak different languages. For

example, below is the symbol for biohazard. (There is a link to a list of other hazard symbols online in the Resource Center.)

Exhibit 8-12: Biohazard Symbol

The international agreement in which dangerous goods controls are documented is the United Nations Recommendations on the Transport of Dangerous Goods (UNRTDG), first published in 1956 by the United Nations Economic and Social Council. Known as the “Orange Book,” these recommendations relate to the classification and labeling of dangerous goods and the requirements for packaging, tanks, and containers. Although the recommendations have no legal force, they present a basic scheme of provisions that allows uniform development of enforceable national and international regulations. Ships that transport dangerous or hazardous materials or goods are governed by the International Maritime Dangerous Goods (IMDG) Code. The code covers such matters as packing, container traffic,

and stowage, with particular reference to the segregation of incompatible substances. Since its adoption in 1965, the IMDG Code has kept pace with the ever-changing needs of industry. Amendments are made on a two-year cycle and are adopted by all authorities responsible for regulating the different modes of transport. With some exceptions, the Code became mandatory in 2002. In the United States, the laws regarding dangerous goods are known as “hazardous materials regulations.” Canada has its own laws governing “transportation of dangerous goods.” In Great Britain, the Health and Safety Commission (HSC) regulates all work-related health and safety risks. A book titled Recommendations on Dangerous Goods is published and updated every other year by the International Civil Aviation Organization (ICAO). The ICAO and the International Air Transport Authority (IATA) also publish special instructions on transporting dangerous goods. Air transport is the most strictly regulated mode of transportation. Here are some areas of specific regulatory concern in the transport of dangerous goods: Identification and classification is required for shipping containers and some vehicles containing dangerous goods. This includes a shipping name and, if necessary, a technical name,

both on the container and on any packaging inside the container. Emergency response information must be posted in case of accidents. Dangerous goods may not be concealed for security purposes. Packaging may have to conform to official specifications, such as those issued by the United Nations. Training is required for anyone handling dangerous goods, including a certification course and periodic refresher courses that must be completed successfully before a person can handle such goods. Documentation must accompany the shipment. In most cases this includes a signed statement from the shipper that regulations have been followed in preparing the cargo for shipment. European Union Efforts The European Union is also contributing to the sustainability movement with legislation relating to material content disclosure, reuse of materials, recycling, and related issues. The EU Waste Electrical and Electronic Equipment (WEEE) directive mandates that suppliers take back equipment at the end of its economic life, and it also sets targets for recycling and recovery of material used in electronics. The directive arises from concerns about specific

materials used in electronics products, such as mercury, cadmium, lead, chromium VI, and other heavy metals and flame retardants. As an example of a mandated sustainability regulation, the European Union’s Restriction of Hazardous Substances (RoHs) directive states that electrical and electronic equipment sold in the EU must be substantially free of six substances identified to be toxic to humans and the environment: cadmium, hexavalent chromium, lead, mercury, and two classes of poly-brominated plastics. To give it legal force, the directive was transposed into the national laws of EU member states. Penalties for products containing these substances can be severe, including removal of an entire stock of product from the market. These laws require no documentation or product certification; rather they assume that all electrical and electronic products on the market after the directive’s July 1, 2006, deadline should be compliant. However, compliance authorities could require that an organization prove that its products are compliant, which can be a very difficult endeavor. Like other supply chains, electrical and electronic equipment supply chains have become extended. Subcomponent designs are often based on functional requirements rather than being rigidly specified by the organization. This means that a supplier could design a subcomponent to function properly using substitutes. For example, several different types of transistors could be substitutes because they work the same even though they

contain very different raw materials. Thus, the RoHs directive has resulted in a need for organizations to minimize their risk of noncompliance by gathering extensive information from not only their suppliers but also their suppliers’ suppliers on a continual two-way basis. The risks involved in noncompliance with mandatory laws generally outweigh the cost considerations; it is a price of doing business in that region. If the costs of compliance prove to be too great to sustain profitable operations, the organization may choose to avoid doing business in that region. Reporting Requirements for Conflict Minerals As defined in the APICS Dictionary, 16th edition, conflict minerals are “minerals mined in conditions of armed conflict and human rights abuses, and are sold or traded by armed groups.” The U.S. Dodd-Frank Act of 2010 included a provision requiring certain companies to disclose their use of conflict minerals if they are “necessary to the functionality or production of a product.” Conflict minerals are tantalum, tin, gold, or tungsten mined in the Democratic Republic of Congo (DRC) or adjoining countries. The intent was to hinder the sale of these minerals when they would be used to finance conflict in the DRC region or worsen the humanitarian crisis there. Disclosure is made to the Securities and Exchange

Commission (SEC) on Form SD. The practical impact for supply chain managers is that any company that uses any of these minerals needs to conduct a reasonable country-of-origin inquiry. It will need to verify its suppliers’ addresses, audit each supplier, and get each to certify that all materials are in compliance. If it does not use or has no reason to believe it uses conflict minerals, it must file this in Form SD and publish it on a publicly available web page along with the process used to make the determination. If it does use conflict minerals, the organization must perform due diligence on the chain of custody for the minerals and file the form and publish the disclosure on a publicly available website.

Sustainability Risks from Packaging Packaging and shipping materials can pose sustainability risks. Wooden pallets, for example, have become controversial for a variety of reasons. A number of countries such as the United States and China and regions such as the European Union have adopted international restrictions on incoming materials packed on pallets made of soft woods that may contain harmful insects. Acceptable methods of heat and chemical treatments are governed under International Standards For Phytosanitary Measures regulation ISPM15. Chemical treatments to sterilize the wood have come under fire for themselves being hazardous. Aside from harboring harmful pests, the pallets can be a significant source of waste if they are

used only once and discarded (as many have been designed to be used). Solutions to the problems with wooden pallets include the following: Sterilizing the wood with heat or chemicals as per regulation ISPM15 Reusing undamaged pallets and repairing damaged pallets Grinding up pallets that are beyond use or repair for recycling Using pallets made of materials such as plastic and corrugated cardboard Using slip sheets (corrugated or plastic sheets) instead of pallets, a solution adopted successfully by Home Depot, Xerox, and Apple Computer The benefits of converting to sustainable shipping materials include lower risk of rejection at ports and possible innovation of even less costly shipping methods that still provide sufficient protection. The costs may include the inability to make full use of prior infrastructure investments and the need to invest in something that is not valueadded in the eyes of the customer.

Topic 2: Sustainability Guidelines and Standards

Sustainability guidelines and standards provide guidance on how to become sustainable so that responses can be complete and well thought out. Sustainability standards that focus on reporting help the organization show it is transparent and help market its sustainability successes. These subjects are first introduced.

Sustainability Guidelines and Standards Road Map Sustainability guidelines and standards include the following: United Nations Global Compact OECD Guidelines for Multinational Enterprises Global Reporting Initiative ISO quality and environmental standards (ISO 9000 and ISO 14000) Social accountability and safety standards (ISO 26000, SA8000, ANSI Z.10) Guidelines are broad, principle-based best practices that lack the authority of a standard and may not provide much information on how to implement them. Standards are best practices developed by the consensus of numerous practitioners and experts in a given profession—or in multiple professions for those standards with more general

applicability, such as quality standards. They carry more authoritative weight than recommendations and provide more information on how to implement them. Internationally recognized standards are of special relevance to global supply chains and multinational organizations. Some standards enable organizational certification to the standard, and becoming certified may require review and acceptance by an accredited third-party testing organization. According to the APICS Dictionary, 16th edition, accreditation is certification by a recognized body of the facilities, capability, objectivity, competence, and integrity of an agency, service, operational group, or individual to provide the specific service or operation needed. For example, the Registrar Accreditation Board accredits those organizations that register companies to the ISO 9000 Series Standards. The Dictionary defines certification as “documentation of competency by a supplier or by an organization, such as ISO 9000 certification.” The organization does not need to be audited by an accredited thirdparty organization when it seeks to conform to a standard that has no certification requirement or if it does not desire to be certified. Using accredited third parties provides an independent confirmation

of the third party’s competence and enables others to rely on their work. When standards are internal or do not require certification, another option is for a supplier to invite its customers to audit the organization’s systems for themselves. This is called a second-party assessment. A third option is to accept a supplier’s “declaration of conformity to [specific standard],” which would be attested to by legally binding signatures and based on an internal audit (first-party) or a second- or third-party audit. This following standards and related certification processes are important to supply chain management: ISO 9000 Series Standards on quality and ISO 9001 certification ISO 14000 Series Standards on environmental management and ISO 14001 certification ISO 26000 Guidance for Social Responsibility (not applicable for certification) SA8000 Social Accountability certification ANSI Z.10 Occupational Health and Safety Management Systems certification

International Guidelines International guidelines include the United Nations Global Compact and the OECD Guidelines for Multinational Enterprises.

United Nations Global Compact The United Nations created the Global Compact as a means of helping businesses voluntarily align their operations and strategies with the ten key principles shown in Exhibit 8-13. Exhibit 8-13: UN Global Compact (UNGC) Ten Key Principles UN Global Compact Ten Key Principles Human Rights Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights; and Principle 2: make sure that they are not complicit in human rights abuse. Labour Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining; Principle 4 the elimination of all forms of forced and compulsory labour; Principle 5: the effective abolition of child labour; and Principle 6: the elimination of discrimination in respect of employment and occupation. Environment Principle 7: Businesses should support a precautionary approach to environmental challenges; Principle 8: undertake initiatives to promote greater environmental responsibility; and Principle 9: encourage the development and diffusion of environmentally friendly technologies.

UN Global Compact Ten Key Principles Anti-corruption Principle 10:

Businesses should work against corruption in all of its forms, including extortion and bribery. Source: UN Global Compact. Used with permission.

With the increasing speed of globalization, the United Nations Global Compact can help ensure that markets, commerce, technology, and finance advance in ways that benefit economies and societies everywhere. Many companies, especially those in lesser-developed regions of the world, recognize the need to collaborate and partner with governments, civil society, labor, and the United Nations. The idea is to leverage the moral authority and convening power of the UN and the resources and solution-finding abilities of organizations. This is accomplished through local Global Compact networks that root these principles into national and cultural contexts by fostering a continuing dialogue between businesses and stakeholders and by focusing on specialized areas of concern such as climate change or women’s or children’s rights. With nearly 18,000 corporate participants and other stakeholders from multiple countries, the Global Compact is the largest voluntary corporate responsibility initiative in the world and the primary entry point for organizations into the UN system. The Global Compact has two complementary objectives:

Incorporate the ten principles into global business activities. Catalyze actions in support of the broader United Nations goals. The UNGC recommends that organizations evaluate their sustainability efforts using the Global Reporting Initiative’s (GRI’s) Sustainability Reporting Guidelines. In 2010, the UNGC signed an agreement with the GRI to adopt the GRI Guidelines as the recommended reporting framework for sustainability reporting. The GRI in turn adopted the UNGC’s ten principles into its latest reporting guidelines.

OECD Guidelines for Multinational Enterprises The Organization for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises are defined in the APICS Dictionary, 16th edition, as a set of recommendations on responsible business conduct addressed by governments to Multinational Enterprises (MNEs) operating in or from adhering countries that encourage and maximize the positive impact MNEs can make to sustainable development and enduring social progress. (A multinational enterprise is an organization that owns or controls production or services facilities in one or more countries other than its home country. Multinational enterprises have been evolving and

include a broad range of organizational structures and business arrangements. The close relations and alliances they have formed with their suppliers and contractors have blurred their boundaries.) Established in 1961, OECD was created to promote policies that will improve the economic and social well-being of people around the world. It provides a forum in which governments can work together to share experiences and seek solutions to common problems and identify factors that drive economic, social, and environmental change. OECD measures productivity, investment, and global flows of trade. It establishes international standards ranging from agriculture, to taxes, to the safety of chemicals. The OECD is located in Paris, France, and has 38 member countries. The goal of the OECD Guidelines is threefold: To ensure that these enterprises’ operations align with government policies To reinforce the trust and confidence between enterprises and the societies in which they operate To strengthen the foreign investment climate and augment contributions to sustainable development made by the enterprises Similar to GRI, the OECD Guidelines cover a wide range of important topics: employment and industrial relations, environment, antibribery measures, consumer interests, science and technology,

competition, taxation. The Guidelines include implementation procedures that promote visibility, accessibility, transparency, and accountability by the MNEs.

Global Reporting Initiative (GRI) Sustainability reporting has emerged as an important tool within an overall supply chain management strategy. According to the APICS Dictionary, 16th edition, the Global Reporting Initiative (GRI) is “a network-based organization that has pioneered the development of the world’s most widely used sustainability reporting framework.” The GRI is committed to the framework’s continuous improvement and application worldwide. In order to ensure the highest degree of technical quality, credibility, and relevance, the reporting framework was developed through a consensus-seeking process with participants drawn globally from business, civil society, labor, and professional institutions. The GRI also has strategic partnerships with the United Nations, the UNGC, ISO, and the Organization for Economic Co-operation and Development. In effect, the GRI is helping businesses develop sustainability and reverse logistics key performance indicators to assess and improve their environmental performance. This form of self-regulation may reduce the need for new laws and regulations.

GRI Reporting Framework According to the Dictionary, the GRI reporting framework is the framework that sets out the principles and performance indicators organizations can use to measure and report their human rights, labor, environment, and anticorruption practices and outcomes. The framework lays out the principles and indicators that organizations can use to measure and report their economic, environmental, and social performance. The cornerstone of the framework is the Sustainability Reporting Standards.

GRI Sustainability Reporting Standards The GRI’s Sustainability Reporting Standards transitioned from guidelines to being standards in 2016 (2018 effective date). More topic-specific standards have been released since then. The aim is to help reporters prepare sustainability reports that provide reliable, relevant, and standardized information.

Exhibit 8-14: GRI Sustainability Reporting Standards

As shown in Exhibit 8-14, the set of standards is made up of three universally applicable standards and a large set of topic-specific standards that are organized into three series. Universally applicable standards include GRI 101, 102, and 103. GRI 101, “Foundation,” sets out reporting principles that are the criteria to be used to guide your choices to achieve effective GRI reporting. GRI 102, “General Disclosures,” are the questions you answer in your report. This is the “what to report” part of the standard. GRI 103, “Management Approach,” is the “how to report” part of the standard. It addresses how to manage the topically applicable standards. It contains explanations of how to apply the Reporting Principles, how to prepare the information to be disclosed, and how to interpret the Guideline concepts. It helps management to provide a narrative explanation of why a given

topic is material (important enough to report on), describe the impact area boundaries (i.e., scope), and management approach to addressing the impact areas. It also focuses on the gathering of the data in order to create a report that contains useful and comparable information. Topically applicable standards come in three series—GRI 200, “Economic,” GRI 300, “Environmental,” and GRI 400, “Social.” The consolidated set of standards also includes a GRI Standards Glossary.

Purposes The GRI Reporting Standards are an internationally recognized reporting format that can be used for any other organization’s or government’s requirements for reporting on economic, environmental, and social impacts. Another purpose is for voluntary sustainability reporting among supply chain members to manage sustainability risks and optimize supplier performance in order to Build capacity Foster commitment to sustainability Improve performance and risk management Improve the flow of reliable sustainability information from supplier to buyer.

Suppliers can proactively communicate their efforts, performance, and goals through a GRI sustainability report, enabling continuous improvement and closer engagement with buyers. Companies in business or industry associations can improve their sustainability performance, fostering a more stable and profitable climate for local and sectoral business groups.

Reporting Principles GRI 101 includes 10 principles classified into two categories: Principles for Defining Report Content Stakeholder Inclusiveness: Identify stakeholders and responses to their reasonable expectations and interests. Sustainability Context: Relate performance in the wider context of sustainability. Materiality: Include aspects that are significant or would influence stakeholders’ assessments and decisions. Completeness: Report on all aspects with significant impact so stakeholders can reasonably assess the period’s performance. Principles for Defining Report Quality Accuracy: Use enough accuracy and detail for a fair assessment. Balance: Include both positives and negatives to be unbiased.

Clarity: Make information understandable and accessible. Comparability: Use consistent methods to allow analysis of trends and competitive benchmarks. Reliability: Reporting methods and processes should be subject to examination of quality and materiality. Timeliness. Report on a regular schedule so stakeholders can make informed decisions.

“In Accordance” and Reporting Options Adhering to the above reporting principles is the cornerstone of report transparency, so all organizations preparing reports should abide by them. To enable your sustainability report to claim to be prepared “in accordance” with the GRI standards: 1. The organization must adhere to these principles with a focus on identifying all aspects that are material to your organization. 2. It also must provide the required disclosures per GRI 102, including information on the context of the information being disclosed. 3. Every topic considered material must be identified and reported upon, which includes identifying the boundaries for each topic. Boundaries are where the impacts occur and what parties are involved. That is, the standards expect reporting not only on direct activities but on the relevant activities of others in the value chain.

4. For every material topic, the organization must also disclose the management approach per GRI 103. There are two options for “in accordance” reporting: a core option and a comprehensive option. The core option has just the essential information, and the comprehensive option has some additional disclosures regarding organizational strategy and analysis, governance, ethics, and integrity. These and some additional core information about the company are part of what is called standard disclosures. The comprehensive option also needs more extensive performance information because each material aspect requires information about all related indicators. (The core option requires reporting only on at least one indicator per material aspect.)

Topics and Material Impact Analysis Often companies are unsure what metrics to use to calculate the impacts they are having on specific topics, both to determine materiality and to determine how they are changing impact over time. Companies can begin by using the performance indicators developed by the Global Reporting Initiative or employ criteria from the Dow Jones Sustainability Index and the Carbon Disclosure Act. The UN Global Compact recommends that impacts should be calculated at both the enterprise level and the product level on a regular basis.

Ideally, over time an organization will strive to identify its impacts that span multiple topics. A review of the boundaries can help show areas of overlap. For instance, by creating a new manufacturing facility that would provide stable employment for local residents, a company may inadvertently impact the local water supply it uses to cool its equipment. Based on the organization’s assessment of risks, opportunities, and impacts, the company develops metrics and goals specific to the organization and then creates a road map to execute its sustainability program. Exhibit 8-15 lists the topics in each GRI standard series. An organization’s sustainability report presents information relating to just those topics deemed to be material. Summaries of each standard follow by topic area. Exhibit 8-15: Economic, Environmental, and Social Series of Standards Economic

Environmental

Economic performance

Materials

Market presence

Energy

Indirect economic impacts

Water and effluents

Procurement practices

Biodiversity

Anti-corruption

Emissions

Anti-competitive behavior

Waste

Tax

Environmental compliance Supplier environmental assessment

Social Employment

Security practices

Labor/management relations

Rights of indigenous peoples

Occupational health and safety

Human rights assessment

Training and education

Local communities

Diversity and equal opportunity

Supplier social assessment

Non-discrimination

Public policy

Freedom of association and

Customer health and safety

collective bargaining

Marketing and labeling

Child labor

Customer privacy

Forced or compulsory labor

Socioeconomic compliance

Source: Global Sustainability Standards Board (GSSB), “Consolidated Set of GRI Sustainability Reporting Standards 2020.”

Economic Economic sustainability refers to how the organization impacts the economic picture for stakeholders at local, national, and global levels. Economic performance reports organizational revenues, costs and expenses, payments to owners and taxes, and community investments. It also assesses organizational risks from climate change, if the organization has pension obligations, and if it receives government assistance or tax advantages. Market presence discusses wages compared to minimum wage by gender and use of local senior management talent.

Indirect economic impacts is about community reinvestment and positive and negative impact on local or other economies. Procurement practices discusses use of local suppliers. Anti-corruption is about corruption risk assessments, employee training, incidents, and responses. Anti-competitive behavior is about legal actions and outcomes regarding restraint of free trade. Tax is about approach to taxation; governance, risk management, and control of tax; and stakeholder engagement.

Environmental Environmental sustainability reports on the organization’s impact on ecosystems, land, air, and water from its inputs, including energy and water, and its outputs, including emissions, effluents, and waste. Materials describes the type and amount of materials used and how much is from recycled sources. Energy relates to internal and external energy use, intensity of use, and reduction efforts both at the organization and in product energy requirements.

Water and effluents is about water as a shared resource, water withdrawal, discharge and impacts, and consumption. Biodiversity relates to proximity to and impact on protected areas or endangered species and protection or restoration efforts. Emissions discusses greenhouse gases. Waste is about waste generation and impact, impact management, waste generated, and waste directed to/diverted from disposal. Environmental compliance refers to sanctions and fines paid. Supplier environmental assessment is about supplier environmental screening and event reporting.

Social The social series of standards reflects the impact the organization has on social systems, including labor law, human rights, health, safety, privacy, and socioeconomics. The bases for many of these social standards include the UN Universal Declaration of Human Rights, the UN Declaration on the Right to Development, a UN declaration related to indigenous peoples’ rights, and UN conventions on civil and political rights and economic, social and cultural rights. Some UN International Labour Organization (ILO)

conventions are drawn upon, including those on forced labor and child labor. The standards also use a number of national charters that protect human rights. Employment is about new hires, turnover, benefits for full-time versus part-time employees, and parental leave. Labor/management relations is about minimum notice periods for operational changes. Occupational health and safety is about having a system, identifying hazards and their risk, occupational health services, worker participation and training, promotion of worker health, prevention, workers who are covered, injuries, and ill health. Training and education is about average hours of training, training programs, and performance reviews. Diversity and equal opportunity is about the diversity of employees and governance bodies and the ratio of pay between men and women. Non-discrimination is about incidents and corrective actions. Freedom of association and collective bargaining is about the level of support for rights of your or your suppliers’ employees to collectively bargain or associate.

Child labor and forced or compulsory labor each identify risk of incidents and preventive measures. Security practices is about training security personnel on human rights. Rights of indigenous peoples addresses incidents and actions. Human rights assessment is a summary aspect on human rights. Local communities is about programs to engage, assess, and develop local communities as well as any negative impacts. Supplier social assessment is about screening suppliers and violations and responses. Public policy is about the size of political contributions and their recipients. Customer health and safety is about known areas for improvement and regulatory and voluntary noncompliance issues and outcomes Marketing and labeling discloses mandatory labeling requirements, noncompliance incidents, and customer satisfaction survey results, whether banned or disputed products are sold, and

regulatory or voluntary noncompliance and outcomes related to advertising, promotion, or sponsorship. Customer privacy is about substantiated breaches of privacy. Socioeconomic compliance is about product fines and sanctions. More information about the GRI and its Reporting Standards can be found in the online Resource Center.

ISO Sustainability and Related Standards The International Organization for Standardization (ISO) is a worldwide federation of the national standards institutes of 165 countries. It is a nongovernmental organization (NGO). ISO is a trusted partner in the global community for the development of globally relevant international standards. The current ISO portfolio includes more than 21,000 standards and other types of documents. Different certification processes and standards are available for many types of industries, ranging from agriculture and construction, through mechanical engineering and manufacturing and distribution, to transport, medical devices, food technology, environmental protection, oil and gas, ship building, and information and

communication technologies. ISO also has standards for good management practices and for services. Why is ISO important? Implementing international standards or guidelines or maintaining a certification can provide the following benefits to companies: Helps improve efficiency of business operations, productivity, and the bottom line Facilitates national and international trade, prevents trade barriers, and makes trade fairer Reduces negative impacts on the environment Provides governments around the globe with a technical base for health, safety, and environmental legislation and conformity assessment Promotes best practices and the sharing of innovative technological advances and good management practices The following are important key aspects of ISO: Voluntary. ISO standards are voluntary. As an NGO, ISO has no legal authority to enforce the standards’ implementation. Conformance relative to ISO standards is an affirmative indication or judgment that a product or a service has met the requirements. However, some ISO standards (mainly those concerned with health, safety, or the environment) have been adopted by

countries as part of their regulatory framework. In some cases, although ISO standards are voluntary, they may become a market requirement (e.g., ISO 9001 Quality Management Systems). Market-driven. ISO develops standards for which there is a market need. An international cross section of experts in the field (e.g., industrial, technical, and business sectors) who have asked for the standards and other parties with relevant knowledge (such as representatives of government agencies, consumer organizations, academia, and testing laboratories) collaborate as technical committees to develop the standards. Consensus. The fact that ISO standards are developed in response to market demand and are based on consensus among the interested parties ensures widespread applicability. Standards are reviewed at least every five years to decide whether they should be maintained, updated, or withdrawn. The review process ensures that the standards remain state of the art. Registration. Registration is the audit of an organization’s implementation and conformance to ISO standards. It should be noted that the conformance to standards themselves does not contain any requirement for registration. Requirements for registration come from customers or governments. In some instances, registration is required by a customer or a government

agency as a condition of doing business. Some companies also choose to seek registration to market capabilities. Generic management system standards. Many ISO standards are highly specific to a particular product, material, or process. However, ISO 9000 and ISO 14000 Series Standards are examples of “generic” standards, which means that the same standard can be applied to any organization, large or small, and any product or service, in any sector of activity. Such generic standards are applicable to business enterprises, government departments, or nongovernment public administration. ISO 9001:2015 provides a set of requirements for implementing a quality management system; ISO 14001:2015 provides generic requirements for an environmental management system. ISO certification must be renewed every three years. When a new ISO version of a standard becomes available, certified organizations have a three-year period to make the transition. Because ISO certification has become so widespread, it has become an expected requirement in requests for proposal (RFPs)/invitations to tender (ITT). Whether an organization achieves ISO registration or merely implements and maintains ISO compliance, the results will be of benefit in supply chain management.

Quality Standards ISO 9000 is a series of standards related to quality, which helps with sustainability by reducing scrap, defects, and returns. ISO 9000 Series Standards The APICS Dictionary, 16th edition, defines the ISO 9000 Series Standards as a set of international standards on quality management and quality assurance developed to help companies effectively document the quality system elements to be implemented to maintain an efficient quality system. The standards, initially published in 1987, are not specific to any particular industry, product, or service.…The standards underwent major revision in 2008 and now include ISO 9000:2008 (definitions), ISO 9001:2008 (requirements), and ISO 9004:2008 (continuous improvement). Note that ISO 9000:2015, ISO 9001:2015, and ISO 9004: 2019 are the current versions of these standards. ISO 9001:2015, Quality Management Systems Certification ISO 9001 specifies the requirements for a quality management system (QMS). To satisfy ISO 9001’s requirements, the organization needs to demonstrate that it can consistently provide products and services that meet all applicable regulatory and statutory

requirements while working to enhance customer satisfaction by applying the principles within ISO 9001 effectively. This includes continually improving the quality management system and being able to provide assurance that the products and services conform both to customer requirements and applicable regulatory and statutory requirements. ISO 9001:2015 is a framework for developing quality processes at an organization and designing quality into product design, research and development, production, implementation or installation, and service. ISO 9001 focuses on customer requirements, top management commitment to quality, a process-centered approach, and continual improvement. It helps organizations achieve product consistency and high quality. For supply chain managers, ISO 9001–certified suppliers are more likely to be able to meet needs and expectations and to comply with all relevant regulations. Note that while ISO 9001 certification indicates conformity to the quality process, it is never a statement of product conformity. It relates to the ability to be consistent and high quality rather than to specific goods or services. For example, the product may meet stated requirements and all applicable regulations but not meet actual requirements.

Certification to ISO 9001 requires that organizations perform their own internal audits of their quality processes and procedures. Accredited organizations can optionally be used to audit the organization and grant ISO 9001 certification. Organizations that pass these audits can state that the relevant processes conform to ISO guidelines. If a certified supplier appears to have ongoing quality issues, this should be escalated first through the supplier itself with appropriate feedback and then, if not resolved, brought up with the independent third-party certification body (registrar). If still not resolved, complaint can be made to the accreditation body (if the certification body is accredited).

Environmental Standards: ISO 14000 Series Standards ISO 14000 is a key method of providing assurance that the organization is living up to its environmental commitments. The APICS Dictionary, 16th edition, defines the ISO 14000 Series Standards as a series of generic environmental management standards developed by the International Organization for Standardization, which provide structure and systems for managing environmental compliance with legislative and

regulatory requirements and affect every aspect of a company’s environmental operations. The standards help companies to minimize harmful effects on the environment due to their activities and to continually improve environmental performance. Originally developed as an outcome of the 1992 Rio Summit on the environment, these standards provide a framework for a company to develop an environmental management system as well as an audit program. An environmental management system (EMS) enables an organization to Identify and control the impact of its activities, products, and services Continually enhance its environmental performance Develop a systematic method for establishing environmental objectives and targets as well as measures of its ability to achieve them. The ISO 14000 family of standards includes the following. ISO 14001:2015 offers a framework for a strategic, holistic approach to an organization’s environmental policy, plans, and actions. It explains the generic requirements for an EMS to be used by businesses or industry. It requires that an organization be committed to complying with applicable environmental legislation and regulations as well as to continuously improving its efforts.

Organizations at any level of sustainability implementation will find this useful. The 2015 revision describes incorporating environmental management into strategic planning and leadership, emphasizes proactive implementation of sustainable practices, looks at how to track performance trends for improvement, focuses on life cycle thinking, and adds a communication methodology. This is the only standard in the series against which it is currently possible to be certified by an external authority. ISO 14004:2016 provides guidelines on the specific elements of an EMS and its implementation and explains the main issues involved. It can serve other purposes as well: providing assurance to stakeholders, complying with regulatory laws, serving as proof of the organization’s claims about its environmental practices, and illustrating its conformity. Other sections provide information about principles of environmental auditing; sampling, testing, and analytical methods; qualification criteria for environmental auditors; labeling concerns; and life cycle issues. While there are as yet no global standards governing electronics or other products in regard to material content reporting, reduction of hazardous materials components, or responsible end-of-life recycling

and disposal, the trend in that direction seems likely to continue to grow. ISO 14001:2015 Certification Certification to the ISO 14001:2015 standard can help the organization meet legal and stakeholder requirements related to environmental performance and improve public image, and it may give the organization a competitive advantage or financial benefit. Industry-Specific Guidelines and Standards ISO 14000 has had such an immense impact on so many organizations’ business practices and trade that ISO has also developed guidelines and standards for specific industries, groups, and areas of interest, such as Automotive Customer satisfaction Education Energy Food safety Information security Health care Local government Medical devices Petroleum and gas

Risk Ship recycling Supply chain security. Familiarity with the standards that are applicable to your industry is recommended. A link to the ISO website with industry-specific standards is provided in the online Resource Center. Not only are there ISO standards for these areas, but in some cases there are documentation requirements developed by organizations such as the U.S. Food and Drug Administration (FDA), the U.K. Medicines and Healthcare Products Regulatory Agency (MHRA), and so on. The U.S. FDA has developed regulations requiring thorough documentation of the chain of custody or audit trail of drugs. Distribution centers and carriers need to understand the documentation and information that must accompany pharmaceutical products as they move from company to company. Documentation of temperatures must also be provided regarding cold chain storage for items that must be kept within a given temperature range, for example, certain foods and vaccines.

Social and Safety Standards ISO 26000 and SA8000 are examples of methods used to assure customers and the community that the organization is living up to its

goals related to corporate social responsibility. Worker safety is an important aspect of social sustainability. ANSI Z.10 is an example of these types of accreditations and certifications.

ISO 26000:2010—Guidance for Social Responsibility ISO 26000:2010 refers to guidance for social responsibility. According to the APICS Dictionary, 16th edition, ISO 26000 is an international standard adopted by the International Standards Organization to assist organizations in contributing to sustainable development beyond legal compliance through a common understanding of social responsibility. ISO 26000 is not a management system standard and it’s not intended or appropriate for certification purposes or regulatory or contractual use. ISO 26000 provides a structure for organizations in the private and public sectors to think about how they can act and operate in a socially responsible manner. The underlying goal of social responsibility is to make contributions to sustainable development. ISO 26000 addresses seven primary subjects within its guidelines, including organizational governance, human rights, labor practices,

the environment, fair operating practices, consumer issues, and community involvement and development. ISO encourages an organization to first take the time to do two critical things: Recognize its social responsibility within its sphere of influence Identify and engage with its stakeholders Once those have been accomplished, the organization is ready to analyze the seven core areas and determine how it will integrate social responsibility into its decisions and activities.

Social Accountability International SA8000 Guidelines The Dictionary defines SA8000 as a widely recognized international standard for managing human rights in the workplace. It provides an auditable framework for assuring that social accountability is being stewarded by an organization. The SA8000:2014 standard produced by Social Accountability International is an auditable social certification standard designed to promote decent workplaces in any industrial sector by providing a common language for measuring social performance. It is based on many of the conventions and declarations of the UN (especially the

Declaration of Human Rights) and the International Labour Organization and on national laws. The standard is built around the idea that continuous review needs to be built in by specifying management systems, structures, and procedures that organizations need to adopt into their normal operations. Thus the organization’s policies and procedures need to reflect the following nine principles of SA8000: Child labor. Neither use nor support child labor, supported by policy and procedure. (A child is a person under 15 years of age unless local laws set the age higher than this. A young worker is a person above the age of a child but under 18 years of age.) Young workers are allowed if they don’t work during school hours or at night or for more than 8 hours per day or 10 hours including transportation. Provide funds to attend school as needed. Expose no minors to physical or mental hazards. Forced or compulsory labor. Neither use nor support forced labor including prison labor and human trafficking. Never retain ID papers, require “deposits” to the organization on hire, withhold pay to force labor, or charge employment fees. Employees are free to leave the premises or quit.

Health and safety. Provide a safe and healthy workplace by minimizing risk and eliminating hazards when feasible, protecting new mothers, providing protective equipment, having a health and safety officer and committee with union or worker representation, providing appropriate training, and using documented safety procedures. Facilities shall be clean and sanitary, including bathrooms, water, break spaces, and dormitories. Employees don’t need permission to escape imminent danger. Freedom of association and right to collective bargaining. Respect the right to form unions through word and deed, unless prohibited by law, in which case employees shall have the right to elect representatives. Avoid discrimination, intimidation, or harassment of union members. Discrimination. Don’t discriminate in any form of pay or promotion against any class of person, and allow persons to observe tenets or practices of the groups to which they belong. Prohibit threatening or abusive behavior of a verbal, physical, or sexual nature. Never use pregnancy or virginity tests. Disciplinary practices. Never tolerate corporal punishment, mental or physical coercion, verbal abuse, or harsh or inhumane treatment.

Working hours. Comply with all laws and union agreements on working hours, holidays, and overtime. Give one day off per week unless allowed by law or union work-time averaging agreements exist. Overtime must be voluntary except to meet short-term business demand and never regularly requested. Remuneration. Pay a living wage and always meet minimum wage laws. Never deduct pay for disciplinary purposes except when permitted by national law and union rules. Never pay in coupons or promissory notes, and make pay promptly available along with clear information on pay and benefits. Pay overtime premium rates. Never use labor-only contracting, consecutive short-term contracts, or false apprenticeships to avoid labor laws. Management systems. Conspicuously display a notice of the voluntary decision to comply with SA8000 and all national and local labor laws. Develop and communicate policies and procedures to implement SA8000. Keep relevant records to demonstrate conformance. Regularly conduct management reviews. Provide policies on request. SA8000 Social Accountability Certification SA8000 cuts across multiple industries. The standard is a way for retailers, brand companies, suppliers, and other organizations to

maintain just and decent working conditions throughout the supply chain. Certification to the standard is available but needs to be redone for each specific work site. Certification is available for almost any industry but is not currently available for fishing, offshore, or maritime industries. Certification is also not possible in Myanmar (Burma) due to International Labour Organization sanctions. Social Accountability Accreditation Services (SAAS) provides certification bodies with information on the steps that need to be taken to be accredited to perform SA8000:2014 certification audits.

ANSI Z.10-2012—Occupational Health and Safety Management Systems As defined in the APICS Dictionary, 16th edition, ANSI Z.10 is a voluntary consensus standard on occupational health and safety management systems. It uses recognized management system principles in order to be compatible with quality and environmental management system standards such as the ISO 9000 and ISO 14000 series. ANSI Z.10-2012 is a standard designed to help organizations design, implement, and continuously improve health and safety management systems to minimize the risk of occupational injuries, illnesses, and fatalities.

This American National Standards Institute (ANSI) standard focuses on principles rather than detailed specifications to allow organizations to implement it in a manner suited for their given industry. It is compatible with ISO 9001 and 14001 and with common practices and regulations in this area in the U.S. Achieving a certification in this area shows that the organization is willing to go above and beyond the minimum regulatory requirements set by government organizations such as the Occupational Safety and Health Administration (OSHA) in the U.S. The ANSI-ASQ National Accreditation Board (ANAB) is the U.S. accreditation body that accredits third-party certification bodies to provide certifications for this standard as well as for ISO 14001 and ISO 28000.

Section C: Technology Trends This section is designed to Consider emerging trends, including the cloud, machine learning, data analytics, sensors, telematics, control towers, quantum computing, drones, and more Understand how the supply chain digital transformation requires an intelligent supply chain that can integrate emerging technologies Describe how an intelligent supply chain depends most strongly on blockchain, intelligent asset management, and the Internet of Things Describe technology selection criteria and choice, technology risks, and technology strategic alignment Explain when to apply project management to supply chain initiatives and when to manage initiatives as normal operations Discuss the basics of project management Describe how to manage projects in terms of scope, time, and budget Identify the steps for managing change and incremental improvements within the supply chain and its partners

Explain how to incorporate change management into any large initiative, especially if it requires changes to organizational culture Maintain technologies using well-defined processes to promote value and longevity. Without technology, the current concept of supply chain management would not exist. Technology has allowed businesses to move from department-centric spheres of control to a focus on business processes that spans departments and extended supply chains. As technology has evolved, it has enabled increasingly complex business strategies, metrics, and analysis, which in turn have sped up the pace of business and given business a global reach. Technology is quickly becoming a world-class performance enabler because it helps interconnect the key elements of a valuedriven network. Here we describe a large number of emerging technologies and show how successful integration of various technologies can lead to an intelligent supply chain. After these discussions, we show how to evaluate and implement technologies in ways that minimize risk. Project management and change management are discussed as key enablers of change. Technology maintenance is also addressed.

Topic 1: Emerging Technology Trends

Here we review some general emerging technology trends, and then we discuss intelligent supply chains, which rely on many emerging technologies, in particular, blockchain, intelligent asset management, and the Internet of Things to provide supply chain visibility and control.

Emerging Technologies Emerging technologies described here include cloud computing, artificial intelligence, machine learning, data analytics, sensors, telematics, control towers, quantum computing, 3D printing, wearable technology, augmented reality, robotic process automation, autonomous/automated guided vehicles, and drones.

Cloud Computing Cloud computing is a distributed set of servers, databases, applications, and networks that provides online access as leased platforms, data storage space, or applications. Rather than storing data on a particular database’s hardware, for example, a cloud solution does not permanently designate space to any one client or use but instead allocates it on a floating basis to enable flexibility in expanding or contracting based on needed capacity. This makes the systems efficient.

Cloud applications are accessed on a web browser and are offered as leased solutions called software as a service (SaaS). For example, rather than purchasing a transportation management system, the software could be leased, which, in addition to providing the basic functions, could be integrated with traffic data and so on. Such solutions can greatly reduce implementation and upgrade costs and speed time to value. The vendor automatically upgrades the software seamlessly. Supply chain partners can also easily sign up for the same service and participate to gain real-time visibility into demand or supply issues. There are also procurement networks that enable buyers and sellers to find each other and to automate their transactions. Similarly, organizations can eliminate their owned platforms or infrastructure and lease platform as a service (PaaS) or infrastructure as a service (IaaS). SaaS providers may be PaaS customers, and PaaS providers may be IaaS customers. Cloud computing downsides include the ongoing lease cost, the fact that ending the lease ends the service, the risk of internet failure restricting access, and the risk of the organization’s sensitive data being in the hands of a third party. These systems tend to have good protections, however, including backing up data in more than one geographic location. Another issue to explore is system response

times. Warehouse management systems are slow to migrate to SaaS in part due to the fast response time needed for materials handling or connecting to terminals.

Artificial Intelligence, Machine Learning, and Data Analytics Artificial intelligence (AI) is advanced software capable of selfimprovement. Machine learning is software that mimics human decision making. It relies on preset logic, policies, and controls. Decision support systems are an example. Data analytics is the processing and manipulation of large amounts of data (called “big data” when the amount of data is very large and a lot of processing is required) from multiple sources to generate useful insights and actionable information. These types of systems are becoming better and better at pattern detection such as for fraud or bottlenecks. They support continuous process improvement through optimization algorithms, for example, for optimization of distribution networks, inventory levels, picking and shipping order, and marketing promotions. Promotions could even be customized to specific customer segments or adapt to demand changes on an hourly basis. Advanced types of data analytics such as predictive analytics rely on AI or machine learning to predict things like equipment maintenance

requirements. This can help reduce excess parts inventory and improve equipment longevity. It can also help predict the best locations for positioning maintenance staff. Similar systems can help allocate resources for manufacturing or service provision.

Sensors and Telematics Sensors and telematics are remote sensing and remote control technologies that rely on photosensors, radio frequency identification (RFID), lasers, and so on to provide automated data capture and control from a remote control center. Sensors and telematics can provide process visibility and automation to a greater range of industries than in the past. In addition to improving internal systems, data from such systems can be shared with supply chain partners to better balance supply and demand and manage inventory levels. For example, an automated bar code scanner or RFID sensor on a conveyor belt can scan goods as they pass by. These technologies also help with asset utilization, such as indicating when a vehicle is idle versus in use. Driving habits can also be assessed. Data analytics or big data systems may be needed to create useful information out of the data from multiple sources. The information can be presented on interactive dashboards or other simplified interfaces.

Control Towers A supply chain control tower is much like an airport control tower in that it is intended to provide centralized visibility and control. A supply chain control tower consolidates real-time, end-to-end data from around the supply chain to enable visibility, analysis, prediction, and control. These control towers are most commonly offered as cloud-based solutions. The software has dashboards that enable operators to drill down into the details for better visibility and to exercise control such as by doing real-time order planning and exception management. The software may also have artificial intelligence, machine learning, and data analytics capabilities. However, there is no standard definition of what a control tower is, so it is critical to do due diligence on requirements and gaps before investing in a control tower. Existing systems may already have many of these capabilities. There are many subtypes of control towers, such as Transportation control towers that analyze on-time orders, transport costs, and performance and enable control such as track and trace, exception management, single-tier inventory sourcing, and transportation optimization Supply chain control towers that analyze on-time in full (OTIF) orders, total cost to serve, and 3PL/broker performance. These towers enable control such as full visibility, a broader set of

exceptions, multi-tier inventory sourcing, and optimization that uses internal and external capacity for storage and transportation.

Quantum Computing Quantum computing is an entirely different way to build a computer. While a supercomputer is just a really extensive version of a regular computer, a quantum computer uses principles from quantum physics and nanoscale superconductors chilled to nearly absolute zero to enable simultaneous mapping of all the millions or billions of permutations of a problem in a vast multidimensional space. Using principles of wave form interference, the correct solutions are magnified in amplitude while the incorrect solutions shrink. Because a quantum computer can look at all answers simultaneously rather than sequentially, it is radically faster than a supercomputer for optimization problems. Consider this example provided by IBM of finding one item in a list of one trillion where it takes one microsecond to check each item. A supercomputer would take about a week to find the answer; a quantum computer could do the task in about one second. While quantum computing is still considered to be in the early stages of development, such computers exist, and organizations like IBM are ramping up related hardware and software engineering.

Since supply chains are all about optimizing systems with numerous tradeoffs, quantum computing services might be leased as a service to optimize many things such as delivery routes to multiple cities to find the option with the smallest fuel cost. In a sustainability example, IBM has teamed with ExxonMobil to use quantum computing to discover new materials to reduce carbon emissions.

3D Printing 3D printing is printing on demand of 3D objects based on 3D digital models, typically by adding a material such as plastic or metal one layer at a time. 3D printing can be used for on-demand manufacturing at the point of demand, such as for replacement parts or items with uncertain demand that would not benefit by being kept in inventory. The lack of need to ship the item can provide sustainability benefits. This type of make-to-order may find applications in aerospace, medical devices, defense, automotive, and consumer products. A key application of 3D printing is rapid prototyping, since any 3D design can be printed and become a real object that can be experienced.

Wearable Technology and Augmented Reality

Wearable technology includes a variety of hands-free devices that are integrated into information systems (e.g., warehouse management systems) to enable visual or voice- or gesture-based interactions rather than requiring keyboard entry or delayed entry of data. Many such systems exist for warehouse picking and put-away (e.g., pick-to-voice). These systems reduce errors and increase worker efficiency. The systems also leave the hands free to enable physical movements of goods and so on. Augmented reality (AR) is a feature of vision-based wearable technology that overlays instructions or graphics on top of normal vision to provide interactive guidance. Smart glasses and heads-up displays in vehicles are examples. Issues with smart glasses include how to accommodate people who wear glasses and how to secure information accessed on such devices. Issues with wearable technology in general include the battery life of the systems.

Robotic Process Automation Robotic process automation (RPA) does not refer to actual robots such as those used in a plant but instead to the use of software “bots” to automate repetitive interactions with customers or with other automated systems. This includes interactions with customers

or third parties such as responses to frequently asked questions or service inquiries. It can take the form of automated emails, texts, or online chat functions. The primary benefit is a large reduction in customer service labor costs. The primary issue is that such systems are not as good as a real person and some customers may be dissatisfied. Some issues will still need to be escalated to a real person.

Autonomous and Automated Guided Vehicles Autonomous vehicles include self-driving cars and semis, but such vehicles still face regulatory hurdles. The primary supply chain management use of automated vehicles at present is in automated guided vehicle systems. The APICS Dictionary, 16th edition, defines automated guided vehicle system (AGVS) as follows. A transportation network that automatically routes one or more material handling devices, such as carts or pallet trucks, and positions them at predetermined destinations without operator intervention. AGVS is used in manufacturing or warehousing. The devices navigate using markers, wires, vision sensors, radio frequency communications, and so on. Amazon and many other warehouses use robots such as this to move warehouse freight to the pickers rather than vice versa. These systems reduce labor costs, help

control inventory, improve worker safety, enhance efficiency, and use less energy. Selection should be based on requirements and cost, but there are many varieties, so there should be a flexible solution to a given materials-handling issue. AGVS may include real-time communication anywhere, GPS, and various types of sensors. The primary issue with such technology is its cost, though this has been falling over the years. Most systems have a payback period in the range of two years, according to Technology in Supply Chain Management and Logistics. Another issue is the time required for the implementation project, which the same source says can range from six months to a year.

Drones Drones are autonomous or remote-controlled aircraft with sensor packages. While drones have significant potential, current uses include tracking assets in yards, performing inventory counts, pipeline inspection, or inspection of difficult-to-access areas. Drones face significant regulatory restrictions on their use.

Intelligent Supply Chains and Enablers

Intelligent supply chains refer to supply chains that take advantage of numerous emerging technologies, including the Internet of Things (IoT), intelligent asset management, blockchain, big data, machine learning, advanced analytics, and so on. An intelligent supply chain integrates all of these technologies into a seamless whole. It reimagines related processes, relationships, and training requirements to enable fast reactions to changes in customer needs or market changes while keeping costs low. Organizations that are succeeding in these areas are said to be at the forefront of the supply chain digital transformation.

Internet of Things (IoT) The Internet of Things (IoT) describes the networking of noncomputer devices such as equipment, drones, automated storage and retrieval systems, shipping containers, electronic shelving (automatic retail price updates), printers, and other devices using internet communications. Each object receives a unique ID. From a track-and-trace perspective, traceable objects such as shipping containers can be linked using IoT technology and GPS devices (such as radio frequency identification [RFID]) to determine their whereabouts in real time. IoT devices can update the organization’s information systems on their status, sensor readings, maintenance status, maintenance

needs, and location. They can be used alongside interactive fleet management software to direct or redirect shipping vehicles or with blockchain and intelligent asset management to provide reliable chain-of-custody information for devices or their cargo. However, universal standards for device security still do not exist. There is a risk that these devices can be hacked to gather information or that the devices may be used for nefarious purposes such as creating a denial-of-service attack using many IoT devices simultaneously.

Blockchain Blockchain is a distributed ledger system in which it is nearly impossible to alter information once it has been recorded in the ledger as a “link” in the chain of records. This is because the ledger is distributed among the participants and all of the versions need to agree with one another. The systems use complex cryptography and networking rules to make this happen without needing to rely on an independent third party. Blockchain can provide a number of benefits for track and trace, including Reliable (irrefutable) evidence of transfer of goods between parties, which in turn creates a chain of custody for goods and their source materials Automated capture and distribution of reliable data from IoT devices, such as temperature records of a refrigerated truck

Preventing insertion of counterfeits into the network by validating serial numbers. Blockchain is most famous for being the technology behind cryptocurrencies, but it has numerous supply chain applications in addition to those noted above, including smart contracts, asset tracking, parts origins, inspections/audit tracking, secure procurement bidding, and other types of supply chain data (e.g., pharmaceutical tracking). There are several competing blockchain solutions for water shipping and ports. TradeLens is a joint venture of IBM and Maersk, and it opened itself up to general availability in 2021 and acquired ten new Chinese companies (port groups and intermodal/inland providers) in the first month. Another blockchain system is the Global Shipping Business Network (GSBN), which includes COSCO Shipping Lines and a number of other major carriers and terminal operators.

Intelligent Asset Management (IAM) Intelligent asset management (IAM) creates a digital version or “digital twin” of an industrial asset. This enables organizations or divisions to control the sharing rights over that asset. The asset’s performance status can be visible not only to maintenance and

operations personnel but also to the engineers who designed the asset so they can engage in continuous improvement.

Blockchain, IAM, and IoT Case Study A technology road map is a tool used to facilitate technology planning, collaboration, and consensus building among various areas of the organization. The road map helps the organization begin with the end in mind and map out the broad steps that will be required to get there over time. These road maps are often used for longer-term planning on agile projects (e.g., for software development) because they are kept at a high enough level that they can be easily revised. This is important in an agile project because customer-driven changes are welcomed even late in development. Since process technology requirements are also subject to change as the market changes or new technologies become available, a road map is often a great tool for flexible planning. Road maps can take many forms, but, in general, they should be easy to interpret, brief, and high level. Exhibit 8-16 shows a road map for a shipbuilder that has decided to transition to blockchain, IAM, and IoT equipment to help track and coordinate the use and maintenance of its ship manufacturing assets, from large equipment down to tools and dies. Larger powered equipment will have RFID tags that broadcast its

whereabouts and maintenance status. Smaller things like tools and dies will have quick response (QR) codes, and these 2D bar codes will be scanned as items are checked out and moved to various locations. The blockchain system will operate in the background to collect these data at multiple locations and create a time line of how the assets are used. Advanced analytics will determine proactive maintenance requirements and optimal amounts and locations of each type of asset. Exhibit 8-16: Shipbuilder’s Road Map for Blockchain, IAM, and IoT Initiative Goals Business

Year 1

Year 2

Year 3

Meet technology initiative budget and schedule.

Meet asset utilization goals using blockchain tracking for QR and RFID.

Break-even, analysis, messaging, and asset optimization.

Product Maintain shipbuilding Enable shipbuilding (i.e., ships project schedules project change being built) during changes. request evaluations related to asset availability.

Enable compressed shipbuilding project schedules.

Process

Develop and train asset checkout and use process.

Develop and train asset optimization process.

Equipment

Install bar code Upgrade heavy Adjust equipment readers and tag equipment with RFID and asset levels small assets with QR and install detectors. based on internal codes. demand patterns.

Develop and train predictive maintenance process.

Goals Software

Year 1

Year 2

Develop blockchain minimum viable product (MVP).

Blockchain release 1: equipment RFID interfaces

Develop IAM MVP.

IAM release 1: predictive maintenance and engineering feedback

Year 3 Blockchain release 2: analytic interfaces IAM release 2: IoT and IAM automated updating

Note how various categories of goals are made clear. Other road maps that have complex dependencies between goals could use a flowchart-type design, with arrows between the various elements to show what aspects of the initiative need to be done before other elements can be started or which sub-initiatives require close coordination.

Topic 2: Technology Assessment and Implementation Technology can fuel the supply chain digital transformation, or it can be a huge expense that does not provide the envisioned benefits. The amount of work put in up front in evaluating the organization’s capabilities, requirements, and gaps and comparing this information to the actual pros and cons of technology solutions strongly influences what results will be realized. Here we address technology

audits and implementation reviews, ensuring alignment, and technology selection criteria and selection. Project management and change management are also addressed here as key technology implementation enablers. The final subject is the ongoing maintenance of technology.

Technology Audits and Implementation Reviews A thorough analysis of the organization is required before making IT investments. What are the firm’s current networking capabilities? What is needed to get to the next stage of supply chain development? A technology audit can answer such questions. It can also help in mitigating risks and allocating technology spending. Technology audits can be performed by internal auditors or external third parties. Technology audits and later technology selection and implementation of new technology are run as projects using project management. IT audits test for system availability, security, confidentiality, and integrity. They play a critical role in compliance with the U.S. Sarbanes-Oxley Act of 2002 (SOX), which requires U.S. public companies to establish adequate internal financial reporting and IT controls. (Canada has a similar Bill 198, known as “Csox.”) For

example, an IT audit should reveal that persons who approve purchase orders cannot also receive goods. The audience for a technology audit is upper management, not IT or a specific department. The audit may investigate multiple companies in the supply chain and report to a cross-enterprise executive committee or boards of directors. Technology audits include pre- and post-implementation IT reviews, system development life cycle (SDLC) reviews, and database reviews, but only post-implementation reviews are discussed more next. A post-implementation review addresses whether or not the company has received the expected return on investment (ROI). This review can also be run as a project. Reviewing lessons learned can help the next project be more successful. If the review is included as part of the initial project plan, each manager will have a strong feeling of accountability. A post-implementation review should focus on items that can be measured and therefore managed. Incentives for project team members are key to success in achieving overall supply chain goals. These incentives should include financial success as well as other measures such as customer satisfaction and quality (i.e., a balanced scorecard system). Stock price is not a

fair measure for IT investment because it fluctuates in response to many factors. Audits can reveal Software vendor promises that were false Failure to provide the promised level of system integration That full features of the software are not being exploited because of resistance to change or inadequate training. The results of audits are rarely entirely positive, but negative results should be used to create positive organizational change. The external auditor’s recommendations on IT should include an explanation of the cost of continuing to use the existing technology versus replacement cost. A benefit-cost study from historical past estimates and true costs can show where costs were poorly estimated or overlooked. If current or prior investments had a negative ROI, the auditor should indicate how future IT can produce a positive return, such as by using add-ons to current technology.

Mitigating Typical IT Risk It is important that the proper analysis be conducted before an IT project is initiated. While a benefit-cost analysis is vital to determine

if the project should have a positive return on investment (ROI), this is just one of many ways to mitigate typical IT risk. IT projects can mitigate typical risks by adopting the following approaches. Make incremental improvements. Management may be tempted to try to solve all problems in one large project. Such projects are hard to manage and prone to failure. Organizations that take incremental steps can add innovation between steps. A large project can have go/no go milestones. Clearly define business requirements. Because evaluations take weeks and thousands of vendors can be available, management must be convinced from the start to clearly define business goals to ensure that evaluators have met management’s principal criteria. Perform due diligence on proposals. Rather than rely only a marketing presentation from the provider, IT purchasers can limit the risk of a new system by interviewing previous purchasers and using third-party evaluators. Many project failures are traced to processes or proposed software that were not properly understood.

Control scope creep. The activities required to carry out a project should be fully and carefully defined in written documents. There should also be written procedures for defining and estimating the costs of additional work. Control excessive customization. When packaged software cannot fit the organization’s business processes perfectly, a dilemma organizations may face is deciding whether to adapt their processes to fit the standard delivered functionality or to customize the software to allow current practices to remain in place. A good rule of thumb is to look for packages that meet at least 80 percent of needs “out of the box.” The remaining 20 percent can be met through customization. While there will be short-term pains in pursuing organizational change over customization, in the long run it will lead to a much lower total cost of ownership, easier software upgrades, and less-expensive training of users. Many companies have faced expensive technology issues because they customized software when they should have updated and changed their business processes. Note that some customizations are riskier than others. At the low risk end, many software packages have built in extra “blank” data fields for custom use; far riskier customizations involve altering raw source code.

Technologies and Alignment

Technology for supply chain management consists of process technology (e.g., operations machinery, warehouse equipment, transportation equipment) and information technology (IT). This may include information processing that helps transform materials or process departmental data. For service industries, technology can help “transform” customers, such as by transforming sales leads into customers or by transforming service requirements into services such as provision of information, experiences, or actions. A process technology strategy provides guidance for those making decisions about how to apply technology to help the supply chain meet performance objectives. The supply chain strategy must be aligned not only with the organization’s overall business strategy but also with the organization’s information system architecture, defined in the APICS Dictionary, 16th edition, as follows: A model of how the organization operates regarding information. The model considers four factors: (1) organizational functions; (2) communication of coordination requirements; (3) data modeling needs; and (4) management and control structures. The architecture of the information system should be aligned with and match the architecture of the organization.

Technology and Equipment Requirements

Technology and equipment requirements start out broad and become more specific. Analyzing requirements at the strategic, tactical, and operational levels helps ensure alignment at each of these levels. Strategic Requirements Organizations develop technology systems requirements or specifications to support organizational strategy and goals. The organization’s technology requirements need to align with its strategy for competition and growth. For example, if the organization is a low-cost provider, technology solutions will either need to help lower costs by far more than the technology investment cost or be inexpensive solutions that keep their own capital investment requirements down. If the organization is working to provide differentiation, the technology requirements need to support that differentiation. Other strategic requirements will relate to the organization’s priorities for quality, speed, dependability, flexibility, and cost. Tactical Requirements Tactical requirements for supply chain process technologies may include degree of automation, user-friendliness, maintainability, throughput, and ability to satisfy storage or transportation objectives such as need for a cold chain.

From a manufacturing environment, layout, and type perspective, technology and equipment requirements need to fit the choices made for the production process. Flexible machines (and workers) are needed to meet product variety requirements. Heavy capital investment is required for the dedicated and often highly specialized equipment used in line production (assembly line) and mass/continuous production processes. High utilization rates and high-volume production runs result in low unit production costs and high production efficiency. In a lean manufacturing organization, high utilization of large machinery is not likely the best path to production efficiency. Here the requirements will be for flexible equipment in terms of the ability to make both fast changeovers and fast equipment layout changes, such as into new cells. Use of smaller machines tends to be more conducive to lean’s small batch production, need for quality control, and the addition or reduction of capacity in small increments when necessary. Technology that enables maximum utilization of highly trained workers will be another lean technology requirement. Technologies that help cross-train workers or that make it easier to do the work with less training will be valued. For example, this could be a system

that has mistake proofing and visual signals built in so that the task is more intuitive. As should be clear, technology requirements can relate to every area discussed in this course, from demand management requirements, to reduced lead times and stockouts for better customer satisfaction, to inventory management technology requirements that relate to tracking and controlling the level of inventory and its accuracy, to distribution technology requirements that help partners share information seamlessly, reduce cycle times, and drive net costs down. Operational Requirements Obviously, technology requirements will need to be made more detailed and specific after high-level requirements have been determined. For example, for a visibility requirement, requirements for sensors could include environment hardening (durable sensors designed for harsh environments), accuracy, and precision requirements. Requirements should be specified as SMART goals (specific, measurable, attainable, relevant, and time-bound).

Technology Gap Analysis The APICS Dictionary, 16th edition, defines a gap analysis as “a tool designed to assess the difference that exists between a service

that is offered and customer expectations.” When used for a technology assessment, a gap analysis starts by determining the current state of capabilities related to technology and then gathers and analyzes the requirements of internal and external customers to envision a future or ideal state for those capabilities. The difference between the current and future state is the gap. A gap analysis will help further refine technology requirements. A gap analysis is more of a process than a single tool. As such, it can make use of numerous tools discussed elsewhere in these materials. This can start with benchmarking to determine one’s technology gaps relative to the competition or the voice of the customer to understand how customer requirements have changed since the last customer scan. (Internal customers should be scanned, too, to reveal gaps or inefficiencies in internal workflows.) Process mapping can use a flowchart to map out the current process and then use this map as a starting point to streamline the process for the future state. A more supply-chain-specific type of process map organizations can use is value stream mapping. This tool adds things like push versus pull symbols and value-added versus nonvalue-added lead-time analyses. In some cases, analysis of current capabilities will reveal that an existing technology system can already satisfy certain requirements,

either as it is currently being used or by further leveraging the technology such as by training, process changes, or add-on tools. This will help reduce the set of unfulfilled requirements and the cost of bridging the gap. In other cases, a gap analysis will reveal system, process, personnel, or partner limitations that need to be addressed before a new technology will be capable of being successfully integrated. Such limitations can include Underlying information system architecture layers that need to be replaced or upgraded prior to being able to support a new technology, such as a legacy system that would be incompatible, poorly scalable, or too expensive to integrate Processes that the technology would not support and that would need to be changed if the technology were adopted, such as an enterprise resources planning system that has different workflows and that would be cost-prohibitive to customize to the organization’s processes Human resource (HR) skills gaps that would need to be closed using hiring, contracting, and/or formal and informal training, for example, process knowledge gaps, technical expertise gaps, and management and leadership gaps HR policy gaps that restrict personnel job expansion, employee empowerment, and so on that would need to be changed for the

technology investment to meet its potential External partner gaps related to their willingness to change their processes and share information, risks, and/or investment costs. The cost and time required to make these organizational changes or underlying technology improvements should be added to the overall cost of a technology feasibility analysis.

Technology Selection Criteria, Selection, and Cutover Organizations adopt emerging technologies that are appropriate for competitive advantage and that fit their risk tolerance levels and limited resources for technology investments. Determining technology requirements and conducting a gap analysis help the organization begin with the end in mind so that it can set technology selection criteria that are based on actual needs rather than wants. The process of selecting technologies also includes considering risks and rewards (e.g., strategic advantage).

Selection Criteria Technology selection criteria include competitive advantage, risk levels, feasibility, and validation against requirements. Competitive Advantage

Technology can convey competitive advantage when it is Scarce. First-of-its-kind technology and proprietary technology (protected by patent) are scarce. Competitors do not possess this technology. Difficult to move. The advantages created by the technology can be captured by competitors only by acquiring the organization and its technology. Difficult to copy. The barriers to competitors for developing the technology is high (e.g., skilled resources/capital investment or the organization has a significant head start on development). The technology security (both physical and digital) makes it difficult to reverse-engineer, emulate, or steal. Difficult to substitute. This occurs usually because the cost of switching from present to comparable technology is high due to barriers to adoption, including capital investment or the need for underlying technologies, processes, or personnel. The organization may be developing its own technologies, acquiring firms that have developed proprietary technologies, or be an early adopter of new technologies developed and offered by others. In the last case, competitors may also be adopting these technologies, so the competitive advantage then comes in the form of who is first to

market and how long that differentiation will last. Assuming that the technology adds value in the eyes of the customer, once most competitors have the technology, it is no longer an order winner and instead becomes an order qualifier. Risk New technology is vulnerable to risk. Risks must be identified and analyzed for impact and probability of occurrence. In general, the risk level accepted needs to be commensurate with the potential for reward, and it needs to fall within the organization’s risk appetite (the level of risk it is willing to accept). Risks include the following: The technology project could be poorly managed and cost far more than planned for, consume too much time, or fail entirely after significant funds are sunk into it. The technology could fail to provide the envisioned level of benefits due to misrepresentation on the part of the seller, misunderstanding of actual requirements on the part of the buyer or seller, or poor project implementation (e.g., underlying system, process, or human resources limitations that were not considered). A change in market needs could wipe out the benefits of the technology —for example, a growing desire for customized rather than identical products.

The introduction of an even newer technology could negate the competitive advantages (e.g., of speed or flexibility) that the investment promised. A change in the external environment could make implementation impossible or costly. For example, a change in regulations could require changes to technology that reduce its benefits. Price increases for components, maintenance, or software configuration could affect the benefit-cost analysis. The technology could have unintended consequences. It could cause harm or long-term damage to workers or the environment, with, for example, the use of a hazardous material. Processes should be examined to understand the effects of technology and job designs on worker health and motivation. Jobs can be redesigned to provide more variety and opportunities to acquire new skills; processes can be redesigned to decrease repetitive stress injuries and to invite workers to participate in improving processes. Feasibility Feasibility tests involve identifying hurdles to implementing the technology. Both financial and organizational requirements are analyzed.

Performing a benefit-cost analysis is a key aspect of financial feasibility. This involves identifying and comparing all relevant costs and benefits for each alternative being considered. The basic analysis is to simply divide the total benefits by the total costs; values over 1.0 will have greater benefits than their costs. Costs that do not differ between alternatives and prior investments (sunk costs) should be ignored. Costs include initial investment, ongoing costs, and opportunity costs. Benefits of the technology options need to be quantified in monetary terms for this analysis. This can be challenging, since many benefits will need to be estimated and may not be measurable, especially before the decision needs to be made. Advanced financial analyses can take into account depreciation, net cash flows, the time value of money, payback period, expected useful life of the technology, and so on. For example, performing a benefit-cost analysis of a piece of materials-handling equipment using a total-cost-of-ownership perspective factors in the initial price, the cost of capital used to finance the purchase, maintenance and repair costs (or service contracts), depreciation, and disposal—offset by the monetary value of increased productivity or security, flexibility, cycle-time or lead-time reduction, reduced material use, tax credits, and resale value at the end of the equipment’s life.

From an organizational perspective, operations determines what will be required to implement the technology and manage the change. Some of the organizational issues will have implications in terms of costs, productivity, and employee engagement. The learning curve required by the new technology affects productivity and calculations of the payback period or the breakeven point. The APICS Dictionary, 16th edition, defines the learning curve as follows: A curve reflecting the rate of improvement in time per piece as more units of an item are made. A planning technique, the learning curve is particularly useful in project-oriented industries in which new products are frequently phased in. The basis for the learning curve calculation is that workers will be able to produce the product more quickly after they get used to making it.

The way the new technology is presented to the organization can accelerate its eventual acceptance by the organization and can save costs related to poor change management. These can include decreased productivity and loss of employees frustrated by the new technology. Discussions about the feasibility of new technology should involve employees whose work will be affected by the technology. Including

these employees in early requirements discussions and in later considerations of potential alternatives will leverage their daily and up-close experience with the work. They may see issues and opportunities that are not apparent to managers. In addition, having input into decisions will encourage employees to “own” the technology decision. It will improve employee engagement and increase employees’ acceptance of the new technology. Validation Against Requirements Once technology investments are determined to be feasible, it is important to circle back to validate the solution against the requirements. For example, will the technology support the attainment of the organization’s priorities related to a set of generic strategic performance objectives? Quality. Does it create quality attributes that customers may value? For example, certain process technology may make materials less susceptible to failure later. Does the technology decrease the rate of specification nonconformance? Speed. Does the technology shorten the processing time or the delivery time (e.g., efficient routes) so that orders can reach customers more quickly?

Dependability. Does the technology improve operations’ ability to deliver products/services as promised? Does it decrease operations’ susceptibility to internal disruptions and improve its resilience after disruptions? Flexibility. Does the technology support meeting different types of market needs in an efficient manner, allowing customization and configuration? Can it be easily adapted to operations’ current capacity needs? Cost. Does the technology allow greater throughput (which will increase profit)? Does it decrease labor or materials costs? Is there a minimum level of capacity utilization below which the investment creates losses rather than profits?

Selection of Technology Organizations may use a request for information (RFI) when they are looking to see the range of market solutions for a specific set of requirements. This should result in a short list of prequalified potential vendors. Once the organization knows what it wants, it can send out a request for proposal (RFP) or an invitation to tender (ITT). A less-involved process can be used for less-expensive investments. An alternative is to develop the technology in house or through a partner contract if this is feasible.

Selection between alternatives will start with a wide list of options that is then narrowed down to a short list of candidates that fit requirements and other criteria. All bidders should be given access to the same information. If one bidder asks a question, the answer should be provided to all bidders. The final bidders can be given a chance to provide a presentation or demonstrate the technology. The organization may accept an offer or negotiate with a short list of bidders for the best price, features, and so on. The winning bidder will get the contract. Note that it is better to have a vendor prove that a technology can satisfy a given requirement than to take their word for it. For example, rather than looking at a generic demonstration of transportation scheduling software, provide the vendor with a sample of actual shipping order data and have them prove that the software can incorporate the data and properly prioritize deliveries.

Technology Cutover Plan Implementation of technologies requires delivery, checking, and acceptance of hardware and software, integration with existing systems, cutover from the old system to the new system, handover of deliverables and documents from the project team to end users, formal user training, and ongoing support and maintenance.

Prior to cutover, all testing of the technology that is possible prior to going live needs to have occurred. Users need to be fully trained on new processes. All of these tasks are accomplished using project management. The technology cutover plan details how the new technology will be activated and put into operation and how the old technology will be retired. The cutover from an old to a new technology presents risk and so should feature formal planning. Depending on the complexity, rehearsals may be needed. Determining the best technology cutover method involves deciding between tradeoffs. One method is to set a go-live date. The migration of data, switching of interfaces, final testing, and going live occur on a tight schedule. Users start using the new processes. The old system is retired. Hardware might be installed and set up in advance if it will not occupy the same space as the old hardware. This method can be efficient but has risks of downtime (customers cannot use the system, plant shutdown, etc.) if any critical task fails. Failure would involve backing out of the plan and turning the old system back on, so the cutover plan should have a process for this as well.

A lower-risk but more-expensive method involves fully maintaining the old technology or system during a cutover period while the new technology is also being used. In the case of software, data would need to be entered in both systems. The benefit is that if something goes wrong, the old system is still usable. The systems can also be compared to see if the same outputs are achieved. However, this duplicates labor, and qualified staff may not necessarily be available or may need to work overtime. In the case of process technology, if there is space to keep an old system available for use, this could serve as backup equipment or a backup work center. Use of that space is an opportunity cost. A third option is a rolling cutover, where implementation occurs in phases, such as at one site at a time if the technology needs to be implemented at multiple sites. This method can allow the implementation team to be smaller, because the same implementation and training staff can move from site to site. It also reduces risk because a failure will be localized and lessons learned from prior phases can improve the process.

Implementing Technologies Using Project Management

Implementing major business changes, including but not limited to new technologies, requires project management experience and the use of proven project management methodologies such as those defined by the Project Management Institute’s Project Management Body of Knowledge, or PMBOK. Project management is defined in the APICS Dictionary, 16th edition, as “the use of skills and knowledge in coordinating the organizing, planning, scheduling, directing, controlling, monitoring, and evaluating of prescribed activities to ensure that the stated objectives of a project, manufactured good, or service, are achieved.”

Project Management Fundamentals Projects are temporary endeavors that have unique deliverables. They have a definite beginning and an end. Regular operations, not projects, are used to plan, source, make, deliver, return, and enable standard products or products that are customized within a certain range. Projects, on the other hand, are needed when deliverables must be based on unique customer requirements, which is why the engineer-to-order manufacturing environment uses project management. Technology implementations need one-time deliverables that are customized to the organization’s requirements, so these also use project management.

Regardless of whether traditional or agile project management is used, projects need clear assignment of responsibilities. All projects need to have a formal charter signed by authorized executives that appoints a project manager or equivalent; formally approves the use of funds and resources up to a limit; sets forth high-level time lines, risks, tradeoffs, and assumptions; and has SMART criteria for determining the degree to which the project is a success. The document should be brief, such as one page. One or more executives should also champion or sponsor the project. This role maintains enthusiasm and champions the project’s importance and the need for the ideal state to be achieved. Project team members need to have the right skills to be involved, because teams are customized to the specific need. This ensures that teams are lean and effective. Team member selection criteria also include availability during the portion of the project in which the person will be needed. While full-time participation improves results, any part-time participation needs to be specifically allocated to the project and approved by the person’s functional manager.

Other stakeholders also need clear roles, and these can be indicated by using a RACI (responsible, accountable, consult, inform) matrix, as shown in Exhibit 8-17. Only one person can be accountable for a given part of a project (i.e., accountable for success or failure), but multiple people can be assigned responsibility for executing a particular task. Some people, like subject matter experts, will need to be consulted for their feedback. Other people, such as executives, just need to be kept informed. Exhibit 8-17: RACI Matrix

As shown in Exhibit 8-18, the project manager is responsible for communicating with the various stakeholders. The dotted line shows how team members allocated from functional areas still need to communicate with their supervisors when a portion of their time is still devoted to ongoing operations work. A formal kickoff meeting

can help formalize these roles, generate enthusiasm, and ensure ongoing communication.

Exhibit 8-18: Project Manager and Communication

Psychologist Bruce Tuckman proposed that teams do not begin their group existence as a highly productive unit. Instead, the group evolves in stages toward greater functionality, as shown in Exhibit 819.

Exhibit 8-19: Tuckman Ladder of Team Development

During forming, team members are trying to understand their roles. During storming, conflict and competition for status are expected; the team may also question the project’s objectives. The project manager needs to work hard to enforce ground rules and expectations. During norming, teams grow in confidence and project managers facilitate collaboration and sustain motivation. During performing, the team is at peak efficiency and project managers help with long-term skill development. During adjourning, lessons learned are captured, successes are celebrated, and teams are disbanded.

Avoiding Common Pitfalls

Simply claiming to use project management is not the same as properly managing a project. Organizations need to fully commit to a rigorous process, get the support of top management, train their project managers and teams, and use change management to instill best practices into the organization’s culture. Here are some common causes for the failure of projects: Budget or schedule (or other important constraint) is significantly missed. Project results are ineffective (e.g., unacceptable deliverables). Deliverables have no valid purpose (e.g., the project used resources without adding to business value). Project sponsors or managers allow scope creep, the uncontrolled expansion of project scope without allocation of additional time or funds. Exhibit 8-20 shows some common pitfalls along with some corresponding best practices described in A Guide to the Project Management Body of Knowledge. Exhibit 8-20: Pitfalls and Best Practices Common Pitfalls

Project Management Best Practices

Harangue and coerce.

Lead and coach.

Micromanage team members.

Clearly delegate responsibility.

Common Pitfalls

Project Management Best Practices

Treat personnel changes as emergencies due to unclear roles and responsibilities.

Assign activities to specific functional responsibilities for clear personnel transitions.

Guess at variances until too late.

Control and account for resources.

Fail to set plan baselines (e.g., schedule, budget).

Routinely measure against the plan.

Hold meetings to gather percent complete estimates (guesses).

Hold meetings to discuss substantive issues and risks.

Allow change and have unrealistic optimism about any consequences.

Control change and analyze tradeoffs between constraints.

Produce static documentation and never use it because it is out of date.

Keep live documentation updated.

Fail to send out new plan versions (so everyone is using different versions).

Ensure that everyone is using the current plan (configuration management).

Source: A Guide to the Project Management Body of Knowledge (PMBOK® Guide), fifth edition, 2013.

Traditional Project Management For projects with requirements that can be frozen early on, traditional (sometimes called predictive) project management techniques can be used, and this will help control project costs and keep the project on its deadline. The project phases—from initiating, to planning, to execution, to closing—are performed sequentially, somewhat like a stepped waterfall, with monitoring and controlling performed throughout. However, even in traditional projects, the work unfolds through a process the PMBOK Guide describes as progressive

elaboration. This means that as a project moves through its phases, there is a continual feedback loop that uses information being gained through project work to make planning and execution more focused, accurate, and efficient. The work done during the planning phase is most critical to a traditional project’s success. Even though, as Exhibit 8-21 shows, the largest cost accumulation occurs during the executing phase, planning represents the largest opportunity to affect project cost. Activities and risks that are poorly planned will contribute to increased costs later—a trend that is very difficult to reverse or correct.

Exhibit 8-21: Project Costs by Phase

Included in the project plan are the critical project baselines, which include the following. Scope baseline. The scope baseline includes the following. Project scope statement—A clear description of the project’s objectives, a list of deliverables, and clarification about what the deliverables include and do not include. The scope statement is a key document since it validates the project’s scope plan (the project manager’s and project team’s perception of deliverables) against the customer’s statement of work (the customer’s perception of deliverables). Work breakdown structure (WBS)—The primary planning tool for organizing project work, defined in the Dictionary as “a hierarchical description of a project in which each lower level is more detailed.” The WBS is critical, since it provides the basis for planning project material, resources, cost, and timing and for identifying project risks. The WBS should include 100 percent of what will be done on the project. If it is not on the WBS, it is out of scope. A WBS lists deliverables or results that should be achieved, not activities to do, so it is a bit like a bill of materials. An example of a WBS is shown in Exhibit 8-22, but note that for brevity some of the categories are left unexploded. For example,

project management would include all of the various project plans such as assembly team staffing plans or installation plans. Exhibit 8-22: Work Breakdown Structure (Conveyor Belt Example)

Project schedule. The project manager first defines activities that are needed to create each item on the WBS. Once all activities are defined, they can be placed in sequence. The project manager may arrange for activities to be done concurrently if they don’t depend on the completion of other activities or have resource

conflicts. Others must be done sequentially. For each activity, the project manager estimates the resources required (human and other), including required skill levels. Next, the project manager calculates activity durations. The total project duration is then how long it will take to do the longest string of activities that need to be done sequentially. This is the shortest possible project duration and is called the critical path. The schedule is perhaps subdivided for important deliverables or milestones that have go/no-go decision points. If approved, the schedule can be revised during the course of the project. Schedules can be represented using Gantt charts or various types of diagrams that show which activities can be done sequentially versus which can be done in parallel. An example is shown in Exhibit 8-23. Exhibit 8-23: Project Schedule (Gantt Chart View) for Conveyor Belt Project

Project budget. Costs are estimated from the bottom up starting at the activity level. The cost of the materials and resources is estimated for each activity, and then these costs are rolled up (aggregated) to determine the budget. As with the schedule, often this results in costs that are unacceptable to cost constraints. At that point, the project manager can work on the project budget from the top down, starting with the cost constraint or target budget and then determining whether it is feasible to get the same work done for less by using fewer resources (and likely a longer schedule) or if the project scope needs to be adjusted to fit within the available budget. The budget includes direct and indirect costs, project reserve funds the project manger can use for possible cost overruns, and separate management-allocated reserve funds that may be available to the project on management’s approval. The budget may be allocated to stages reflective of the resources used in each stage. The project manager will monitor and control the project against these baselines. Specific project management measurement tools exist and can be used to provide detailed information on performance relative to the schedule and budget baselines. Regular and reliable reports are vital for control. Control should be exercised daily, since a project gets off schedule a day at a time and off budget a dollar at a time.

When course corrections are needed, project managers may need to rearrange some additional activities to allow them to be done concurrently (called fast tracking) when possible or will add workers on activities to shorten their duration (called crashing) as is feasible from a cost and human resources perspective. The project manager will reject or put off changes to the scope unless formally approved by a change control board and additional funds and schedule are provided. This is to help avoid scope creep (customer requests for extra work) or gold plating (team members do unasked-for work). The change control board reviews formal change requests to assess budget/schedule feasibility, technical merit, and potential for integration impact. Approved changes result in updated project baselines. As needed and at the close of the project, the project manager will end team member assignments and close contracts with providers. This helps control project costs. The customer will review deliverables and accept or reject them. Additional work requested after formal approval will require new contractual arrangements and cost, so it is vital to carefully inspect deliverables prior to formal acceptance.

Agile Project Management (e.g., Scrum) For technologies such as software or for new technologies that require prototypes, the customer requirements might need to have a high degree of variability and might change even late in the project.

This helps such technologies to be responsive to competitor actions, to information learned from prototype feedback, and so on. For such projects, an agile project methodology is recommended. One type called scrum is used below as an example. Basically, the various agile methods use intense customer participation, regular iteration with planning just for that iteration, and incremental planning to enable rearranging the priority of work on a regular basis. A key benefit of agile methods is that they can turn innovation into results much faster than traditional project management. For software, for example, a first release called a minimum viable product (MVP) is created to get the product functioning at a basic level quickly, and then future releases add functionality in stages. Some supply chain management functional areas even run their operations as a series of agile projects. Scrum Example Scrum is a rugby term that implies that the team needs to move forward as a unit by letting various members take the lead as needed. Scrum can be used to prioritize and reprioritize continuous improvement tasks or mini-projects (i.e., kaizen events) such as to alleviate a new bottleneck area. The basic process is to create a visual board that has cards with all of the work to do (backlog) in the first column, all the work in

process, perhaps in various stages, in one or more columns, and the work that is done in a final column. This is called a kanban board or scrumboard. (It was inspired by lean kanban boards.) The team meets on a regular basis and plans tasks that can be done before the next regular meeting. Each fixed time period is called a sprint or iteration. In the meeting, the team can reprioritize the items in the backlog (moving the most important cards to the top) and update the status of tasks by moving a card to a new column. A goal is to keep the team focused on current work before starting too many new things. The team also meets briefly on a daily basis (a daily standup) to discuss what they did, what they are doing, and any problems. At the end of the sprint, they review lessons learned and decide on ways to improve the process (a retrospective). Rather than using a formal project manager, a scrum master is used. This person ensures that the scrum methodology is used and works to remove obstacles while letting various team members take the lead as needed. A product owner role represents the needs of the customer. (This could be an internal customer.)

Supply Chain Digital Transformation Using Change Management

A supply chain digital transformation is an umbrella term for a wide variety of supply chain improvements designed to upgrade supply chain maturity. This includes providing end-to-end visibility, supply chain agility and resilience, process or transaction automation, and better customer and supplier relationships. Change management is critical to making such changes happen; moreover, it is needed for any continuous or breakthrough improvement for an organization. The bigger the change, the more it will be resisted. Resistance sources include the organization’s culture, persons who understand how to operate within the status quo, and suppliers and customers who do not want the expense or sustained effort required to make a change. Resistance will be especially strong if prior organizational change initiatives have failed, perhaps because they were treated as projects that, once finished, were ignored in favor of familiar routines. Change itself must be planned and executed, leaders need to inspire commitment and enthusiasm, and managers need to provide clear direction and monitor and control results long after any change projects are completed if the organization’s strategic changes are to be realized over the long term.

Change Management Road Map For change management to be effective, there needs to be two levels of implementation plans. Each plan should identify milestones,

tasks, and resources. A road map (a high-level master plan that can be continuously reprioritized as needed) contains all improvements in sequence and delineates where projects end and use in operations begins. Project plans schedule all steps required to achieve the targets for each key performance indicator (KPI), set deadlines, and assign accountability for achieving results. Note that change is usually difficult due to the high potential for unintended consequences. A change to one part of a system will affect the other parts. All companies and functional areas involved in the process must know what the improvement initiative involves so they can develop their own objectives and strategies to contribute to a synchronized effort. When planning change across organizations, a successful pilot study with a limited number of companies may inspire confidence in other supply chain partners and make full implementation easier. In effect, the outcome of the pilot sets a benchmark for the rest of the partners. Change can be enormously disruptive across a large organization if it isn’t handled properly. To ease an organization, let alone several supply chain partners, into change, the team, along with executives, must prepare the ground carefully before the initiative and maintain

communication during, and possibly long after, implementation. Some organizational and personal issues may hinder progress toward goals if they aren’t addressed in the beginning: Some companies may need to change from a functional to a process-oriented structure—to get to a minimum level of supply chain maturity, in other words. Structural changes may be major and should be included in the plans. Leadership from the top ranks of the organization is crucial to success. The leaders in the affected partner companies must be brought into the process as full partners and passionate advocates to get the employees to commit to the change. Incentives should be adjusted to reflect a balanced scorecard. The measures of success must reflect the four quadrants of the scorecard, not only the success of the initiative in meeting its process improvement goals. Growth and learning will most likely have to be integral to the initiative. People must not be introduced to new roles and new expectations without being thoroughly prepared. Training can take different forms depending on roles and responsibilities. New skills may best be learned in a person-to-person or classroom context with follow-up on the job. New procedures may best be taught on

the job with easy-to-use job aids for reinforcement. (If the processes are computer-based, the training should also be computer-based.) All companies involved in the revised process will have to work together in true partnership, sharing information and adjusting their strategies with an eye to the success of the overall supply chain and the positive impact on the end customer. Information sharing may have to be approached diplomatically, with an emphasis on what can be gained in terms of enhanced value for the customer and smoother operation of the supply chain. Periodic targets for KPIs from the balanced scorecard should be set, being sure to meet financial goals as well as other scorecard goals. Prerequisites for Change According to Stephen Covey’s The Seven Habits of Highly Effective People, three things are needed for any change to succeed in becoming a long-term practice, on either a personal or organizational level: Desire: You need to want to change. Knowledge: You need to know why the change is beneficial and what the end results look like. Skill: You need to acquire and apply the right tools and techniques to achieve your goals.

If any of these elements are missing, the change will fail. Change management processes address all of these things methodically. Change Processes One example of a change process is a model developed by John P. Kotter, author of several books on change management. In Kotter’s book Accelerate, he outlines eight accelerators, a set of principles that relate to a change driver he calls “the big opportunity.” A big opportunity is a new idea. It could be an agile reaction to an emerging threat, orchestrating visibility technology among partners, a new business model or methodology, a new product, and so on. What distinguishes a big opportunity from other potential changes or improvements is that it is a solution or opportunity that will create lasting benefits into the future rather than just addressing present problems, it would be difficult to achieve the change without a sustained impetus, and it is something that people can get excited about. It has to be an idea that top management agrees makes great sense and aligns with the organization’s mission, vision, and core values, but it is not just a reiteration of those ideals. It may be aligned with the current strategy or may be the impetus to change the strategy. Kotter’s eight accelerators form the process that turns the big opportunity into action more rapidly than an established hierarchical

system can because a key element is the establishment of a network organizational structure intended to mimic the creative thinking of an entrepreneurial start-up. The existing hierarchical organizational structure remains in place to addresses ongoing operations and business administration. The two structures share people. The network is more informal and is driven by the current or next big opportunity. The eight accelerators are paraphrased here: Big opportunity and urgency. Determine a big opportunity and create a sense of urgency around it, getting buy-in and enthusiasm from as many people as possible. People who feel this urgency will be thinking continually about how to advance the goal and how to sustain its urgency. Guiding coalition as change agents. The first big opportunity helps form the core of the network, as a guiding coalition forms to help win this opportunity. These core members will be change agents who want to lead, feel passionately about the big opportunity, and have something to contribute. As the team forms, it will need guidance to understand how a network needs to differ from a hierarchy, so they keep the entrepreneurial spirit rather than starting to build a hierarchy within the network (e.g., a focus on budgets, project management, roles).

Vision and inspiration. The network forms a vision for the big opportunity and develops related strategic initiatives. The initiatives worked on first are those that most inspire the guiding coalition. Legion of volunteers. The network grows by creating an army of volunteers who can devote a portion of their time either on an ongoing basis or just for a temporary period. They help create buyin and get things done. Kotter’s research indicates that a network made up of five to ten percent of the total workforce is sufficient to make a well-functioning network. Volunteers need to be vetted for both the necessary level of commitment and the ability to help. The ability to help could take the form of relevant knowledge or expertise, relationship-building skills and a network of relationships, or possession of influence and credibility. Obstacle and duplication avoidance. The network’s members focus on removing obstacles to ensure rapid progress on the big opportunity. They also pay close attention to initiatives on the hierarchical side to avoid duplications of effort. Credibility through wins. The network proves its worth by creating quick wins as well as bigger wins that have strategic relevance. These wins are highlighted and celebrated to help the network gain credibility, even starting to win over managers who

either did not support the dual network concept or did not volunteer to help. Self-sustaining network. The network sustains itself by recognizing and supporting numerous sub-initiatives, which provide the quick wins described in the prior principle. It also continues to look for the next big opportunity and continues to recruit new members based on the needs. Institutionalize. Successful initiatives are incorporated into the organization’s hierarchical organizational structure so they can be sustained and institutionalized. This includes integration into the organization’s policies and procedures, metrics and enforcement, and eventually the culture, as the culture becomes one that supports change as a necessary element of thriving in a rapidly changing world. Many of the concepts expressed in Kotter’s change methods are also captured in the following generic change management process. (How these step address the desire, knowledge, and skill prerequisites for change is also described.) Prepare for change: Identify the need to change (knowledge), set forth a compelling vision of the future (desire and knowledge), explore the costs and benefits of change and the organization’s

strengths and weaknesses that can complement or deter change (knowledge), and build consensus and enthusiasm for change (desire). Plan for change: Determine success criteria (knowledge), discover what areas (e.g., business units, roles) need to change (knowledge), develop detailed plans for each area including formal projects, training, and focused events (skill), develop ongoing management, monitoring, and controlling plans (skill), and gain approval and funding (desire and skill). Execute change: Execute projects, training, and events (skill). Monitor change: Lead and manage using the new operational policies, procedures, and processes (skill), and monitor and control against new metrics that align incentives to strategic goals (skill). These generic change management steps are discussed in more next.

Prepare for Change Preparing for change needs to involve everyone. When more people see the need to change because they are involved in identifying that need, more people will support the change. Executives need to

initiate and champion change but cannot simply hand it down from above. They need to get people involved at all stages so that they all “own” the change. The steps that lead to this buy-in from all parties follow. Identify Need for Change Rather than changing simply because a new method exists, the right reasons for change usually involve the realization that the status quo will no longer suffice to achieve organizational goals. Identifying the need for change starts with taking stock of the current state of the organization. This information is then compared to the new methodologies being contemplated as well as to what competitors are doing. The process could involve a formal project or a series of meetings, depending on the scope of the change. The idea is to use careful investigation to arrive at a frank understanding of the as-is state and to envision whether continuing to operate in this fashion will work in the future. Create Change Vision If some type of change is needed to continue growing and prospering, then the next step is to determine what the end results of the change will look like. Beginning with the end in mind involves understanding what the organization wants to accomplish with the

change. This involves executives first determining strategic goals such as becoming agile, then building this into a high-level concept of the end results, and then communicating this vision to everyone in the organization in a compelling manner. Once executives settle on a strategy that will help the organization achieve its long-term goals, the next step is to develop a big-picture view of what the change will look like. This requires developing an understanding of not only what needs to be accomplished and its scope but also who will be accountable for success and when the results are to be achieved. This effort cannot be an executives-only process. As many people as is feasible should be involved in conceptual design, not only to gather unique perspectives from managers and functional staff but also to give people a chance to make this their change program rather than being handed one. More perspectives can be contentious but also can bring a wealth of new ideas. Setting a compelling vision is the essence of leadership. This is where top management shows that it is fully invested in the change, that they are going to champion it, and that they are going to enlist the help of everyone in getting it right. Top management support sounds almost like a given, but many change initiatives fail because executives don’t get involved, their involvement trails off, or they fail

to keep reinforcing how important the initiative is to the organization’s future. Top-level support also needs to be active. This includes executive- or board-level governance, monitoring of key milestones and progress, and periodic recognition of program achievements. Determine Costs and Benefits of Change Participants in a change program can help brainstorm the costs and benefits of the change. Costs may include monetary costs, technical or external barriers, or anticipated resistance to change in its many forms (e.g., ignoring, complaining, actively resisting). Persons or areas who would be more resistant than others might be identified so they could be handled specially. Benefits of the change are also enumerated and communicated to everyone. Assess Organization’s Strengths and Weaknesses Exploring the strengths and weaknesses of the organization is where the organization’s culture is explicitly considered. A given methodology will have many standardized features, but some elements will work better with the organization’s culture than others. Determining the organization’s organizational and cultural strengths can help show where these will reinforce the change and make it uniquely this organization’s initiative. Similarly, developing an

understanding of organizational and cultural weaknesses will show which areas of a program will meet the most resistance. Some of these program areas might be modified to better fit the organization. Others will require changing the culture when the weakness would otherwise endanger the success of the strategy. Build Consensus Getting buy-in from people cannot be overemphasized in a change management initiative. People like to feel that they have a say in matters. People are naturally resistant to any decision that they feel they have had no input in. It goes against a desire for autonomy and personal growth. Even when people’s ideas are not eventually adopted, giving them a chance to express them from the outset of an initiative will give a sense of buy-in. Buy-in can be accomplished in many ways, including brainstorming sessions, distributing surveys, asking for people’s reactions to ideas, and formally involving representatives from affected business functions on project teams and in change planning meetings. Some persons will need to have full-time involvement, while others can have part-time or small roles. Another essential element of consensus building is to emphasize that the only way to achieve these goals is to work together. Tools and techniques to facilitate coordination, cooperation, and

collaboration might include new types of supplier contracts, measurements that emphasize common goals over individual goals, or information systems such as collaborative planning, forecasting, and replenishment (CPFR). Build Enthusiasm Building enthusiasm is an ongoing task for leaders at the executive and project management levels. While this is especially important right from the start, leaders need to sustain excitement for change in multiple ways, such as expressing excitement during large team meetings, by networking with individuals, by publishing a newsletter, or by advertising with short marketing messages that encapsulate the goals of the program, such as, “Supply chain resilience will allow us to seamlessly and rapidly shift to alternate supply sources when supply disruptions occur.”

Planning for Change Planning for change involves developing formal plans to provide everyone who is affected with the tools and skills they will need to succeed. This starts by determining specific, measurable, attainable, relevant, and time-bound (SMART) success criteria. Setting baselines will help an organization determine whether the initiative is succeeding or failing and will help with continuous

improvement after any related projects are complete. The organization can use the SCOR Digital Standard to help determine key performance indicators to use. Supply chain change initiatives may affect more business units than just the obvious ones. For example, marketing might need to change its focus from a make-and-sell philosophy to a sense-and-respond philosophy, purchasing may need to move from a low-cost emphasis to a relationship-building emphasis, manufacturing may need to retool whole plants and retrain staff to perform quick changeovers, distribution may need to have new information systems to select better modes of transportation on the fly and track inventory movements closely, and finance and accounting may need a new set of measurements that can show the financial benefits of the new operating methods rather than making them seem like purely negative costs. Last but not least, the organization’s culture may need to change, and doing so requires finesse. Changing an organization’s culture requires knowing human nature and how to develop incentives that will lead people to change their ways. Change Plans Change plans for each area of the organization might involve formal projects with all of the detailed initiating, planning, executing,

monitoring and controlling, and closing that this entails, or it might involve planning various types of training for individuals such as formal classroom training, or it could involve brief continuous improvement events. Regardless of the method of planning for change, from a change management perspective the most vital aspect of these plans is on people and relationships. While a new technology will have many challenges and costs, it is critical to invest significant time training people on how to use the new tool. People and relationships will also be a top concern when changes involve moving from a transactional to a partnering relationship with suppliers. These paradigm shifts are difficult to achieve and so require serious attention and planning. Plans to improve relationship building may need to include talent acquisition and development, executive training and support, and leveraging new collaborative tools and communication channels that are implemented across multiple organizations. Plans also need to include specific and detailed relationship-building activities for each area. For example, executives might need to initiate contact with specific supplier and customer counterparts regarding collaboration. Marketing might need to define what additional information they need to collect on customers and how to determine customers’ actual wants and needs. Purchasing may

need to develop a mentoring program to help other business units develop supplier relationships. Operations may need to work on empowering employees by providing them with more autonomy and cross-training. Distribution may need to determine how to share order information with suppliers and customers. And finance and accounting may need to collaborate with other organizations to develop total cost of ownership or other total supply chain metrics. Culture change is also about people and relationships. Plans for changing culture may involve getting expert consultants to help design new metrics and incentives that pull people toward desired behavior rather than pushing them. Organizational change plans cannot stop with projects, training, and events. These things are temporary endeavors, while the changes will be part of ongoing operations. Therefore, plans will necessarily also involve aligning business rules to institutionalize the changes. Enforcement needs to be consistent and vigilant so that people aren’t allowed to slip back into their old ways or develop workarounds. Organizational structures may also need changes. Often, this means that the organization becomes flatter to allow faster communications (more allowed direct communication channels) and fewer organizational silos.

Approval and funding for change plans and projects is mandatory. Sufficient funding for change management is a signal on top management’s part that they want the changes to succeed.

Executing Change If the plans for physical and social change are well developed, they can be implemented smoothly in a step-by-step fashion. Usually the physical changes, like configuring a new information system, receive a lot of time and attention. Communication flows need to precede and follow these physical changes, first preparing individuals for the change, then guiding them through the change, then providing training, and then reinforcing the training through practice, certification as applicable, mentoring, and so on. The cultural changes are also initiated from the start, but these will take the longest to complete, since culture changes slowly. Realizing the glacial pace of culture change is the key to successful culture change. The effort to change culture—to help people see the world in a different way—needs sustained effort that is built into an operations mentality rather than treating it as a temporary project. New business goals may require the following: New business vision and mission statement. A new vision and mission statement is an opportunity to define the values of the new

culture. Those values may involve a greater focus on the customer, meeting customer needs, and delivering complete satisfaction. It may mean abandoning traditional interdepartmental and/or intercompany boundaries in favor of open, cooperative, and collaborative relationships. Involving as many people as possible in crafting these statements makes the drafting process itself into a culture change tool. New business organization. In the past, organizational structures focused primarily on individual profit centers. The information moved up the organization’s hierarchy where decisions were made and then moved down the channels where the decisions were carried out. In contrast, many types of reorganizations may require pushing decisions down the organizational structure from upper management to those involved in the actual processes. Traditional hierarchical organizations may flatten and move toward interdisciplinary teams or add a parallel network structure for big opportunities. New job definitions and organizational structures. The skills needed may require redefining job descriptions or organizational structures. Employees and management need to understand different perspectives in their new teams. They may need to provide support and backup for other employees. Many members

of the organization will need to acquire knowledge and develop new skills. The criteria for job success will change as well. Managers may need to migrate from being taskmasters and scorekeepers to being process owners and mentors who are responsible for identifying resources as well as coaching and providing problem-solving facilitation for their employees.

Monitoring Change When people resist change—and they will—the goal is to listen first, because people need to feel understood before they will attempt to understand. Showing that you are willing to listen and are taking complaints seriously will help people feel more comfortable sharing their issues and fears. The more people share, the better idea the organization will have of the current level of acceptance of the change. The organization needs to take individuals’ fears seriously, address them by listening and carefully considering how these fears can be alleviated, and then provide the response not only to the individuals who brought them up but to everyone affected by the change, since many persons who are remaining silent will likely have similar fears. Monitoring change also involves leading and managing using the new methods and monitoring and controlling using the new metrics.

Leading and managing using the new operational policies, procedures, and processes will institutionalize the change. Projects and events cannot sustain a change effort. They are limited in duration and funding. The change has to become the new way of doing business—the new normal. This requires both leadership and management. Leadership is used to continue refining strategy based on feedback from management and to set the tone and the vision for fully realizing the benefits envisioned by the change. When top management lives by the new methods, the change becomes something that cannot be ignored. Management provides clear direction as to policy, procedure, and process and makes organizational changes as needed, such as by replacing staff members who refuse to learn or apply the new ways. Monitoring and controlling to a new paradigm requires new metrics that create the proper incentives. A new metric that measures whether or not the entire supply chain benefits will deter suboptimization. A procurement executive who is rewarded for establishing collaborative supplier contracts will work to get such contracts signed. Once the new strategically aligned metrics are in place, systems and individuals need to be monitored against those metrics. Control of significant variances and trends then enforces the change process.

Finally, analysis of actual results can be used as feedback to show which metrics need modification. Since it is difficult to predict some of the side effects of incentives, continually improving these metrics will help to get the organization closer and closer to its desired strategy.

Maintaining Technologies Maintaining technologies involves designating responsibility for maintenance to specific parties and individuals, setting maintenance policies and procedures, performing maintenance according to a schedule, and regularly reassessing maintenance requirements, It is important to determine who will be providing maintenance for a given technology as part of the contracting discussions with vendors, since this will impact ongoing costs and staffing requirements. If the vendor will maintain the system, the organization may not need certain job positions at all. Some technologies will be purchased and maintained by the organization, while others may be leased and possibly maintained by the vendor via cloud computing and software as a service (SaaS). In general, leasing can drastically reduce the initial investment and implementation time but will increase the ongoing cost relative to a purchase. The cost of upgrades and maintenance will usually be the vendor’s responsibility, and this may

partially offset the higher ongoing cost of the lease. Ending a lease will end the provision of the service, however. For technologies that will be maintained in house, these roles need to be explicit, including by ensuring that the maintenance role is listed in the job description. Once who will be maintaining technology is clear, it is important to set maintenance policies and procedures for the technology so that it will remain useful over its expected life cycle. To monitor and control technology maintenance, policies and procedures should Emphasize the necessity of developing and using testing protocols such as testing samples for quality using specific sampling and testing procedures. Enforce restrictions on who can use existing technologies, their acceptable parameters for use (e.g., for equipment longevity, worker safety, or customer privacy), and specific checks and balances or controls on their use such as required approvals for changes. Specify a process for assessing usage impacts and tradeoffs related to the current state of machine wear, the maintenance impact of different configurations or rates of throughput, and so on to minimize risks to existing technologies.

Develop priority planning techniques and communication skills for technology maintenance so that critical technology for ongoing operations (e.g., for a bottleneck area) is maintained and any emergency situations get an immediate response. Predictive analytics can help determine maintenance needs. Determine maintenance schedules that minimize conflict with ongoing operations, including by scheduling maintenance after operation hours or in conjunction with changeovers. These policies will require a communication element between the person doing the maintenance and the operators. Include a process for carrying some replacement parts in stock, ordering some replacement parts in advance of scheduled maintenance, and ordering other parts only on demand. The process should have an approval step for parts above a certain value. Predictive analytics can help with this as well. Assuming that the policies and procedures are well designed, maintenance scheduling and execution will be straightforward. There still needs to be a system and process for expediting emergency maintenance and repairs. Advanced training in troubleshooting is important, since the cause of an unexpected breakdown will not necessarily be obvious.

As technologies age, their maintenance requirements may change. Maintenance managers can compile data on part breakdown rates and revise what parts are kept in stock, for example. The expected remaining useful life of a technology can also be updated. This information should be provided not only to managers responsible for considering when and what technologies to upgrade but also to the organization’s accounting function, who can update depreciation rates.

Cumulative Course Bibliography The following materials were used during the development and revision of the APICS CSCP Learning System. “2017 Aon Risk Maturity Index Insight Report Uncovers New Insights on Relationship of Risk Maturity and Financial Success.” Aon, www.aon.com/risk-services/thought-leadership/report-rmi-insightnov-2017.jsp. “About the UN Global Compact.” United Nations Global Compact, www.unglobalcompact.org/about. “Adapto.” Vanderlande, www.vanderlande.com/systems/storage-asrs/adapto/. Amazon Web Services. “What Is Pub/Sub Messaging?” aws.amazon.com/pub-sub-messaging/. American Society for Quality, www.asq.org. Andersen, Mette. “Corporate Social Responsibility in Global Supply Chains.” Supply Chain Management: An International Journal, Volume 14, Issue 2, 2009. APICS. Advanced Supply Chain Management (CD-ROM). Chicago, Illinois: APICS. APICS. Advanced Supply Chain Management Reprints. Chicago, Illinois: APICS, 2000. APICS. APICS Certified Supply Chain Professional (CSCP) Learning System, Version 3.3. Chicago, Illinois: APICS, 2015. APICS. APICS CPIM Basics of Supply Chain Management. Chicago, Illinois: APICS.

APICS. APICS Dictionary, 16th edition. Chicago, Illinois: APICS, 2019. APICS. APICS Global Sourcing Workshop Series. Chicago, Illinois: APICS. APICS. APICS Master Planning of Resources, Version 3.1. Chicago, Illinois: APICS. APICS. APICS Operations Management Now, July 2, 2010, edition. Chicago, Illinois: APICS, 2010. APICS. CPIM Workbook. Chicago, Illinois: APICS. APICS. Introduction to ERP: Enterprise Resources Planning, Facilitator Guide. Chicago, Illinois: APICS, 2002. APICS. Introduction to ERP: Enterprise Resources Planning Reprints. Chicago, Illinois: APICS, 2002. APICS. Lean Enterprise Workshop Series, Version 1.0. Chicago, Illinois: APICS, 2008. “Application Programming Interface (API).” IBM, www.ibm.com/cloud/learn/api, August 19, 2020. Arnold, J. R. Tony, Stephen N. Chapman, and Lloyd M. Clive. Introduction to Materials Management, sixth edition. Upper Saddle River, New Jersey: Pearson Prentice Hall, 2008. ASCET. Achieving Supply Chain Excellence Through Technology, Volume 6. San Francisco: Montgomery Research, Inc., 2004. Ashkenas, Ron, Martha Craumer, Anthony K. Tjan, Gina Trapani, David Silverman, Jane Heifetz, June Delano, Jodi Glickman, and Melissa Raffoni. “HBR Guide to Making Every Meeting Matter.” Harvard Business Review, April 11, 2011.

“AS/NZS ISO 31000:2009 Risk Management—Principles and Guidelines.” Standards Australia/Standards New Zealand. Association for Financial Professionals. AFP Financial Planning and Analysis Learning System, Version 2.0. Bethesda, Maryland: AFP, 2014. “ATA Truck Tonnage Index Increased 1.4% In January.” American Trucking Associations, www.trucking.org/news-insights/ata-trucktonnage-index-increased-14-january, February 23, 2021. Aurelie, Charles, Matthieu Lauras, and Luk Van Wassenhove. “A Model to Define and Assess the Agility of Supply Chains: Building on Humanitarian Experience.” International Journal of Physical Distribution & Logistics Management, Volume 40, Number 8/9, 2010. Ayers, James B. Handbook of Supply Chain Management. Boca Raton, Florida: St. Lucie Press, 2001. Ayres, Ian. “Paying People to Quit: What Law Schools Can Learn From Zappos.” freakonomics.com/2011/11/21/paying-people-to-quitwhat-law-schools-can-learn-from-zappos/. Banker, Steve. “20 Things to Know About Digital Supply Chain Transformations.” Forbes, www.forbes.com/sites/stevebanker/2019/09/18/20-things-to-knowabout-digital-supply-chain-transformations/?sh=23e59bd945b1, September 18, 2019. Banker, Steve. “Top Takeaways from the State of Logistics Report 2019.” Forbes, www.forbes.com/sites/stevebanker/2019/06/18/toptakeaways-from-the-state-of-logistics-report-2019/#5dec6c765b2c, June 18, 2019.

“Barge Transport Wins on Fuel Efficiency.” The Maritime Executive, www.maritime-executive.com/article/barge-transport-wins-on-fuelefficiency, March 29, 2017. Barnes, Jim. “To Hear the Voice of the Customer, Listen Outside the Box.” customerthink.com/hear_voice_of_customer_listen_outside_box/. Basu, S., and R. G. Schroeder. “Incorporating Judgments in Sales Forecasts: Application of the Delphi Method at American Hoist and Derrick.” Interfaces, Vol. 7, No. 3, 1977. Bauer, Michael J., et al. E-Business: The Strategic Impact on Supply Chain and Logistics. Oak Brook, Illinois: Council of Logistics Management, 2001. Baumer, D. L., and R. B. Handfield. “Managing Conflict of Interest in Purchasing.” Journal of Supply Chain Management, 42(3), 2006. Begley Bloom, Laura. “35 Countries Where Americans Are Most Likely to Get Kidnapped.” Forbes, www.forbes.com/sites/laurabegleybloom/2019/04/25/35-countrieswhere-americans-are-most-likely-to-get-kidnapped/? sh=1c7f1095bdf1, April 25, 2019. Bhasin, Kim, and Patrick Clark. “How Amazon Triggered a Robot Arms Race, Revolutionizing the World’s Warehouses and Putting Human Jobs at Risk.” Financial Post, business.financialpost.com/fptech-desk/how-amazon-triggered-a-robot-arms-race, July 1, 2016. Bhattacharya, Ananya. “Amazon Is Just Beginning to Use Robots in Its Warehouses and They’re Already Making a Huge Difference.” Quartz, qz.com/709541/amazon-is-just-beginning-to-use-robots-inits-warehouses-and-theyre-already-making-a-huge-difference/, June 17, 2016.

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Boyle, Robert D. “Achieving Your Supply Chain Goals: Conquering the ‘First Mile’ Hurdle of Data Capture.” APICS—The Performance Advantage, July/August 2004. Brigham, E., and M. Ehrhardt. Financial Management—Theory and Practice, 10th edition. Fort Worth, Texas: Harcourt College Publishers, 2002. Brown, Scott A., and Don Hess. “Activity-Based Management of Supply Chain Methodologies.” International Conference Proceedings. Chicago, Illinois: APICS, 2003. Brown, Stanley A. Customer Relationship Management: A Strategic Imperative in the World of e-Business. Etobicoke, Ontario: John Wiley & Sons Canada, 2000. Bugler, Will. “Extreme Weather Events Blow a Hole in Lloyd’s of London’s Balance Sheet.” Acclimatise News, www.acclimatise.uk.com/2019/04/18/extreme-weather-events-blowhole-in-lloyds-of-londons-balance-sheet/, April 18, 2019. Bureau of Industry and Security. “Guidelines for Preparing Export License Applications Involving Foreign Nationals.” www.bis.doc.gov/index.php/documents/deemed-exports/709guidelines-for-foreign-national-license-applications/file. Burnson, Patrick. “Improving Reverse Logistics with a Returns Management Strategy.” Logistics Management, www.logisticsmgmt.com/article/improving_reverse_logistics_with_a_r eturns_management_strategy. “Business to Business to Consumer (B2B2C).” Techopedia, www.techopedia.com/definition/23169/business-to-business-toconsumer-b2b2c.

Byrne, Robert. “What’s Ahead in Transportation Forecasting?” Inbound Logistics, www.inboundlogistics.com/cms/article/whatsahead-in-transportation-forecasting/, July 15, 2010. Byrnes, Jonathan. “You Only Have One Supply Chain?” Working Knowledge, August 1, 2005. Calculated Risk—Finance and Economics, www.calculatedriskblog.com. Caldwell, Bruce. “Reverse Logistics.” Information Week, April 12, 1999. Callioni, Gianpaolo, et al. “Inventory-Driven Costs.” Harvard Business Review, March 2005 Canales, Katie. “Amazon Reportedly Hopes to to [sic] Double Its Delivery Fleet This Year by Investing in Smaller Trucking Companies that Would Exclusively Serve the E-commerce Giant.” Business Insider, www.businessinsider.com/amazon-double-delivery-fleetexclusive-incubator-freight-2021-2, February 5, 2021. “Capacity of Oil Tankers in Seaborne Trade 1980-2020.” Statistica, www.statista.com/statistics/267605/capacity-of-oil-tankers-in-theworld-maritime-trade-since-1980/, April 14, 2021. Carlson, Andy. “SCEM: Help or Hype?” InTech, November 2002. Carlson, Scott. “Target Hits While Wal-Mart Misses.” St. Paul Pioneer Press, May 13, 2005. Cartin, Thomas J. Principles and Practices of TQM. Milwaukee, Wisconsin: ASQ Quality Press, 1993. Caruso, David. “Get a Backbone.” Intelligent Enterprise, Volume 1, Number 3, December 1998.

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Index A Accreditation [1] Agile project management [1] AI [1] Artificial intelligence (AI) [1] Audits Technology audits [1] Augmented reality [1] Availability [1] See also: Available time

B Benefit-cost analysis [1] Blockchain [1] Budgets Project budgets [1] Bullwhip effect [1] Business models [1] Business plans [1] Business strategies Focus strategies [1]

Low-cost strategies [1] Buyer-supplier relationships Mergers [1]

C Capacity [1] Centralized inventory control [1] Certification [1] Change [1] Change management [1] Cloud computing [1] Competitive advantage [1] Competitive analysis [1] Complexity [1] Control towers [1] Core capabilities [1] , [2] , [3] Core competencies [1] , [2] , [3] Costing Target costing [1] Cost leadership strategies [1] Customer requirements [1] Customer satisfaction [1] Customer service [1] Customer value [1]

Cutover plans [1]

D Data analytics [1] DDMRP systems [1] Decentralized inventory control [1] Demand-driven enterprises [1] Demand-driven material requirements planning systems [1] Demand-driven MRP systems [1] Drones [1]

E Economic bottom line [1] Economic value added (EVA) [1] Effectiveness [1] See also: Efficiency Efficiency [1] See also: Effectiveness Environmental bottom line [1] Environmentally sensitive engineering [1] Environmental standards ISO 14000 Series Standards [1] EVA [1]

F

Feasibility [1] Financial modeling [1] Financial value [1] Focus strategies [1] Forecast-driven enterprises [1] Functional products [1]

G Gap analysis [1] , [2] General capabilities [1] Global Reporting Initiative Reporting Framework [1] Global strategy [1] Government regulations [1] GRI Reporting Framework [1] See also: Global Reporting Initiative (GRI)

H Human resources [1]

I Implementation reviews [1] Information system architecture [1] Information systems [1] Information technology (IT) [1] , [2] , [3]

Innovation strategy [1] Innovative products [1] International strategies Global strategy [1] Multicountry strategy [1] Internet of Things (IoT) [1] Inventory optimization software [1] Inventory ordering systems Demand-driven MRP systems [1] IoT [1] IS [1] ISO 14000 Series Standards [1] ISO 26000 [1] ISO 9000 Series Standards [1] IT [1] , [2] , [3]

L Learning curves [1] Low-cost strategies [1]

M Market changes [1] Market conditions [1] Marketing

Mass marketing [1] Niche marketing [1] Market knowledge [1] Mass marketing [1] Mergers [1] Metrics [1] Modeling Financial modeling [1] Network modeling [1] Multicountry strategy [1]

N Network modeling [1] Niche marketing [1]

O OECD Guidelines for Multinational Enterprises [1] Operational research [1] Operations [1] Operations research (OR) [1] OR [1] Organizational design [1] Organizational strategies Demand-driven enterprises [1]

Forecast-driven enterprises [1] Product-type-driven strategies [1]

P Postponement [1] Process improvement tools Scrum [1] Procurement [1] Product differentiation [1] Product life cycle [1] Products Functional products [1] Innovative products [1] Product-type-driven strategies [1] Project budgets [1] Project management Agile project management [1] Project management plans [1] Projects [1] Pull systems [1] See also: Push systems Push systems [1] See also: Pull systems

Q Quality standards ISO 9000 Series Standards [1]

R RACI charts [1] RACI matrices [1] Responsibility charts [1] Responsibility matrices [1] Return on assets (ROA) [1] Return on investment (ROI) [1] Revenue models [1] , [2] Risk management [1] Risks Technology risks [1] ROA [1] Robotic process automation (RPA) [1] ROI [1] RPA [1]

S Safety standards [1] Scrum [1] Sensors [1]

Social bottom line [1] Social standards ISO 26000 [1] Social value [1] Software Inventory optimization software [1] Spend management [1] Stakeholders [1] Standards Quality standards [1] Safety standards [1] Strategic planning [1] Strategic plans [1] Strategy alignment [1] , [2] , [3] Supply chain capabilities Core competencies [1] , [2] , [3] General capabilities [1] Supply chain cost structure [1] , [2] Supply chain design [1] Supply chain misalignments [1] , [2] Supply chain partners [1] Supply chain realignment [1] Supply chain strategies [1] , [2] Sustainability [1] , [2] , [3]

T Target costing [1] Taxes [1] TBL [1] Technology audits [1] Technology maintenance [1] Technology risks [1] Technology selection [1] Technology strategies [1] Telematics [1] Three Vs Variability [1] Velocity [1] Visibility [1] Triple bottom line (TBL) Economic bottom line [1] Environmental bottom line [1] Social bottom line [1]

U UNGC [1] UN Global Compact [1] United Nations Global Compact [1]

V Value Customer value [1] Financial value [1] Social value [1] Value added [1] Value chains [1] Value propositions [1] , [2] Value stream mapping [1] Value streams [1] Variability [1] Variety [1] See also: Three Vs Velocity [1] Visibility [1] Vocalization [1] See also: Three Vs Volume [1] See also: Three Vs

W WBS [1] Wearable technology [1] Work breakdown structure (WBS) [1]

APICS Certified Supply Chain Professional (CSCP) Learning System This product is based on the APICS CSCP Exam Content Manual (ECM) developed by APICS. Although the text is based on the body of knowledge tested by the APICS CSCP exam, program developers do not have access to the exam questions. Therefore, reading the text does not guarantee a passing score. The references in this manual have been selected solely on the basis of their educational value to the APICS CSCP certification program and on the content of the material. APICS does not endorse any services or other materials that may be offered or recommended by the authors or publishers of books and publications listed in this module. Every effort has been made to ensure that all information is current and correct. However, laws and regulations are constantly changing. Therefore, this product is distributed with the understanding that the publisher and authors are not offering legal or professional services.

Acknowledgments We would like to thank the following dedicated subject matter experts who shared their time, experience, and insights during the initial development and subsequent updates of the CSCP Learning System: Greg P. Allgair Celeste Ayers, CFPIM, CSCP Curtis Brewer, CFPIM, CIRM, CSCP Jashobrata Bose, CSCP Al Bukey, CFPIM, CIRM, CSCP Jesús Campos Cortés, CPIM, CIRM, CSCP, PLS, C.P.M., CPSM, PMP,PRINCE2, CQIA, CEI, CPF, CS&OP, CAAM Luc Chalmet, Ph.D, CFPIM, CSCP Prashant Choudhary, CSCP David N. Dadich, CSCP, LSS Blackbelt

Rajesh Kumar Jagadeeswaran, CPIM, CSCP Dave Jankowski, CFPIM, CSCP Julie Jenson, CPIM, CSCP Honey Johnson, CFPIM, CIRM, C.P.M., CSCP Rajesh Kamat, CSCP Prakash Kanagalekar, CPIM, CSCP Jack Kerr, CPIM, CSCP, C.P.M. Jose Lara Paul S. Lim, CPA, CSCP, CPIM, PMP Mike Loughman, CSCP Giuseppe Lovecchio, CFPIM, CSCP

Prasanta K. Dash, CSCP, Thiagu Mathan, CSCP PMP Sudripto De, CSCP Arnaud Deshais, CPIM, CIRM, CSCP, CPM, CPSM Alan Downs, CPIM, CSCP

Roberta McPhail, CPIM, CIRM, CSCP, PMP Richard Merritt, CFPIM, CSCP, C.P.M. Steven J. Miller, CSCP Alan L. Milliken, CFPIM, CIRM, CSCP

David Rivers, CFPIM, CIRM, CSCP Maryanne Ross, CFPIM, CIRM, CSCP Kimber Rueff, CPIM, CIRM, CSCP, C.P.M. Frank Sabin, Ph.D., CSCP Ignacio Sánchez-Chiappe Carolyn Sly, CPIM, CSCP, C.P.M. Liezl Smith, CPIM, CIRM, CSCP, ACPF, CDDP Pam Somers, CPIM, CIRM, CSCP Chad Stricklin Shashank Tilak, CPIM, CSCP Ken Titmuss, CFPIM, CSCP, SCOR-P, CPF, PLS, CS&OP, CDDP, CSCA, CDDL Huan-Jau (Arthur) Tseng, CFPIM, CSCP Dave Turbide, CFPIM, CIRM Sudeep Valmiki, CSCP

Ralph G. Fariello, CFPIM, Paulo Mondolfo, CPIM, CIRM, CSCP CSCP

Rob Van Stratum, CPIM, CIRM, CSCP

Sue Franks, CPIM-F, CSCP-F, CLTD-F

Rosemary Van Treeck, CPIM, CIRM, CSCP

Laura E. Gram, CSCP Janice M. Gullo, CFPIM, CSCP Amit Kumar Gupta, BE, CSCP Debra Hansford, CFPIM, CIRM, CSCP, CPSM Marwa Hassan Aburahma, MCIPS, CSCP, SCOR-P, CMILT Joni Holeman, CFPIM, CIRM, CSCP Eric P. Jack, Ph.D., CFPIM, CSCP

Peter W. Murray, CIRM

Eric-Stephan Neill, CSCP, CLTD, PMP Wout Verwoerd, CFPIM, CIRM, CSCP, SCOR-P Mike Okrent, Ph.D., CIRM, CSCP Roberto (Jake) Ordonez, CSCP, CQA, CTL, PLS, MPS, SCPro1 Kasthuri Rengan Ponnambalam, CSCP Gautam Chand Pradhan, CPIM, CSCP Ho Dong Rhee, CSCP

Robert Vokurka, Ph.D., CFPIM, CIRM, CSCP, C.P.M. Eddie J. Whitfield, CPIM, CIRM, CSCP Vivek Wikhe, CSCP Blair Williams, Jonah, CFPIM, CSCP

Intellectual Property and Copyright Notice All printed materials in the APICS CSCP Learning System and all material and information in the companion online component are owned by APICS and protected by United States copyright law as well as international treaties and protocols, including the Berne Convention. The APICS CSCP Learning System and access to the CSCP interactive web-based components are for your personal educational use only and may not be copied, reproduced, reprinted, modified, displayed, published, transmitted (electronically or otherwise), transferred, sold, distributed, leased, licensed, adapted, uploaded, downloaded, or reformatted. In addition to being illegal, distributing CSCP materials in violation of copyright laws will limit the program’s usefulness. APICS invests significant resources to create quality professional development opportunities for its membership. Please do not violate APICS’ intellectual property rights or copyright laws. No portion of this publication may be reproduced in whole or in part. APICS will not be responsible for any statements, beliefs, or opinions expressed by the authors of this publication. The views expressed are solely those of the authors and do not necessarily reflect endorsement by APICS. Version 5.1 © 2023 APICS APICS 8430 W. Bryn Mawr Ave., Suite 1000 Chicago, IL 60631

Module 7: Supply Chain Risk Supply chain risk management has become an essential element of any successful supply chain strategy due to globalization and global upheavals. This module provides an overview of the risk management process, which includes identifying risks; assessing impact, timing, and probability; determining responses to mitigate risks; and executing and evaluating risk responses. The module also goes over several risk management frameworks. Specific supply chain risks and examples of proactive and reactive responses to various scenarios round out this module.

Section A: Risk Management and Supply Chain Risks This section is designed to Explain the risk management process, including risk identification, categorization, analysis, and evaluation as well as planning a costeffective risk response Define risk, threat, and opportunity, and discuss some common supply chain risks Proactively address risks to reduce their impact or likelihood and preplan reactive responses if the risks occur anyway Understand that some areas of supply chain risk have more mature response systems than others at most organizations Describe the importance of developing a strategy and plan for risk management, including specifying the organization’s risk tolerance Describe features of the COSO Enterprise Risk Management framework and the Governance, Risk, and Compliance (GRC) framework Describe ISO 31000 and its supplemental standards (ISO 31010 and Guide 73) List some common tools for identifying risk

Categorize common supply chain risks and provide instigating factors, possible related root causes or red flags, and possible preventive and contingent responses Show how to document risks in a risk register Protect intellectual property while working in multiple countries. Risk is basically uncertainty. Business investors and owners reward organizations that can keep the level of this uncertainty as low as is feasible. This section explores the basic risk management process, which can be simply qualitative or can also involve quantitative analyses. Leveraging standards in this area is a good way to ensure that the process is well thought out. In addition to the overall process, this section explores supply chain risk categories, including loss of goods, losses from malfeasance (e.g., fraud, bribery, abductions), losses from lawsuits, and intellectual property losses.

Topic 1: Risk Management Determining how to manage risk in the supply chain starts with a strategy and a plan. Therefore, the concepts of risk management, a risk management strategy, and a risk management plan are discussed first here. After that, we address risk management

frameworks, including COSO Enterprise Risk Management (ERM) and Governance, Risk, and Compliance (GRC), and we present an overview of the ISO 31000 family of risk standards.

Risk Management Road Map Supply chain risk management has always been important, but it has taken on greater importance due to the increasing pace of change in the world and the increase in the use of supply chain technology. Attempts to make the supply chain more lean have also created risk exposures. Therefore, it is vital that supply chain managers understand risk management basics, standards, and supply chain applications. A key resource in this area is the Supply Chain Risk Management Consortium; a link to this organization is provided in the online Resource Center. The basic process of risk identification, assessment, and classification helps supply chain managers identify key risks, prioritize them, devise a cost-effective response strategy for each risk, develop a risk response plan, execute the plan, and keep it up to date. Risk is generally defined as an uncertainty that could positively or negatively affect the accomplishment of business objectives—for example, it could be an uncertainty related to delivery dates, quality,

or revenue/cost. Negative risks also include hazards, sources of danger, lawsuits, or the possibility of incurring loss, misfortune, or injury. The above definition of risk includes uncertainties that could have a positive impact. Risks are not always bad things, but they are always uncertain. Why does risk include things that could be positive? Because an uncertain investment might not produce the benefits that are desired, thus wasting the time and money put in up front. When a risk describes a positive uncertainty, it is called an opportunity. Threat is a more precise term for just the negative types of risk. These are the opportunities and threats of a SWOT analysis, for example. Risk is often defined only from a negative perspective, such as in the APICS Dictionary, 16th edition, definition of supply chain risk as the variety of possible events and their outcomes that could have a negative effect on the flow of goods, services, funds, or information resulting in some level of quantitative or qualitative loss for the supply chain. All investment involves uncertainty, including investing in a supply chain. Even a street food vendor’s operations can illustrate the threats and opportunities of managing a supply chain.

Imagine some of the possibilities. The vendor could have an accident going to work. The vendor’s wife who serves as an at-home cook could fall ill and fail to prepare some of the items to be sold that day. Customers could get sick from eating spoiled product and sue. Regulators could shut the stand down for noncompliance with health regulations or lack of a license. The wholesale supplier or a nearby business that provides a great deal of foot traffic (customers) could go out of business. Bad weather could keep customers away, drive up the price of raw materials (food products or fuel), or destroy the stand. Thieves could steal inventory while the vendor is busy. A regular customer might move out of the neighborhood. Street gangs might cover the stand with graffiti or intimidate the vendor or customers. A competitor could set up a cart nearby. From an opportunities perspective, perhaps the vendor wants to expand to a new neighborhood. It may be that a vendor who worked that area has gone out of business and is offering a cart for sale at a bargain. Of course opportunities are still uncertain, so it may be that after purchasing the cart and more inventory and hiring a worker, due to different cultural backgrounds, no one buys the products. The problems in this microcosm imply all the dangers that lie in wait for larger enterprises. And so do the solutions. In brief, a little redundancy might be in order as a buffer: the availability of a second

car, a neighbor who can help cook, or a second or third source for supplies. The ability to sense and respond to issues can also help, such as moving the stand to where police are usually nearby or establishing a personal relationship with customers to keep them loyal. Finally, building an adaptable business and supply chain can make the organization resilient. Research and contingency planning could help avoid disruptions caused by weather or inadvertent violations of the law. The vendor could reduce the uncertainty of the opportunity by finding out what people in a different neighborhood like to eat. Redundancies, visibility, responsiveness, and adaptability can promote the steady operation of any organization. Let’s add complexity now and look at some examples of risks for global enterprises. Example: A Canadian company that manufactures electric motors established new relationships with global vendors to accommodate booming international demand. A few seemingly justified shortcuts were taken in the initial site inspections to expedite the selection process. Subsequently, poor-quality issues have skyrocketed, and external failure costs due to defective products being shipped to customers are eroding profits and damaging the company’s reputation. Example: A multinational medical device manufacturer experiences many service problems caused by technology

incompatibilities with business partners and third parties. The root cause—a lack of open standards and problems with business process integration. Example: Shipping seasonal textile goods made in Southeast Asia to a global retailer involves multiple parties, transportation modes, and port calls. Along the way, a political uprising paralyzes air freight and a labor dispute disrupts operations at a major port of call. Example: Cyber risk has huge implications for supply chains. For example, a major U.S. retailer had its customers’ personal data stolen by hackers. In that case, the credit and debit card account information of 70 million customers was stolen using malware introduced at the point of sale. The store’s sales and reputation suffered, and it spent money repairing the damage, offering zero liability for fraudulent charges and a year’s free credit monitoring and protection.

Processes for Managing Risk in Supply Chain The key processes that supply chain managers need to be able to perform related to managing risk in the supply chain are Identifying the risks Assessing and classifying the risks Developing a risk response plan Executing the risk response plan.

Each of these processes is introduced next at a general overview level. Prerequisites to these processes involve strategizing and planning: Developing a risk strategy by discovering the organization’s tolerance toward risk taking and the maturity level of its risk management processes Developing a plan for how you will identify and assess risks and plan and execute risk responses Identifying Risks The process of identifying risks involves the following steps: Brainstorming all of the possible risks (threats and opportunities) related to the business process or project Assigning attributes to each risk, such as who it may affect, what causes might make the risk occur, and other details Entering the risks and their attributes in a risk register, which is usually a spreadsheet with risks in rows and attributes in columns Assessing and Classifying Risks The process of assessing and classifying the risks involves the following steps: Performing a qualitative risk assessment, which involves discussions with subject matter experts and persons closest to a

given process to perform the steps shown in .

Exhibit 7-1: Qualitative Analysis Steps

Performing an optional quantitative risk assessment, which involves doing further analysis for significant risks, as shown in .

Exhibit 7-2: Quantitative Analysis Steps (Optional)

Developing Risk Response Plan The process of developing a risk response plan involves the following steps: Selecting the best type of response for each risk given the organization’s attitude toward risk and the costs of the response Developing a risk response plan showing what to do for each risk and when to do it, including what events might trigger action if applicable Clearly assigning one person to be accountable for each risk response that requires management Getting approval and funding for responses Adding the risk responses and response owners to the risk register

Executing Risk Response Plan The process of executing a risk response plan involves the following steps: Implementing planned risk responses either on a schedule or as a contingent response to specified triggering events Analyzing trends and variances from expected results to see how effective risk responses are and identify new risks or triggering events Analyzing the risk budget to determine if reserve amounts are sufficient to address ongoing and planned risk responses Regularly meeting to review the risk register: Adding new risks and reassessing existing risks Determining the results of responses Generating new planned responses Retiring risks that are no longer relevant

Risk Management Types, Roles, and Maturity How do organizations manage the numerous risks to a supply chain? They engage in risk management. The APICS Dictionary, 16th edition, defines risk management as the identification, assessment, and prioritization of risks followed by coordinated and economical application of

resources to minimize, monitor, and control the probability and/or impact of unfortunate event or to maximize the realization of opportunities. In supply chains, risk management is a complex end-to-end concern. A supply chain presents many opportunities in terms of resource availability, technology, market access, and the like. But it also has substantial dependence on critical resources (human expertise and materials), transport capability, and supply chain partners. Globalization adds many other risks that can expose a supply chain to upheaval. Next we explore supply chain risk management, the role of risk managers, and an organization’s risk management maturity level.

Supply Chain Risk Management The APICS Supply Chain Council (SCC) defines supply chain risk management as the systematic identification, assessment, and quantification of potential supply chain disruptions with the objective to control exposure to risk or reduce its negative impact on supply chain performance. Accenture produced a set of principles to help establish supply chain risk management as a discipline, here paraphrased as follows:

Integrate: Align the risk management systems across the organization. Model: Develop a model of end-to-end risks and their priorities. Diversify and add flexibility: Create a diverse supplier portfolio, be flexible, and develop global visibility. Quantify: Develop contingency plans and identify unknown risks using probability modeling. Perform due diligence: Research suppliers and ensure that they are performing their own due diligence on their suppliers. Insure: Make prudent decisions to insure against hazards and business disruptions. In addition to integrating risk management with internal departments, supply chain risk management must be conducted by both the channel master and all the individual players, who each create their own risk management and risk response plans (a list of planned responses). The organization needs to assess each party’s ability to continue the relationship and conduct business. Developing an end-to-end risk model might involve using a variety of tools and information sources to understand the environment in which the organization is operating. An AMR report cited meetings

and discussions with suppliers and associates, use of predictive analytic tools, and reviewing suppliers’ business continuity plans, third-party reports, and performance risk dashboards as the most common methods executives used to develop a holistic understanding of supply chain risk. In regard to diversification and flexibility, an Aberdeen group report discussed how businesses that used risk-adjusted strategies and had processes to clearly see risks and risk events and react quickly to them were also more likely to have more effective budgeting and profitability. One example of how supply chain risk is becoming better quantified is the emergence of new metrics such as time-to-recovery, which is how long it takes a supply chain to recover from an adverse event such as an earthquake or severe weather. Benchmarking against competitors using metrics like these can provide a better idea of the organization’s actual levels of flexibility and supply chain visibility. The need for multi-tier due diligence is evidenced in a report by Zurich, a global insurer. Part of the report stated that 40 percent of all disruptions had a root cause from below the tier 1 supplier level. Performing due diligence only with direct suppliers will not catch a large number of potential failures.

The same report published statistics to show what areas of the supply chain needed insuring the most. It stated that 50 percent of supply chain disruptions were weather-related. Many losses related to weather disruptions are often not covered by insurance. Lloyd’s of London reported in 2013 that only US$47 billion of the US$240 billion in losses from the 2011 Japanese earthquake and tsunami and the Thailand floods were covered by insurance. Much of these losses was for business disruptions, while much of what was insured was assets like plants and equipment. The second largest area—40 percent of disruptions according to Zurich—were IT/telecommunications outage–related. Lloyd’s had large losses from climate-change-driven weather events in 2018 and beyond. (The U.S. National Oceanic and Atmospheric Administration reported that in the 2010s there were 119 billion-dollar disasters versus only 28 in the 1980s, as cited in an article by John Kamensky.) Also, the running aground of the Ever Given in the Suez Canal in 2021 resulted in large insurance losses, so clearly many organizations have been insuring against business disruptions. Lloyd’s also stated that the COVID-19 pandemic would be the largest loss on record for insurers to date.

Risk Managers Risk managers have a critical role in supply chain risk management. They must examine the supply chain to

Map the entire chain and understand interdependencies Identify potential failure points along the supply chain Create risk awareness throughout the supply chain. Key additional duties of risk managers include the following: Devise methods to lessen risks before they become a costly problem. Prioritize funds allocated for risk management to address critical risks and minimize overall system risk. Implement risk prevention plans as projects and prepare and practice contingency plans. Collect, analyze, and implement feedback to improve future plans. Chair regular risk review meetings to keep plans current.

Risk Management Maturity Level Risk management maturity level refers to how well developed the organization’s risk management processes are relative to benchmarked competition. What evidence is there that more mature risk management processes matter? According to an RIMS.org article, AON Insurance and the Wharton School of Business developed a risk maturity index showing that organizations with the highest level of risk maturity had 50 percent lower stock price volatility than those at lower maturity

ratings. From 2010 to 2012, only organizations with the highest risk maturity ratings had positive returns during the most volatile parts of those years. Conversely, organizations with lower risk management maturity levels experienced losses between 17 and 30 percent during the same periods. A 2017 version of the study supported the earlier results and also found that a 10 percent increase in risk maturity on their index was correlated with a 3.8 percent improvement in directors and officers (D&O) insurance premiums. An organization’s supply chain management team may have more advanced risk management processes in some areas than in others. According to Gregory Schlegel and Robert Trent, authors of Supply Chain Risk Management, most supply chain functions are fairly advanced in how they manage risk related to supply issues and are moderately advanced in terms of demand risks but are frequently lacking in the areas of process risk and environmental risk. What they mean by each of these broad categories of risk and why they feel the supply chain in general is at these levels are shown in Exhibit 7-3. Exhibit 7-3: Supply Chain Function Risk Management Maturity Levels by Type of Risk Type of Risk Defined

General Maturity Level and Rationale

Type of Risk Defined

General Maturity Level and Rationale

Supply risk: Risks related to strategic sourcing, supplier communications, viability, quality, capability, logistics, supplier due diligence, and malfeasance (e.g., counterfeiting, corruption, and fraud).

Most mature category. Many years of development and many tools such as SRM, spend management, credit management. Advancements like supplier risk assessment and cloud-based software tools to detect malfeasance.

Demand risk: Risks related to customer acquisition and retention, demand management and forecasting, market and consumer trends, distribution requirements planning, competitor actions, reputation, and customer service.

Moderately mature. Sales forecasting is well established but doesn’t incorporate risk in models. However, collaborative planning, forecasting and replenishment (CPFR) does consider risk. Sales and operations planning (S&OP) includes what-if analysis capabilities.

Process risk: Risks related to supply chain strategy and implementation, manufacturing and quality processes, IT processes, as well as organizational issues such as mergers.

Middle low maturity. Multiple tools for inventory planning and scheduling, etc., but most don’t incorporate risk.

Type of Risk Defined

General Maturity Level and Rationale

Environmental risk: Risks related to government regulation and compliance, tax, the economy, currency fluctuation, security, and natural disasters.

Low maturity. New area for risk management. Regulations continue to change rapidly, and processes and tools have trouble keeping up.

Note that these are generalizations; individual organizations may be more or less mature in each of these areas.

Risk Management Strategy and Planning A risk management strategy describes how an organization plans to address the vulnerabilities it has identified throughout the supply chain by controlling, mitigating, reducing, or eliminating risk and mitigating or reducing the impact of risk events—the materialization of a seen or unforeseen adverse event. It also captures the organization’s overall attitude toward risk, such as risk seeking or risk averse.

Known Versus Unknown Risks Organizations will set different strategies for addressing known risks versus unknown risks. A known risk is one that has been identified and analyzed. These risks can be planned for using the processes

discussed in this area. An unknown risk is one that exists but no one knows about it currently. These unforeseen risks can be addressed by putting funds in a reserve account to deal with the unknown. The size of this account, who authorizes expenditures, and the conditions under which it can be accessed are part of an organization’s risk management strategy.

Risk Management Attitude Organizations differ in how much risk is too much risk in exchange for the envisioned benefits, but for all individuals and organizations, risks and rewards are interrelated. Investors in general require a higher reward when there is higher risk, and this is as true for business decisions as it is for financial investments. That being said, an organization may be risk-seeking while others are risk-averse. To understand the continuum, contrast an organization that is riskseeking because it intends to manufacture and sell innovative IT products with high margins but a short life cycle (it is necessary to accept risk related to an unknown market result to get the opportunity for high returns) with a risk-averse pharmaceutical company (where a risk like contaminated raw ingredients or improperly certified suppliers could lead to deaths, lawsuits, substantial negative publicity, or a drop in share value). The pharmaceutical company might also take large risks to market an innovative new product but would always be risk-averse related to

safety. There are a few risk attitude terms available to convey this nuance. Three ways of expressing an organization’s attitude toward risk are risk appetite, risk tolerance, and risk threshold. The APICS Dictionary, 16th edition, defines the first two of these terms: Risk appetite : Amount and type of risk that an organization is willing to pursue or retain. Risk tolerance : An organization’s or stakeholder’s readiness to accept a threat or potential negative outcome in order to achieve its objectives. Risk threshold: A cutoff point below which a risk will be accepted and above which some type of proactive response is required. Risk appetite refers to overall attitudes like risk-seeking or riskaverse. A risk-seeking organization will take measured risks if the return seems worth it, while a risk-averse organization may want to find ways to minimize uncertainty to the highest degree possible. These attitudes may lead to different business strategies with different payoff profiles (e.g., cutting edge for the risk-seeking and low, steady returns for the risk-averse). Other ways that risk appetite plays out in organizational decisions include flexible supply chain strategies, diversification, and redundancy, such as the ability to

produce the same part at all plants rather than specializing at each plant. Risk tolerance and threshold are ways of customizing this appetite to specific risks. An organization may specify that it has a low tolerance for quality risks, a moderate tolerance for delivery time risks, and a higher tolerance for cost-related risks. The organization’s risk tolerance level influences which response is chosen for each identified risk. Other organizations and individuals will also have their own risk appetite levels that need to be discovered and taken into account when developing a supply chain risk management plan. One impediment to getting risk management practices adopted across the supply chain is that many small and midsize organizations have yet to develop policies on risk tolerance in the first place. They may need to be motivated to devote sufficient time and funding to risk management.

Risk Management Plan A risk management plan is a way to ensure proactive and consistent risk management. A supply chain risk management plan may be integrated with an organizational or interorganizational risk management plan.

The plan delineates how risks will be identified, grouped, and assessed. It identifies appropriate internal and external data sources for making risk assessments and then specifies standardized tools to help various team members arrive at consistent definitions of risk levels. Tools can include risk categories or tables with guidance to help consistently define probability and impact. A risk management plan also has controls to ensure that risk plans and responses are appropriate to the degree of risk being faced relative to the importance of the business objectives or project being conducted. It ensures that risk planning and responses are costeffective, meaning they provide more benefit than they cost. Also, the agreed-upon risk thresholds and tolerances are in the risk management plan along with required response types for various risk levels. To give decision makers visibility on risk issues, the plan also addresses how to track and report on risks on an ongoing basis. A risk management plan contains a budget for a given period of time or a project duration. It should include a reserve fund for unknown risks. When a formal plan is generated, it can be used as a tool to gain buy-in and sign-off/funding for the plan. Furthermore, it will specify who will be responsible for implementing the plan, who is

accountable for success, and who has authority to approve funding for specific risk responses or release funds from a reserve fund.

Risk Management Frameworks A risk management framework is a set of risk management standards that are universally applicable to all organizations because they can be tailored to support organizations’ strategic and tactical choices regarding risk management. Frameworks that address risk include COSO’s ERM framework and the Governance, Risk, and Compliance (GRC) framework.

COSO ERM The Committee of Sponsoring Organizations of the Treadway Commission (COSO) developed an Enterprise Risk Management (ERM) framework in 2001. Its 2017 update was renamed Enterprise Risk Management—Integrating with Strategy to reflect the additional emphasis on top-level governance. COSO ERM is a process that the board of directors, management, and staff enact to set risk strategy, identify risk events, and manage risk within the organization’s risk appetite, with the goal of ensuring that organizational objectives can be met. The COSO ERM framework has eight components that need to be tightly integrated:

Internal environment. This is the perspective from which risk is viewed, including risk management philosophy, appetite, ethics, and integrity. Objective setting. A formal objective-setting process aligns with organizational mission and risk appetite. Event identification. Threats and opportunities related to objectives are identified. Opportunities loop back to strategy/objective setting. Risk assessment. Risk likelihood and impact determine response. Risk response. A type of response that aligns with the risk appetite is selected. Control activities. Policy and procedure reinforce responses. Information and communication. Timely information is shared down, up, and across the organization. Monitoring. Management and audit continuously improve enterprise risk management.

Governance, Risk, and Compliance (GRC)

The GRC framework is like a three-legged stool. Each leg (governance, risk management, compliance) must be in place for the organization to remain balanced. Governance is the oversight function at an organization that monitors the organization’s ethics, controls, decision-making hierarchy, and overall management approach. Governance is conducted by the board of directors or an equivalent, and top executives also play a role. Governance includes setting the tone at the top. It also includes the tools and processes in place to integrate that tone at the top and the organization’s mission and vision into management activities so they are aligned with the needs of owners/stakeholders and are systematic, effective, and efficient. Risk management is the methodology to identify, analyze, and respond appropriately. GRC risk focus categories include commercial and financial risk, IT security risk, and legal and external risks. Compliance is conformance to applicable laws, regulations, contractual requirements, and internal policies. The organization may have a compliance functional area. The compliance process involves identification of compliance requirements, assessment of the as-is state compared to the to-be state and of compliance costs

and benefits, prioritization of compliance areas, funding relative to priority, and corrective action as needed. GRC is implemented by Focusing on alignment of executive and management agendas Risk-weighting organizational initiatives for selection Promoting accountability and standard communication channels Ensuring that staff have visibility to current regulatory requirements Standardizing risk management workflow Using a central risk database Looking at expected monetary value from the perspective of brand equity Monitoring key risk indicators Getting and staying compliant Moving GRC activities from feeling obligatory to being part of the culture. GRC software helps plan and track GRC activities. For example, ServiceNow is a cloud-based SaaS (software as a service) platform with a GRC suite for policy setting, auditing, risk management, and compliance. For the compliance part, they partner with Network Frontiers for access to a Unified Compliance Framework® (UCF®) through their Common Controls Hub® (CCH®), which is a database

of over 10,000 common controls (e.g., segregation of duties), over 100,000 individual mandates, a dictionary with interconnected terms, and over a thousand compliance standards from various authoritative sources. Network Frontiers partners with many associations and vendors to provide this hub. A benefit of adopting GRC is that organizations can start taking more risks to pursue opportunities because they know what their appetite is and can quantify the costs and benefits. Emphasizing rapid rampups related to a nation’s compliance requirements can also help an organization successfully expand globally. Organizations will know they are succeeding with GRC when their the board and senior executives take an active role in governance and the overall expected monetary value of risk goes down each year along with the overall cost of compliance.

ISO Risk Standards The ISO Working Group on Risk Management, chaired by Kevin W. Knight AM (Order of Australia), developed ISO 31000, ISO 31010, and a complementary resource, ISO Guide 73:2009, Risk Management Vocabulary.

ISO 31000

According to the APICS Dictionary, 16th edition, ISO 31000 is a standard adopted by the International Standards Organization that outlines principles and a set of guidelines to manage risk in any endeavor. The standard outlines guidelines for understanding risk, developing a risk management policy, integrating risk management into organizational processes (including accountability and responsibility), and establishing internal and external risk communication processes. ISO 31000 is not a management system standard and is not intended or appropriate for certification purposes or regulatory or contractual use. ISO 31000:2018 is designed to help any size or type of organization effectively manage risk. It includes a framework and processes for systematic development of risk management at an organization. Proper management of uncertainty makes an organization more attractive to investors and helps the organization to achieve its objectives. According to Knight in an ISO press release, “It can be argued that the global financial crisis [of 2009] resulted from the failure of boards and executive management to effectively manage risk. ISO 31000 is expected to help industry and commerce, public and private, to confidently emerge from the crisis.”

Knight added that “ISO 31000 is a practical document that seeks to assist organizations in developing their own approach to the management of risk. But this is not a standard that organizations can seek certification to. By implementing ISO 31000, organizations can compare their risk management practices with an internationally recognized benchmark, providing sound principles for effective management.” ISO 31000 Principles ISO 31000 follows a set of principles that help develop and implement transparent and credible risk management systems. These principles are the key to successful risk management. They can be paraphrased as follows: Risk management adds value to the organization and protects that value. It is integral to the organization’s operational and decision-making processes. It unambiguously addresses uncertainty in an orderly, structured, comprehensive and well-timed manner. It makes use of the best available information. It is customized to the organization and accounts for human and cultural factors. It is inclusive of all stakeholders, auditable, and transparent.

It has a cyclical framework that allows for continual improvement, organizational learning, and dynamic responsiveness to changing environments. ISO 31000 Framework The ISO 31000 framework, at a high level, is an iterative process that starts with a board and executive-level mandate and commitment toward risk management, starting with governance. This mandate should be based on the ISO 31000 principles just mentioned. With this in mind, the ISO 31000 framework starts with an area for leadership and commitment, which provides guidance on designing, integrating, implementing, evaluating, and improving the framework. This step leads to the customization and design of the process framework, which is then implemented, monitored and reviewed, and continually improved based on review results, which leads back to further customization and design. In the implementation phase, the framework contains a set of subprocesses that are also iterative, as shown in . (Actual ISO process names differ slightly.)

Exhibit 7-4: ISO 31000 Process Framework for Implementation Phase

ISO 31010, Risk Management—Risk Assessment Techniques ISO 31010 is a supporting standard for ISO 31000. ISO 31010:2019 is intended to help organizations select systematic risk assessment techniques. After providing an overview of risk assessment concepts such as a framework and the overall process, the standard reviews the process discussed in ISO 31000 with more emphasis on risk analysis, including the following topics: Controls assessment Consequence analysis Likelihood analysis and probability estimation Preliminary analysis Uncertainties and sensitivities

In addition to discussing how to monitor and review risk assessments, the standard also discusses how to apply assessments during various life cycle phases. The standard then turns to how to select techniques based on what resources are available, how much uncertainty is present and its nature, and the relative complexity of the system. An appendix to the standard reviews and compares a wide range of risk assessment techniques, many of which are discussed elsewhere in this learning system. Examples of techniques reviewed include interviewing, brainstorming, root cause analysis, Ishikawa (fishbone) diagrams, checklists, probability and impact matrices, decision tree analysis, failure mode and effects analysis (FMEA), Monte Carlo simulation, and many more.

ISO Guide 73:2009 ISO also published ISO Guide 73:2009, Risk Management Vocabulary. The APICS Dictionary, 16th edition, definition of ISO Guide 73 follows: Provides the definitions of generic terms related to risk management. It aims to encourage a mutual and consistent understanding of, and a coherent approach to, the description of activities relating to the management of risk, and the use of uniform risk management terminology

in processes and frameworks dealing with the management of risk. This glossary complements ISO 31000 by providing organizations and their extended supply chain partners a way to discuss risks using a common understanding of risk management terms and definitions. According to Knight, ISO Guide 73 will “ensure that all organizations are on the same page when talking about risk.”

Benefits of ISO 31000, ISO 31010, and Guide 73 Benefits for organizations of implementing ISO 31000, ISO 31010, and Guide 73 include the following: Implementation increases organizational risk awareness and identification. It increases the probability of meeting or exceeding organizational objectives due to better operational resilience, efficiency, and effectiveness. It reduces the probability of identified risks and reduces losses from risk events. It allows more accurate assessment of internal strengths and weaknesses and external opportunities and threats (i.e., SWOT analysis). It helps with compliance with regulations, laws, and international standards.

It enhances internal controls and corporate governance. It enhances external controls such as for financial reporting. It reduces uncertainty, improving stakeholder trust and confidence. Managers can proactively prepare for problems instead of just reacting. Managers can plan, decide, and budget based on reliable and custom-tailored risk assessments. It assists with organizational learning.

Topic 2: Risk Identification and Supply Chain Risks The process of risk identification and documentation must be comprehensive but still focus on critical risks. We will discuss a number of common and emerging supply chain risks.

Identification and Documentation of Risk Risk in a supply chain can take many forms, and supply chain risk managers need to take a systemwide perspective on risk. Risk managers determine risks to the supply chain using a number of analytical tools. For each risk identified, they define certain parameters for each risk in a risk register.

While a large number of risks may be identified in the first pass, risk identification is iterative, meaning that new rounds of identification need to occur. During these rounds, some known risks might become better understood and new risks might be identified. A number of tools might be used to identify risks, including the following: Documentation and assumptions reviews: Reviewing preconfigured supply chain risk management software checklists and dashboards (some of which are industry-specific), supply chain documents, existing analytical tools, variance analyses, and the like can reveal risks. Reviewing assumptions made about a process or project can help determine if these assumptions seem valid to a consensus of stakeholders, and the team can also consider what might happen if the assumptions turn out to be wrong. Brainstorming: Brainstorming is a group meeting where a wide range of experts are gathered to discuss risks. A facilitator sets down some rules in advance, such as that all ideas are welcome and none are criticized. If risk categories exist, they can be used to promote completeness. Brainstorming can also be done remotely as a distributed survey.

Delphi technique: Anonymous questionnaires are collected and compiled in multiple rounds until the group reaches consensus. Interviews: Formally or informally talking to experts and stakeholders can reveal new perspectives on risk. Root cause analysis: Searching for the underlying causes of a risk can help focus on the actual problem rather than the symptoms. Risk checklists: Since risk analysis has been conducted in the past at the organization, and at other organizations, a list of risks from other processes or projects can be reviewed to see what applies. Risk diagramming: Flowcharts or other relationship diagrams can be used to show a process. Analysis of such charts can reveal weaknesses. Also, various tools from the quality discipline such as a cause-and-effect or Ishikawa diagram can be leveraged for risk analysis. SWOT analysis: A strengths, weaknesses, opportunities, and threats analysis starts by looking at the organization’s capabilities and areas that need work and then looks at external opportunities and threats. This strategic-level analysis is good at seeing the big

picture—in other words, what opportunities or strengths might offset threats or vice versa. One starting point for supply chain managers may be to list each raw material used, identify which materials are of strategic value, and invest time in understanding the organizational and financial structures of each strategic material supplier. This process can help with defining the relative vulnerabilities of the supply chain and the implications of doing nothing.

Risk Identification Risks need to be described in a consistent manner and at a level of detail that will allow them to be understood and evaluated against one another. When identifying risks, specify Cause(s): The root causes, if applicable and known. Event(s): The triggering events, if applicable and known. Impact: The internal and external threats (or opportunities) for each critical asset or process. This includes an assessment of criticality. For threats, this is the critical assets or processes of the organization that, if not operating effectively, would prohibit the company from fulfilling its mission, such as providing its key products or services.

Effect: Areas within the organization or up and down the supply chain that would be impacted as a result. The final task is to combine these into a definitive statement of each risk. For a company that ships most of its products by train, an example might be Derailment of multiple cars due to sabotage or disrepair of train tracks resulting in destruction of products onboard, possible injuries to train personnel, and delays of future shipments while track is repaired. An automotive original equipment manufacturer that produces gas supply lines using a patented raw material from a single source might identify the risk as follows: Nylon-12 is available from only one supplier, Corporation ABC, and is produced in just one plant in Germany. A disruption or accident at this plant could critically disrupt the supply of this raw material for product lines A and B.

Risk Definition The scope and time frame of each risk must be well understood before organizations can decide what would be an appropriate response. The APICS Supply Chain Council notes that each identified risk must also have a time dimension or a specific time horizon (e.g., day, month, year) and a specific perspective or view

that defines the scope (e.g., boundaries, what is not included). Some risks will exist for only a given time period, such as risks of warranty returns in the warranty return period. Other types of risk are ongoing but can be defined further. For example, risks of delivery truck hijacking could be subdivided into risks as cargo is transported through specific countries or at particular times of the day. Risks of piracy (and resulting insurance costs) for containerships is defined by the countries that the trade routes pass by.

Risk Register As defined in the APICS Dictionary, 16th edition, a risk register is a useful summary report on qualitative risk analysis, quantitative risk analysis, and risk response planning. The register contains all identified risks and associated details. A risk register is often a spreadsheet with a row for each risk and a column for each risk attribute. More attributes can be added whenever they are desired. The register contains the risk identification information and risk definition information, along with all other information related to that risk. Since much of this information is determined during later steps in the risk management process, these fields would remain blank until those steps are completed. This

can include a list of potential responses or references to planned responses. Exhibit 7-5 shows an example of a risk register.

Exhibit 7-5: Risk Register Example

Supply Chain Risks Supply chain risks include the risk of loss of tangible assets (property, inventory, or money) or intangible assets (intellectual property, reputation). These losses can occur from internal or

external threats. Internal threats include employee theft, collusion (working with a person or group outside the organization), fraud, misplacement, damage or destruction from accidents, or improper handling. External threats include theft by unknown parties or by external business partners, abduction, hijacking of modes of transportation and their cargoes, counterfeiting, computer hacking (e.g., ransomware), government appropriation, or damage or destruction from a host of threats.

Risk of Loss of Tangible Assets Loss of goods, losses from other forms of malfeasance, and losses from lawsuits are discussed next. Loss of Goods Keeping domestic and import/export shipments secure from loss, damage, theft, and vandalism has always been a concern for businesses. The growing threat of terrorism has added a new sense of urgency to these long-standing security worries. Who bears the risk of loss during transfer of goods is not ruled by who currently holds the title to those goods. International Commercial Terms 2020 (Incoterms® 2020), outline that the risk of loss or damage to the goods, as well as the obligation to bear the costs relating to the goods, passes from the seller to the buyer when

the seller has fulfilled his or her obligation to deliver the goods. For example, in an FOB (Free on Board) transaction in which the terms of sale identify where title passes to the buyer, as soon as the goods are “on board” the main vessel the risk of loss transfers to the buyer or importer. The buyer must pay for all transportation and insurance costs from that point and must clear customs in the country of import. In North America, two FOB terms (very often shown as F.O.B. and followed by Origin or Destination, and meaning either free on board or freight on board) are used (not to be confused with the FOB Incoterm® for sea and inland waterways) for domestic shipping via various modes of transport. The U.S. Uniform Commercial Code (UCC), Section 2-509, states that the risk of loss in a FOB Origin contract passes to the buyer when the inventory is duly delivered to the carrier. The risk of loss in a FOB Destination contract (where the seller is responsible for the goods until the buyer takes possession) passes to the buyer only when the goods reach the destination point. However, parties are free to allocate the risk of loss in any way the two parties can agree upon. Losses from Other Forms of Malfeasance Organizations can face significant losses from various other types of malfeasance (wrongdoing), including bribery, fraud, corruption,

abduction, and counterfeiting. (The last item is a type of intellectual property theft, so it is discussed later). Losses can take the form of money paid out or lost, fines, enforced shutdowns of operations, and seizure of goods. Illegal activities—even without the knowledge or consent of the organization’s leaders—place a great risk on the organization’s reputation. In the case of bribery, fraud, or corruption, the negative press from government or criminal investigations can cause loss of sales. Fraud and corruption. Fraud and corruption can take many forms. For a supply chain, it often has to do with attempting to make an unfair profit by avoiding laws and regulations. In an example of risks related to fraud and corruption, a U.S. honey importer was caught passing off Chinese honey as honey from other sources. The organization’s incentive was to avoid the large tariffs that could triple the cost of the honey, so two executives produced fake documents and subsidiaries shipped the honey to multiple countries, where it was relabeled and filtered to hide its origin. The organization fired the executives and paid a $2 million fine, had to destroy and replace the inventory, and then faced lawsuits from its competitors. It was eventually forced into bankruptcy when it went into default on a loan.

Bribery. A bribe is when a person gives another individual a gift, money, or a favor intending to influence his or her decision, judgment, or conduct. The bribe can be in the form of anything the recipient considers to be valuable. According to Bowersox, Closs, and Cooper, although bribes are unethical and illegal in most developed nations, these types of payments may be necessary in the sale and movement of product through customs in developing countries (although one’s home country may still specifically prohibit the act). An example of risks related to bribery involves a large clothing retailer. An Argentinian subsidiary admitted to bribing officials to get customs clearance for goods and to avoid inspections. The company was also accused of creating fake invoices to hide the payoffs. The company had to pay to the U.S. SEC a fine of $1.6 million, which was less than it could have been since the organization cooperated fully and there was no evidence the practice occurred in other subsidiaries. There are three types of criminal bribery: commercial bribery, bribery of public officials, and bribery of foreign representatives. Commercial bribes are usually aimed at covering up for an inferior product or obtaining new business or proprietary information. They can also involve industrial espionage, where

sensitive information is stolen or kickbacks or payoffs are made for trade secrets or price schedules. Any attempt to influence a public official in a manner that serves a private interest is considered a crime. The crime of bribery occurs when the bribe is offered even if the potential recipient does not accept it. Legally, a second separate crime occurs when a bribe has been accepted. In 1977, the U.S. implemented the Foreign Corrupt Practices Act to discourage bribing of foreign officials in order to secure favorable business contracts. Since then, U.S. laws have been established that criminalize that bribery. Abduction. According to an article by Anne Diebel, about $5.1 billion in ransoms are collected each year. Most of this is abduction of persons without kidnap and ransom (K&R) insurance. Over three-quarters of all Fortune 500 companies have K&R for their executives. (These premiums are worth between $250 to $300 million per year to insurance companies, but premiums have fallen by about half in the last decade.) Such insurance pays out about $500 million per year. About 90 percent of kidnappings are successfully resolved in the return of the victim, usually through payment of ransom. Use of professional negotiators raises this to a 97 percent success rate.

Abduction is primarily perpetrated on citizens of the countries where the abduction occurs. According to the Diebel article, foreigners make up only two to six percent of all kidnap victims. This is primarily an issue in countries that have high rates of kidnappings. The U.S. State Department maintains a four-level list of countries with abduction risk. Places like Afghanistan, Haiti, Iran, Iraq, Syria, and Venezuela are in the fourth and highest risk level (do not travel). Nigeria, Sudan, Turkey, and other places are in the third level (reconsider travel). Places including Colombia, Mexico, Russia, and the Ukraine are in the second level (exercise increased caution). Angola and Malaysia are in the first level (exercise normal precautions). However, kidnapping can occur anywhere. In 2010, the chairwoman of Columbia Sportswear was a victim of an attempted abduction while in her own U.S. home. Luckily for her, she knew how to respond and protect herself, and the criminal fled after she triggered a silent alarm that was sent to police. Losses from Lawsuits Organizations also need to protect themselves from potential lawsuit losses.

Risk of Loss of Intangible Assets

Intangible assets include various types of intellectual property (IP), which can range from brands and marketing images to engineering designs or software code. Loss of IP is a serious risk to organizations since a competitor or government could use the information to steal market share or produce counterfeit items. Intellectual property rights (IPR) is an area where compliance is voluntary but so necessary to ongoing business that it calls for proactive efforts. Protecting IP may mean different things in different countries, so after discussing the overall risks of loss of IP, the subject is then discussed from the perspective of two types of countries: those with highly developed regulations and enforcement and those with large gaps in this area. Loss of Intellectual Property Intellectual property losses can include the threat of counterfeit goods or services using the organization’s designs and patents and possibly the organization’s name and brand (or a close approximation of them). Counterfeiting can reduce the organization’s reputation for quality, or counterfeit goods could compete unfairly with the organization’s products. Counterfeits can be actual goods, replacement parts, or copyrighted digitized materials. The counterfeiters can be operating for profit or be freely distributing the materials (in the case of digital property). Counterfeit goods are often introduced into a legitimate supply chain when a supplier faces a

shortage. Rather than turning down the sale, the supplier turns to what are called “grey markets.” These are markets selling goods that are legal but are produced by unknown third parties. Such goods become counterfeit when the supplier passes them off as its own manufacture. Working with global suppliers creates intellectual property risk. If global suppliers have access to proprietary designs and already perform the manufacturing, they could go into business for themselves and become a competitor. A way to mitigate this risk is to source materials that involve trade secrets either domestically or only in countries with robust trade secret protections. Another solution is to divide up parts of a trade secret and have different suppliers work on only a small portion of the overall requirements. IP in Countries with Developed Regulations and Enforcement Protecting intellectual property in countries with highly developed regulations and enforcement can be straightforward. In many countries, IP is strictly enforced through laws and the court systems. In the U.S., for example, Article 1, Section 8, Clause 8, of the U.S. Constitution protects patents, copyrights, and trade secrets. Large damages can be assessed for violations, though the cost of and length of litigation can be high.

Patents need to be filed as quickly as possible to protect IP. However, it is imperative that a detailed patent search be performed as part of this process, with legal review. A risk is that organizations who own a prior and often more general patent can sue the organization for patent infringement. While any company owning a patent can do this, a special class of organization called a patent assertion entity (PAE), or “patent troll,” has come to exist. According to a U.S. White House report titled “Patent Assertion and U.S. Innovation,” PAEs “focus on aggressive litigation...asserting that their patents cover inventions not imagined at the time they were granted.” These companies form shell companies to hide their identities and threaten or sue both large and small organizations. Protecting the organization from such lawsuits is especially needed in software-related patents because it can be difficult to separate the software’s “function” from its “means” of creating the function. In addition to an exhaustive patent search, a clearly written patent can offer some protection. However, changes in patent law are needed to make this type of lawsuit no longer profitable. Violations of IP in the U.S., including counterfeit goods, can be reported to a Department of Homeland Security task force, the National IP Rights Coordination Center. In the European Union, violations are reported to the official customs department of any member state.

IP in Countries with Higher IP Risk Many countries have cultures, laws, and enforcement differences that make it very difficult to enforce IP rights. Just doing business in such countries creates risks. IP violations in many countries often must be enforced through civil litigation, with no guarantee of a fast or successful resolution. Organizations often search for lower-cost suppliers, but the culture in many of the countries with such suppliers is more permissive of intellectual property theft, so organizations need to invest more time and money in protecting their trademarks and patents. In some cases, corporations or even governments of some countries engage in active corporate espionage, for example, stealing data from visitors’ computers or other devices when they leave them in their hotel rooms. An AMR Research study ranked China and India as problem countries related to IP infringement and other risks such as security breaches. China has demanded that some large companies provide their IP as the price of doing business there. Chinese law also stipulates that the first entity to use a trademark in that country owns that trademark, even if it is a trademark that is already registered in a different country. Therefore, it is imperative to file trademarks in China at the same time as in other countries even if the organization

does not plan to do business there right away. Many countries require active use of a trademark in that country for the protection to be maintained. From a compliance perspective, it is important to get in-country representation and legal review to protect the organization’s interests. Organizations need to review not only each country’s patent, trademark, and copyright laws but also its product liability laws and relevant tax laws. IP resources exist. In the U.S., the Patent Cooperation Treaty allows organizations to file an international patent application and seek patent protection in 115 countries with one application to the U.S. Patent and Trademark Office if the applicant has filed a foreign filing license. In another example, the U.S. and the European Union have partnered to provide a set of resources for small and mid-sized organizations to manage IP rights in foreign markets. They have developed the TransAtlantic IPR Portal, which includes toolkits for specific countries, information on how to manage IP rights, training, and links to enforcement authorities.

Section B: Risk Analysis and Response This section is designed to Differentiate between qualitative and quantitative risk analysis techniques and when to apply each Assess risk probability and impact and interpret risk rating on a probability and impact matrix Assess the quality of data used in risk assessments Understand how to represent risk on a probability distribution so it is clear that a range of results could occur Calculate the expected monetary value of a risk with or without an up-front cost Understand the basic uses of sensitivity analyses and simulations Define the four basic risk responses of accept, avoid, transfer, and mitigate Define risk response plan and risk response planning Explain the difference between preventive actions and contingent or corrective actions Describe how to generate and implement preventive action, prepare contingency plans, and share risks among supply chain partners.

Once risks have been identified and classified, the next steps are analysis and response planning. Qualitative techniques are the place to start, and quantitative techniques may then be used to supplement this analysis in key areas. Responses include accept, avoid, transfer, and mitigate. The appropriate response depends in part on analysis and in part on the organization’s risk appetite/tolerance. Preparing contingency plans is also discussed. These plans help restore processes, IT, and support services to operation after a failure.

Topic 1: Risk Analysis Risk analysis involves classification and prioritization of risks followed by risk assessment and classification, including expected monetary value, sensitivity analysis, and simulation. These are presented after a brief overview of the process.

Risk Analysis Road Map Organizations use risk assessment and classification processes to prepare for uncertainty by prioritizing scarce time and money toward risks with the greatest probability and impact. Risk assessment and classification thus include prioritization.

Classification and prioritization occur first, involving a qualitative, or subjective, analysis of risks using expert judgment and tools that assess probability and impact, risk urgency, and data quality. Risks can then be further assessed with quantitative risk analysis, which uses mathematical formulas or models to better quantify the monetary impact of certain risks weighted by their probabilities. Risk assessment and classification are influenced by the organization’s tolerance for risk, the specific level for each risk, the basic responses to each risk that are possible, and the cost of the risk response. These are part of the risk management plan.

Classification and Prioritization: Qualitative Risk Analysis Qualitative analysis is used in risk classification and prioritization to understand, categorize, and rank risks quickly and efficiently. It is a non-mathematical analysis of the various qualities that make up each risk. The analysis can take into account many factors and thus can be nuanced while being cost-effective. The primary factors are probability and impact, but other factors such as urgency are accounted for. Analysts also may need to compensate for data quality or completeness and potential estimator bias. Another factor is the risk

tolerance for the specific business constraint, such as time or cost, which may differ by constraint. The various factors are weighed, and the result is a risk rating that can be used to rank the risks in order of importance. Methods and tools used in qualitative risk analysis include the following: Risk categorization Probability and impact assessment Risk urgency assessment Data quality assessment

Risk Categorization Different conventions exist for categorizing supply chain risks. The APICS Dictionary, 16th edition, defines a risk category as “a cluster of risk causes with a label such as external, environmental, technical, or organizational.” The Global Association of Risk Professionals classifies risk in operational categories: Personnel risk (e.g., internal fraud, human error) Physical assets (e.g., loss of business environments/assets) Technology (e.g., virus damage, system failures) Relationships (e.g., liabilities, lawsuits, loss of reputation)

External/regulatory (e.g., external fraud, government incentives/ restrictions) Each organization will define categories of risks in such a way that it helps the organization cluster planned risk responses, perhaps finding actions that can address more than one risk simultaneously. Exhibit 7-6 lists categories of internal and external risks to the supply chain. Exhibit 7-6: Internal and External Supply Chain Risks Internal Risks to Supply Chain

External Risks to Supply Chain

Internal Risks to Supply Chain

External Risks to Supply Chain

Poor quality Unreliable suppliers (lead time, capacity) Supply shortages Equipment breakdowns, lack of equipment Incompatible/inflexible technology or technology disruptions Uncertain demand or poor forecasting SKU (stock keeping unit) proliferation Too frequent production schedule changes (system “nervousness”) Communication across different cultures Service failures Compliance risks Poor labor relations, work slowdowns, or strikes Poorly trained labor, high labor turnover or illness, or morale issues

Labor shortages Political instability (e.g., riots, government business appropriation) Transportation delays due to weather, etc. Financial risks from currency instability/fluctuations Natural disasters, wars, or terrorism Poor infrastructure in developing countries (e.g., unreliable electricity) Large variability in demand caused by economy, competitor actions, etc. Legal/regulatory changes Taxation changes Customs risks Customer or consumer pressures

There are many other ways to categorize supply chain risks, for example

Strategic supply chain risks Supply risks Demand risks Process risks Environmental risks Hazard risks Financial risks Malfeasance risks Litigation risks. Each of these categories is discussed next. Note that supply risks, demand risks, process risks, and environmental risks might be grouped together in a larger category of operational risks, which together comprise the core risks facing most supply chains. Strategic Supply Chain Risks Strategic supply chain risks are those risks that endanger the success of the organization’s long-term supply chain strategy. Risks in this category include those that have strong potential to impact business continuity, brand image, reputation, and market share. Supply Risks Supply risks include the types of risk discussed in . The exhibit includes some examples of root causes or red flags that could be

recorded for each risk. Some other supply-related risks mentioned in later categories, such as supplier insolvency or counterfeiting, might instead be located in this category. Exhibit 7-7: Supply Risks and Common Root Causes/Red Flags Supplier/subcontractor availability

Failure of initial source/supplier.

Supplier pricing

Poor performance may lead to price increases. Contract changes or violations.

Supplier quality

Suppliers may be using lower-quality raw materials. Supplier manufacturing processes allow variability.

Supplier lead time

Suppliers may not have sufficient capacity. Suppliers may not have sufficient raw materials.

Transportation lead time

Fleet may have high rate of breakdowns. Supply/demand imbalances may create lack of availability of origin-destination pairings, carriers, containers, drivers, etc. Other risks may play a factor, e.g., hazards, customs.

Customs/import delays

Paperwork errors or customs paperwork delays. Port strikes or other labor issues.

Labor disruption

Union contracts require renegotiation. Country-specific general labor unrest.

Demand Risks lists some examples of demand risks and possible root causes or red flags. A key risk in this area is forecasting errors. Most organizations use a mix of statistical forecasting tools and expert judgment, but the error at the level of aggregated product lines (aggregating to reduce forecast error is called risk pooling) is still around 10 percent, and forecasting error at the SKU level is 40 percent or more, according to Schlegel and Trent in Supply Chain Risk Management. Exhibit 7-8: Demand Risks and Common Root Causes/Red Flags Forecasting error or bias

Seasonality, bad data, or inadequate model/modeler. Poor communications or assumptions (e.g., optimism).

Interorganizational communications

Separate forecasts cause bullwhip effect/variability. Attitudes that forecasts are trade secrets.

Outbound shipping delays

Capacity, information system, or product issues. Customer order changes.

Outbound transportation delays

Carriers experience capacity issues or instability.

Other risks may play a factor, e.g., hazards, customs. Customer price changes/promotions

Unannounced prices/promotions create demand surge and upstream stockout/capacity issues.

Quality issues

Poor quality auditing (process audits)/quality control. Poorly communicated requirements/specifications.

Warranties/recalls

Poor integration of business units/subsidiaries. Poor product portfolio or specification management.

Lost customers

Inability to fulfill expectations due to failures in other risk areas.

Unprofitable customers

Services offered are not tailored to customer profitability or longevity.

Customer's requirements change

Poor communications and change control.

Customer product launches

Failure to get involved early, which the customer may not be allowing, leading to poor planning/execution.

Process Risks lists some examples of process risks and possible root causes or red flags. Exhibit 7-9: Process Risks and Common Root Causes/Red Flags

Capacity and flexibility

Too reliant on certain equipment, persons, or places. Poor planning, visibility, or communications.

Manufacturing yield

Material shortages. Human or equipment failure.

Inventory

SKU proliferation. Poor life cycle planning (obsolescence, legacy maintenance costs, brand confusion). Poor inventory planning or forecast error.

Information delays

Union contracts require renegotiation. Country-specific general labor unrest.

IT/telecommunications

Power or service outages in region or at host. Hackers, malware, and human or internal errors.

Poor payables processing

In-house cash flow shortages. Deteriorating relationship with suppliers.

Poor receivables processing

Customer financial difficulty. Poor organizational follow-up or contract enforcement.

Intellectual property

Outsourcing/contractor due diligence failures. Failure to compensate for country risk/espionage.

Poor planning

Poor systems, processes, and infrastructure for planning.

Poor management oversight (e.g., no sales and operations planning) or training. Mismanagement

Failure to develop strategy or execute strategy and tactics. Poor measurement, management, and communications.

Environmental Risks lists some examples of environmental risks and possible root causes or red flags. The definition of what counts as an environmental risk might be expanded to include the political environment, currency exchange rates, and weather-related events, but in these materials these are addressed in other categories. Exhibit 7-10: Environmental Risks and Common Root Causes/Red Flags Environmental legislation/regulation

Poor commitment or management. Failure to use due diligence or audit self/suppliers.

Industry regulations

Same as above plus new entry into industry (e.g., mergers or operating in many industries).

Country regulations

Same as above plus lack of or failure to acquire cultural understanding/sensitivity.

Shifts in cultural expectations

Evolving societal expectations go unheeded.

Competitors using stricter environmental practices. Conflict minerals

Failure to use due diligence with suppliers’ suppliers. Willful indifference or active obfuscation of conflict region sourcing.

Customs regulations

Packaging poorly balances goods protection, customs access, and packaging minimization.

Interest group attention

Unwelcome negative press. Pressure to adopt less-profitable methods for sustainability.

Voluntary reporting

Voluntary sustainability reporting used to highlight negatives. Peer group comparisons don't favor the organization.

Hazard Risks Hazard risks are called force majeure in legal terms or acts of God colloquially. These are primarily the natural disasters that cause property damage and business disruptions, but hazards can also include political turmoil, war, government appropriations, product tampering, acts of terrorism, and similar events beyond the organization’s control. Financial Risks

Financial risks relate primarily to the financial solvency and credit issues of the organization and of others up and down the supply chain. Financial risks also include risks related to volatility of the overall financial market or of commodity or foreign exchange markets. Risks of insolvency or financial difficulty need to be monitored not only for suppliers and customers but also for service organizations such as third-party logistics providers, third-party payment vendors, and so on. Financial metrics and monitoring supplier events can provide red flags to watch for that can show when a supplier is in financial distress: Supplier changes its early payment incentives or needs payment first. Supplier is paying its suppliers late. (Payables period is increasing.) Quality or grade is decreasing. Unusual early shipments may indicate lack of business. Longer lead times may mean that they must order their materials late. Investments in research and development (R&D), equipment, resources, or IT are falling off. Supplier invested heavily in personnel, R&D, or equipment but there are delays getting new products to market.

Supplier’s customers are industries in distress. Unusual executive turnover or stock sales occur. Supplier must restate financial statements. Supplier is laying off workers, closing plants, and denying rumors. Organizations in financial distress may make unwise and selfish choices that they would otherwise not be motivated to make. The great recession of 2008 is a clear example of a market risk that impacted many areas, not the least of which was a severe tightening in credit availability. Commodity market volatility is another large area of risk for supply chains. According to the IMF, commodity prices since 2005 have had three times as many fluctuations in comparison to the period of 1980 to 2005. According to a McKinsey & Company white paper by Gerken et al., between 2014 to 2018 commodity prices averaged between 10 to 20 percent in volatility per year, but peaks were as high as 70 percent of a given year’s average price. The energy market was the most volatile, in the 20 to 25 percent range, while metals and minerals and agriculture were in the 5 to 15 percent range. End product prices often tend to track fairly closely to their underlying commodity prices (e.g., copper wire tracks very closely to copper). Currency exchange risk also exists because most (but not all) currencies are free floating, meaning that their value can go up or

down relative to market forces. If you must pay for inventory or equipment in a different currency, even though the price is fixed, you might need to pay more or less in your own currency after the exchange is factored in. Malfeasance Risks Risks of supply chain theft (or other types of loss), fraud, corruption, bribery, abduction, and counterfeiting can be placed in a category such as malfeasance (wrongdoing) risks. Litigation Risks Types of litigation risk include product liability, breach of contract, and many others.

Probability and Impact Assessment A probability and impact assessment involves estimating these attributes for each risk: Impact. This is the magnitude of the loss (or gain). It considers the importance of the process or asset at risk to the organization. The impact of potential worst-case scenarios is evaluated and ranked, for example, from insignificant (5 percent), to minor (10 percent), to moderate (20 percent), to major (40 percent), to extreme (80 percent). The organization can decide how to label the categories

and assign percentages to these labels. Percentages help estimators come to a common idea of the value of each category. Probability. This is the probability of occurrence. The probability of the scenario occurring is evaluated and ranked, for example, from rare (10 percent), to unlikely (30 percent), to possible (50 percent), to likely (70 percent), to almost certain (90 percent). Once again the organization can decide on percentages and labels. The final task in this step is to create a matrix where the consequence levels and likelihood are identified for each scenario. This reveals each scenario’s overall risk rating. An example from a packaged food company might be “Employees planning to strike over poor working conditions threaten to deface product packaging as it’s being loaded into work trucks bound for a distribution center.” This would probably be ranked as possible in likelihood with minor consequences, since the company has been informed about the threat in advance and can take the necessary precautions. A risk rating can be made for a supplier, customer, or product. It is basically a numerical rating of risk that has been normalized so it can be used for benchmarking purposes. Risk rating is commonly described using the following equation:

The combination of probability of occurrence and impact (magnitude) of loss creates at least four basic categories of risk levels, as shown in Exhibit 7-11. Organizations can use risk level categories to decide on a risk response.

Exhibit 7-11: Categories of Risk Levels

Obviously, risk levels may occupy a spectrum rather than fitting neatly into categories, but more categories can be made to better approximate this spectrum. Exhibit 7-12 uses the percentage-based probability and impact percentages defined earlier to create a fiveby-five matrix with 25 category areas.

Exhibit 7-12: Probability and Impact Matrix

In Exhibit 7-12, each box in the matrix is simply the probability percentage times the impact percentage, such as 90% × 80% = 72%. (The exhibit rounds to the nearest percent.) The risks can then be placed in categories such as low (no shading), medium (darker shading), and high (darkest shading) as above. The organization will specify in the risk management plan how each category should be addressed, for example: Accept all low risks. (Do nothing, but monitor them on a watch list.) Use expert judgment to decide how to handle medium risks. Make a proactive plan to address all high risks. Note that when an organization’s risk tolerances differ by business objective, the risk management plan may specify how to rate risks differently by objective, such as rating delay-related risks as having a higher impact than cost-related risks, and so on.

Risk Urgency Assessment

Organizations need to increase the priority of risks that will require further action based on their urgency. If action is required quickly for a response to be effective, then this analysis might move the response higher in priority and earlier in the schedule. Similarly, other factors may also be used to adjust a risk’s priority, such as whether the risk impacts safety, the organization’s reputation, or legal obligations.

Data Quality Assessment A data quality assessment is used to determine how well the given risk is understood. It also assesses the reliability, accuracy, and integrity of the underlying data used to make the assessment. Lowquality data can lead to inaccurate risk ratings. When a risk is rated incorrectly, it can lead to very poor decision making. For example, a major bank’s US$6 billion trading loss was due in part to spreadsheet errors. A weakness included error-prone manual copying and pasting between spreadsheets. Also there was an error in a value-at-risk (VaR) spreadsheet model. In one place, it divided by the sum of an old rate and a new rate rather than by their average (i.e., failed to divide by two), which lowered the VaR and made the stock trades seem far less volatile. If the data for the risk assessment are hard to come by, it is important to indicate how tentative the risk rating is and that the risk

is not well understood. Flagging such risks for later analysis can help, because many risks become easier to assess as relevant events grow nearer. In the context of data quality, reliability refers to whether the same result would be obtained if the same measurement procedure is used multiple times. Reliability may be affected by bias on the part of estimators, such as preconceived notions or different assumptions about a process or environment. This is one reason why it is important to provide as much guidance as possible to estimators on shared assumptions and give them clear tools like a probability and impact matrix, perhaps with supporting examples at each risk level. Accuracy and data integrity are two related data quality terms. Accuracy is the “degree of freedom from error or the degree of conformity to a standard” (APICS Dictionary, 16th edition). Accuracy can be verified by checking the data for math errors and so on. Accuracy may also involve checking risk levels against external sources to see if they conform to available external standards such as risk databases. Insurance specialists might also check them against actuarial tables. The APICS Dictionary, 16th edition defines data integrity as “assurance that data accurately reflects the environment it is

representing.” For risk data, this may be determining the predictive quality of risk assessments or responses over time by comparing them to actual results.

Circling Back Once all of the various assessments are complete, supply chain managers circle back to reevaluate each risk. This follow-up step involves Reevaluating the organization’s risk priorities, determining if each is at an acceptable level relative to related risk tolerance levels or if there needs to be further action taken Adding the results of the analysis to the risk register. In many cases, risk categorization and analysis is complete at this point. Some organizations choose to quantify certain significant risks or create risk models.

Quantitative Risk Analysis A quantitative risk analysis is a numerical analysis of the effect of risk on business objectives. Because these types of analyses produce quantifiable results, they can further reduce uncertainty and provide clear information for assessing the benefits and costs of doing nothing versus developing a proactive risk response. After

individual risks have been assessed, they can be re-ranked in priority. While individual risk analysis is useful, the real power of a quantitative risk analysis is the ability to assess the aggregate level of risk in a business endeavor. Aggregating all the uncertainties facing a particular operation or project (weighting the various threats and opportunities by probability and then summing them) can show when there is a likely net positive or negative impact. This is sometimes called a risk and opportunity analysis or, as SCOR calls it, overall value at risk (VaR). This text introduces expected monetary value (EMV) below as one way to calculate individual VaRs as well as overall VaR when the individual values are summed. Quantitative risk analysis should be performed for only those risks that have sufficiently high data quality. Performing this analysis on risks that are less well understood can lead to worse decision making than if the mathematical analysis had never been done. In these cases, it is best to rely on qualitative risk analysis only.

Data Gathering When more reliable data on risks need to be gathered but the best source available is interviews with those persons closest to the process, a good way to get better results is to ask each person for

three estimates: a most likely estimate as well as an optimistic and a pessimistic estimate. These three estimates can then be averaged by adding them and dividing by three. For example, if the estimates for a cost are $40,000 as most likely but are as high as $75,000 or as low as $30,000, the simple average would be ($30,000 + $40,000 + $75,000)/3 = $48,334. Another method of averaging is the weighted average. A commonly used weighted average method is the one used in PERT (program evaluation and review technique), which is a project management methodology used to develop budgets and schedules given significant uncertainty in estimates. The PERT method places four times more weight on the most likely estimate, and it then divides by six because there are effectively six things to average. The formula for the PERT weighted average follows with a continuation of the prior example:

Probability Distributions A continuous probability distribution is a way of showing how results could differ from an expected result. (A well-known example is a bell

curve.) When shown on a graph with probability on the vertical axis and the possible results on the horizontal axis, the statistically most likely occurrence would be at the peak of the graphed data. Using the simple average estimation example above, the peak is at the average of $48,334. The low end would be at $30,000 and the high end would be at $75,000. The usefulness of such graphs is that they illustrate that an estimate could fall within a certain range rather than looking more certain than it is. A tall and narrow curve would show that the results are fairly predictable, while a fat and low curve would show that the results are more likely to be off a significant amount. A curve could also fall off more steeply in one direction than the other, as would be the case with the estimate above: The results are more likely to be on the $48,334 to $75,000 end of the scale, so this side would be a little wider than the $30,000 to $48,334 side (skewed in the direction that is wider).

Expected Monetary Value (EMV): Risk Response Cost Versus Benefit Prior to deciding on an appropriate response for each identified risk, the organization must balance the cost of the risk response against the risk level. That is, the cost of a preventive action and/or contingent action must be balanced against the benefits the action

provides in terms of reduced costs from a risk event occurrence and/or reduced probability of occurrence. This allows the organization to achieve a best-cost outcome for each supply chain vulnerability. The best-cost outcome is one that addresses all of the highest priority risks first and in which the response is never more expensive than the risk itself would cost. The basic formula for EMV is the basic risk rating formula, probability times impact. However, in EMV, the impact is expressed in terms of a monetary impact:

The resulting dollar amount can be used as a spending target or limit for risk mitigation or prevention efforts. For example, if a risk has an anticipated cost of US$1 million and a probability of 5 percent, the response should cost no more than US$50,000 (0.05 × US$1,000,000 = US$50,000). Risk managers can use a cost justification formula such as this when presenting their plans and budgets for approval. Risk mitigation plans can also be justified by showing how much the risk probability will be reduced and what this means in terms of reduced costs from avoiding harmful risk events. However, cost justifications may need qualitative adjustments. For example, insurance on buildings often

costs a little more than the expected value, but the insurance is justified because the potential loss is so great. EMV for Multiple Outcomes of Risk or Decision EMV can be used to evaluate the risk of a decision that could have more than one outcome. For example, establishing a formal partnership with a supplier could result in an increase in revenues of US$10 million in the first year in the best case, but in the worst case it could bring in only US$1 million that year. EMV makes the simplifying assumption that the options being considered are the only possible outcomes and so these outcomes sum to 100 percent of the possibilities. Therefore, if these are the only two options being considered, if there is a 75 percent chance that the partnership will bring in US$10 million, then there is a 25 percent chance of the US$1 million result. EMV is calculated separately for each option and then the options are summed to find the expected value of that decision. The calculations for this example follow:

Here, the expected value of return is US$7,750,000 after all risks are accounted for. So while the expected result is less than the US$10,000,000 best case, the result is positive so the risk seems worth taking. However, this may not be true after the up-front investment is considered. Net Impact EMV When a risk has a response cost or an opportunity has an up-front cost, this can be factored into the analysis. To continue the previous example, say that there is a US$5 million up-front investment. This cost is deducted from the impact prior to multiplying it by the probability. If the net result is positive, then it is an opportunity. If the net result is negative, then it is a threat (negative risk). The formula for calculating a EMV when there is an initial cost follows along with a continuation of the prior example:

Note that the formula shows impact plus cost. This assumes that the cost will be a negative value and thus a deduction. If both numbers are negative, adding them makes a larger negative net impact.

Now the opportunity does not seem quite as appealing, but since the net value is still positive, it is still an opportunity. If the risk-adjusted benefits and costs of later years were added, the decision would become clearer. EMV can also be used to decide between two alternatives. A decision tree is a way of diagramming a decision point where chance may be involved in some of the decisions. For example, in a decision involving whether or not to purchase insurance, one “branch” of the tree could calculate the net EMV of no insurance and the other could calculate the net EMV of getting insurance. Each of these branches would have a best and worst case, the best case for either option being that no insurance claim is needed. The best case for the “get insurance” option still requires paying the insurance premiums. The worst case in the “get insurance” option would be the cost of the insurance plus the cost of any deductible (multiplied by probability). However, the worst case in the “no insurance” option would be that a risk event occurs and the organization needs to make a large payout. When calculating the EMVs, the probability adjustment would reduce the size of this payout to reflect its likelihood. In this case, both options would likely result in a negative EMV after the insurance payments are factored in, but the value of the model is that it would allow the organization to select the option with the

smallest loss—in other words, to purchase the best amount of insurance relative to the risk.

Sensitivity Analysis and Simulations Risk models can be developed to understand how risks impact multiple parts of a supply chain system. Two common tools for modeling include sensitivity analysis and simulation, both of which are often developed in spreadsheets, but more specialized tools also exist. Users enter various input values, called variables, automated calculations occur on them, and the outputs show the impact on various supply chain metrics.

Sensitivity Analysis The APICS Dictionary, 16th edition, defines sensitivity analysis as a technique for determining how much an expected outcome or result will change in response to a given change in an input variable. For example, given a projected level of resources, what would be the effect on net income if variable costs of production increased 20 percent? The key point about sensitivity analysis is that only one variable is changed at a time so that its impact can be studied in isolation. It can be used in risk analysis to study risks that have monetary impacts.

For example, what would be the effect on net income if gasoline prices rise by 10 percent?

Simulation The Dictionary defines a simulation as 1) The technique of using representative or artificial data to reproduce in a model various conditions that are likely to occur in the actual performance of a system. It is frequently used to test the behavior of a system under different operating policies. 2) Within MRP II, using the operational data to perform what-if evaluations of alternative plans to answer the question, “Can we do it?” If yes, the simulation can then be run in the financial mode to help answer the question, “Do we really want to?” A simulation can be used in risk analysis to enter a given risk scenario, meaning that multiple input variables might be altered from their baselines to fit a given set of assumptions. For example, if it is assumed that rising gasoline prices would place more demand on rail travel, then rail prices would be increased as well in the model. A common type of simulation is a Monte Carlo simulation. The Dictionary defines a Monte Carlo simulation as “a subset of digital simulation models based on random or stochastic processes.” Monte Carlo simulations use specialized tools or spreadsheet add-ons to

allow developers to enter a range for each input variable rather than just one value. Then the simulation is run thousands of times using different random values from each input range at each pass. The result is an averaged set of results along with statistics such as probability distributions. Once the organization has decided on an acceptable risk tolerance, has identified, described, categorized, and defined a risk rating for each risk, and has entered these results in the risk register, it is time to debate possible risk responses.

Topic 2: Risk Responses, Action Plans, and Business Continuity Here we first look at the general process of risk response planning. Then some potential responses to several types of risks (strategic supply chain, supply, demand, process, environmental, hazard, financial, malfeasance, litigation) are covered. Business continuity planning and plan implementation are also discussed.

Risk Response Planning A key step in acquiring sufficient funds for supply chain risk management and for risk responses is to highlight that designing a

secure supply chain—one that can keep functioning despite disruptive events—is a form of supply chain resilience. You don’t want to lose the ability to keep products and information flowing during a disruption because part of your cost-management initiative has been to eliminate disaster planning. Every company buys insurance as a prudent investment. Risk response plans are investments like insurance. The organization needs to invest in resilience. Deciding on risk responses starts with selecting a basic type of response for each identified risk, bearing in mind that what is needed is a best-cost risk response. While this means that the individual response needs to be cost-effective, it also means that the organization needs to use the funds it has allocated to its risk budget wisely. This might mean that some risks get no response or a very inexpensive response. Once basic responses are selected, if a proactive response is called for, individual risk response plans are developed. The organization then generates a risk response plan and summarizes all planned responses in the risk register.

Basic Risk Responses An organization can take four basic responses for any identified risk: accept, avoid (exploit), transfer (share), and mitigate (enhance). The response in parentheses is the equivalent response for an

opportunity. Accept is a passive response for either a threat or opportunity, while the rest are all types of proactive responses. Each type is defined as follows: Accept. The APICS Dictionary, 16th edition, defines risk acceptance as “a decision to take no action to deal with a risk or an inability to format a plan to deal with the risk.” In addition to risks that cannot be dealt with through planning, risk acceptance is often the strategy for low-probability, low-impact risks or risks that have high costs for a proactive response. For example, sovereign risk includes the risk that a government could nationalize an entire industry. For each country the organization operates in, it will have to accept this risk. (If the risk is considered significant, it could avoid or transfer the risk by not working in the country or by finding an outsourcing partner in that country.) For opportunities, accept means to do nothing to make the opportunity become more likely or have a greater positive impact. Avoid. The Dictionary defines risk avoidance as “changing a plan to eliminate a risk or to protect plan objectives from its impact.” For example, some pharmaceutical companies do not develop vaccines because of the risk of lawsuits from harmful side effects. For opportunities, the response is to exploit, which is the opposite

of avoid, meaning that you invest as much time and money as is feasible in order to realize the opportunity. Transfer. Organizations can move the resource or financial effects of a risk to a third-party organization such as an insurance company or a supplier. This requires purchase of insurance or bonding or contractually transferring risk to an outsourcing partner. However, not all risks can be transferred, such as risks to production schedules for core competency activities that define part of the process’s total end-to-end lead time (i.e., critical path). For opportunities, the response is to share, which transfers some of the benefits of the opportunity to ensure that it can be realized, for example, by partnering with a specialist to add capabilities. Mitigate. Organizations apply preventive measures to reduce the probability and/or impact of identified risks. Proper design of facilities and processes, employee training, and compliance management are all examples. For opportunities, the response is to enhance, which means increasing the probability or impact of the opportunity. This might mean adding more personnel to a task, for example.

Responding to Supply Chain Risks

Strategies to address supply chain risks should include a risk response plan and risk response planning. The Dictionary defines these terms as follows. Risk response plan : A document defining known risks including description, cause, likelihood, costs, and proposed responses. It also identifies current status on each risk. Risk response planning : The process of developing a plan to avoid risks and to mitigate the effect of those that cannot be avoided. Risk response planning needs to be fully integrated into the organization’s regular business processes for it to be effective. A way to achieve this integration is to perform regular progress reviews and risk response plan update meetings involving staff from a number of areas. Meeting outputs should include assignments of specific responsibilities to individuals. The risk response plan is a living document that should be revisited regularly, such as at weekly or monthly meetings. The status of planned actions is tracked at these meetings and signed off on once completed. New items can be added as new risks arise. Some organizations will choose to combine the risk register and the risk response plan, generating just one large spreadsheet. In either

case, some responses will require additional detailed plans of their own, such as a business proposal or project documents. Exhibit 7-13 shows an example of a risk response plan.

Exhibit 7-13: Risk Response Plan Example

Risk responses can be implemented in one or both of the following types of risk response plans: Preventive action. A preventive action is any risk response that occurs before a harmful risk event occurs. The intent is to respond proactively rather wait until an urgent response is needed. Contingent/corrective action. A contingent action is any risk response that occurs during a harmful risk event or after it has occurred. The intent is to minimize the monetary, physical, or reputation damage from the risk event. A contingent action is called a corrective action when it involves responding to risk events related to variances from a plan. The intent of a corrective action is to get back on plan (e.g., back on schedule/budget). Given a set of risks that are considered significant enough to warrant a proactive response and an approved action plan to address the risks, the risk response process may involve the following actions: Preparing preventive action plans Implementing the preventive action plans Preparing contingent/corrective action plans Coordinating supply chain risk management and transferring/sharing risks among supply chain partners

Generating Preventive Action Plans for Each Risk to Be Mitigated The primary function of a supply chain is to keep goods, information, and payments flowing through the network and arriving in the right numbers at the right time and in good shape. Therefore, the significant risks to supply chains are events that might disrupt these flows. provides a high-level overview of key supply chain risks and some possible preventive action plans for each. Exhibit 7-14: Examples of Significant Risks and Preventive Action Plans Examples of Significant Supply Chain Risks

Examples of Preventive Action Plans

Failure of a mode of transportation, such as a train derailment, a power outage that closes down pipeline pumping stations, operator strikes, or similar disruptions

Preventive maintenance of equipment and vehicles, safety training, backup power supplies, extra capacity at plants, safety stock, maintenance of good labor relations

Harm to goods, facilities, or markets caused by adverse weather, fire, floods, vandalism, or terrorist activities

Insurance, geographic diversification, security systems and guards, financial diversification, GPS tracking of transport vehicles

Lead time variability, orders incorrect, Safety lead time, counting or quality or quality problems control at receiving, supplier certification

Examples of Significant Supply Chain Risks

Examples of Preventive Action Plans

Loss of a key asset or supplier

Understanding suppliers’ organizations and financial solvency, contractually obligated backup suppliers, redundant equipment and repair parts on hand

Inadvertent noncompliance with regulations, ordinances, licensing requirements, etc.

Compliance audits, legal review of new regulations, supplier certifications

Theft of real or intellectual property

Security guards and ink tags on items, digital product protection requiring license verification

Failure of or dramatic change in patronage by an important customer

Diversification of customer base, customer relationship management, rewarding customer loyalty

Preventive actions can lead to easier implementation of contingency plans. For example, an article by John Kamensky highlighted how a city government in Nebraska addressed river flooding. An administrator for the city said, “Following the flood of 2011, we took advantage of FEMA mitigation funds to build berms around water and wastewater plants. After struggling to keep plants dry in the 2011 flood, in the 2019 flood we simply raised the flood gate, turned on emergency pumping, and had to do nothing else. Mitigation plan and project worked perfect.” Note that FEMA stands for the U.S. Federal Emergency Management Agency.

Strategic Supply Chain, Supply, Demand, and Process Risks Here we discuss preventive (proactive) and contingent/corrective (reactive) examples of responses to risks in the categories of strategic supply chain, supply, demand, and process risks. It is important to prepare both types of responses when feasible.

Responding to Strategic Supply Chain Risks Often the best way to address risks to supply chain strategy is to focus on the fundamentals, for example by developing better, more integrated products and communications in the first place. This may be done using design for X or the many similar strategies discussed elsewhere in this learning system. Getting suppliers involved early or investing in information technology for better design, analysis, and visibility are other examples.

Responding to Supply Risks Exhibit 7-15 shows examples of preventive and contingent/corrective action plans for selected supply risks. The particulars of the supply chain and business model will dictate what responses are useful. Note that many of the contingent/corrective plans are more along the lines of traditional responses while the preventive action plans are often more progressive.

Exhibit 7-15: Responses to Supply Risks

Supply Risks

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Supplier/subcontractor availability

Contracts with backup suppliers. Audit suppliers on capacity resilience. Right-size category supply base.

Approach supplier finalists from RFP processes or use approved vendor lists.

Supplier pricing

Careful contract crafting and enforcement. Due diligence. Consolidate suppliers for bulk deals or diversify if too few.

Visit supplier and negotiate.

Supplier quality

Contract penalty clauses. Supplier selection due diligence process.

Supplier corrective action plan and probation.

Supplier lead time

Safety stock. Large orders for priority. Diversify suppliers.

Place next order early.

Supply Risks

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Transportation lead time

Benchmark and notify. Contract penalty clauses. Contracts assuring a given level of passage volume for shipping. Outsource to 3PLs.

Customs/import delays

Translate/edit paperwork. Outsource to freight forwarding organizations.

Call government contacts.

Labor disruption

Diversify sources. Safety stock.

Negotiate in good faith and prepare alternative solutions.

For manufacturers, a critical area for supply risk management is related to the cost, timing, and availability of raw materials, since these represent 50 to 70 percent of a manufacturing organization’s cost of goods sold. To control cost, organizations need to carefully balance the number of suppliers in a given purchasing category. Consolidating to fewer suppliers may enable better pricing due to higher volume with those that remain. This is often quite beneficial for a category that has more suppliers than it needs. One risk of this method is that the remaining suppliers may not have sufficient

capacity for peak demand. Going even farther and consolidating to just one supplier creates significant risk and provides a disincentive to use due diligence with that supplier due to overdependence. Finding just the right level of diversification is therefore a critical risk management principle for supply categories. When it comes to logistics-related risks, a common solution is to benchmark one’s own logistics costs and risks to that of specialist 3PLs. After performing due diligences, if use of such providers lowers costs and risks, then it is generally a good way to transfer risk.

Responding to Demand Risks Exhibit 7-16 provides examples of preventive and contingent/ corrective action plans for demand-related risks. Exhibit 7-16: Responses to Demand Risks

Demand Risks

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Demand Risks

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Forecasting error or bias

Flag variances from Use statistical forecasts and investigate. forecasting to set safety stock. Aggregate forecasts. Use sales and operations planning and demand-driven techniques to balance supply to demand.

Interorganizational communications

Promote supply chain Request a meeting among supply chain participants. visibility and data sharing. Adopt processes and shared systems.

Outbound shipping delays

Set realistic expectations with customers.

Notify customers of problems right away.

Outbound Follow up with freight transportation delays forwarders.

Have discussions with carriers and customs agents.

Customer price changes/promotions

Regular conference calls. Price concessions.

Rescheduling other deliveries to handle their demand spike.

Quality issues

Reschedule and rework, Audit quality increasing inspections. processes. Near-term specification changes and lower prices.

Demand Risks

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Warranties/recalls

Carefully craft public Renew message and avoid being in quality/integration. denial. Use liability, tort, and warranty insurance. Limit warranty period.

Lost customers

Find new buyers for Improve other risk earmarked inventory if areas. possible, or write off. Develop win-back and new customer programs.

Unprofitable customers

Use profitability metrics. Developed tiered service.

Avoid win-back programs with unprofitable customers.

Customer’s requirements change

Contractually require change review and control. Assess profitability and turn down if unprofitable.

Insist on contract addenda or a new contract as needed.

Customer product launches

Meet regularly and get involved early.

Increase capacity if needed, including overtime.

Unplanned customer promotions are a key source of demand risk because they can create demand spikes that then result in shortages up the supply chain, followed by overreactions in terms of excess

safety stock. Improving communications may require extraordinary efforts to develop trust up and down the supply chain to enable information sharing. Collaborative planning, forecasting, and replenishment (CPFR) systems can help. As with supply management, if 3PLs can move freight to customers at a lower cost and with less risk, it is a good risk transfer given due diligence.

Responding to Process Risks Exhibit 7-17 provides examples of preventive and contingent/corrective action plans for process-related risks. Exhibit 7-17: Responses to Process Risks

Process Risks Capacity and flexibility

Manufacturing yield

Examples of Preventive Action Plans

Examples of Contingent/Corrective Action Plans

Invest in configurable Reschedule production runs equipment to handle or deliveries. more than one product line. Contract with backup suppliers. Improve regular maintenance.

Reschedule or use excess capacity.

Process Risks Inventory

Information delays

Examples of Preventive Action Plans

Rationalize number of SKUs (stock keeping units). Use product life cycle management. Improve communications and visibility. Control safety stock. Inter-organizational information sharing.

Examples of Contingent/Corrective Action Plans

Discount or write off obsolete/spoiled inventory. Offer replacement products to customers with old products that have high maintenance costs. Hold ad hoc meetings and overtime if off schedule.

IT/telecommunications IT backup system projects. Practice team responses and responsibilities in drills. Poor payables processing

Discuss situation early. Build cash flow cushion or get credit. Contract renegotiations.

Poor receivables processing

Phone calls and dialogue. In-person visits.

Intellectual property

Use the courts, fines, and International penalties. contracts. Split up trade secrets among vendors or vertically integrate.

Consider using a collection agency.

Process Risks Mismanagement

Examples of Preventive Action Plans

Emphasize collaboration. Clarify roles and goals.

Examples of Contingent/Corrective Action Plans Measure and report on gaps.

Process risks are usually internal risks without an easily developed response because they are systemic and difficult to change. It takes real change management. Often the culture becomes ready for such changes only after a serious failure. In the mean time, issues with poor processes reduce the supply chain team’s ability and motivation to respond to other risks. Organizations need to resist the tendency to just select responses that are workarounds. These can compensate for chronic but low impact risks, but this is a form of addressing the symptoms instead of the cause.

Environmental, Hazard, Financial, Malfeasance, and Litigation Risks Here we discuss preventive (proactive) and contingent/corrective (reactive) responses to environmental, hazard, financial, malfeasance, and litigation risks. It is important to prepare both types of responses when feasible.

Responding to Environmental Risks Exhibit 7-18 provides examples of preventive and contingent/corrective action plans for environmental-related risks. Exhibit 7-18: Responses to Environmental Risks Examples of Contingent/Corrective Action Plans

Environmental Risks

Examples of Preventive Action Plans

Environmental legislation/regulation

Create a change management project. Invest in ordered change.

Use overtime and contractors to get in compliance quickly, pay fines and penalties.

Industry regulations

As above, and hire industry experts.

Acquire industry contractors.

Country regulations

As above, and hire local experts/start a subsidiary.

Contract with local experts.

Shifts in cultural expectations

Develop media talking points Learn about and control who talks to the expectations and media. develop change plan. Develop brand image marketing plan.

Conflict minerals

Use due diligence. Find alternate sources.

Customs regulations

Remedial paperwork or full Switch to 3PLs. Develop relationship cooperation with requests. with customs agents.

Disclose facts if already in public domain along with a remediation plan.

Environmental Risks

Examples of Preventive Action Plans

Interest group attention

Voluntary reporting

Examples of Contingent/Corrective Action Plans

Develop media talking points Discover what they and control who talks to the want and their media. motivations. Develop plans that take as many of their concerns into account as feasible. Adopt standard reports like Prepare rebuttals to negative the UN Global Compact. representation of the report.

While environmental regulations are often perceived as a burden, they tend to develop or change slowly, so the organization should have ample time to develop a response plan.

Responding to Hazard Risks Two important means of addressing hazard risks are contingency planning for business continuity and purchasing the right amount and types of insurance. Avoidance of working in certain geographic areas or geographic diversification can also help. A brief overview of insurance is provided next. Types of Insurance reviews various types of insurance for the supply chain.

Exhibit 7-19: Types of Insurance for Supply Chain

Responding to Financial Risks When responding to financial risks related to the insolvency of a customer or supplier, some traditional preventive measures include

monitoring their financial ratios and metrics that predict bankruptcy risk, contracting with alternate suppliers, or diversifying the customer base. Some contingent measures include loans, possible mergers, and litigation. In regard to market volatility and credit risk, preventive measures include developing larger cash balance cushions, maintaining unused credit facilities, and developing specific contingency plans for serious reductions of revenue streams, including what products or services will be trimmed or stopped first. For commodity price risk, responses include buying larger quantities of rare raw materials than are needed when the prices are favorable and purchasing of hedging instruments, as discussed below. Hedging can also be used for currency exchange risk, but another option is to avoid the risk by buying and selling in the home-country currency whenever the other party also agrees to it. If the party maintains a foreign currency account, it can use these funds for all transactions in that currency. The transaction becomes risk transfer if the other party will need to exchange the foreign currency. In this case, it will require different pricing as a compensation. The parties can also agree to share these risks (splitting the burden between both parties). An example of this is an agreement to revisit a price when it comes nearer to the payment being due and then to take into

account changes in exchange rates. This is called a formal currency review and would need to be specified in the contract and be subject to legal and financial review. Hedging Hedging is a risk transfer tool for commodities, currency exchange, and financial instruments. Hedging is often used to lock in a price now for something that needs to be purchased in the future, such as a commodity or a foreign exchange transaction. By locking in the price now, the organization is transferring the risk of the price going in an unwanted direction to the party offering the hedging instrument. The organization is also sacrificing the benefit it would receive if the price of the underlying asset being hedged goes in a favorable direction. In this sense, a long-term contract with a supplier that fixes prices is a form of hedging, since the supplier bears the risk of the costs of its raw materials going up but cannot pass on those costs. For this reason, many fixed-price contracts have escape clauses in the event of severe commodity or foreign exchange rate changes. The opposite of hedging is speculation. The hedger is working to reduce risk (uncertainty), not to increase profits. The speculator is the other party to a hedging transaction, who is betting in the opposite direction to make a profit. It is absolutely critical to have financial experts arrange hedges and that even these experts have

governance review. Hedging can become speculation in the hands of inexperienced persons. Hedging can create large liabilities that must be settled. Hedging does not guarantee a favorable result. Three types of hedging instruments are forwards, futures, and options. Forwards and futures are very similar. The key difference is that forwards are customized deals between two parties (the other is often a bank) while futures are standardized deals offered by large financial exchanges in standard amounts and for a limited number of currencies and commodities. Otherwise the two instruments serve the same purpose: lock in a price now for something needed in the future. Both are mandatory, meaning that you need to settle them regardless of what the market does. Forwards are often used for things not on the organized exchanges or when another party offers customized terms that fit very well. A risk is that the other party will default. This risk is very low when working with an exchange, but it can be significant with other parties. An option is like a forward or a future except that you have the option to use it or not. You pay the writer a premium (fee) to gain this flexibility. The fees can be sizable and must be taken into account when calculating the overall savings or loss from the hedge. For example, if oil options are offered at €65 per barrel and you purchase an option to buy 100,000 barrels of oil next year for a

premium of €5 per barrel, then you are effectively paying €70 per barrel, but at least you have some budget certainty. If the price were €66 per barrel, you would exercise the option and pay €65 + €5 per barrel (since the fee is due either way). The market price would need to be higher than €70 per barrel to be a real savings. If the price was €$50 per barrel, however, you would not use the option and would buy on the open market but would still need to pay the €5 per barrel fee as well.

Responding to Malfeasance Risks Responses to theft (and other loss), bribery, abduction, corruption, counterfeiting, and other forms of criminal behavior need to be comprehensive and start at the top of the organization in the form of good governance and clearly stated policies and procedures. A good general response is to set up a comprehensive security system for the supply chain. A relevant standard to guide such a system is ISO 28000. As defined in the APICS Dictionary, 16th edition, ISO 28000 is an International Standard that specifies the requirements for a security management system, including those aspects critical to security assurance of the supply chain. Other examples of responses follow.

Theft, Damage, and Vandalism Theft, damage, vandalism, and other forms of loss of goods can be combated in part by investing in information gathering and sharing. Organizations exist that track thefts and help coordinate theft incident communications, recovery, and deterrence, thus helping to coordinate the responses of law enforcement in multiple countries. For example, the CargoNet platform provides near-real-time theft alerts to organizations and law enforcement. Loss of goods can be mitigated by insurance, but insurance cannot immediately replace inventory, nor will it fully reimburse a loss if there is a deductible. Proper security and handling procedures can reduce the occurrence of internal and external threats to inventory loss. Many of these procedures involve setting and enforcing proper operational and financial controls. One example of a key control is segregation of duties. For example, a warehouse employee should not be able to approve a material move and also carry out the move. Matching of invoice to purchase order and receiving documents is another control. Incomplete enforcement or special exceptions for controls can cause problems. For example, one organization had a rule that prohibited unauthorized vehicles from parking in the warehouse yard. An exception was made for one employee, and one night after work he

discovered a package taped to the underside of his bumper. He informed security and they left the package in place, eventually discovering a ring of warehouse employees engaging in theft. While the employee with the vehicle was trustworthy, the exception to the control had been costly to the organization. Other examples of preventive security measures include the following: Reducing product complexity or standardizing parts across product families to reduce the total number of supply chain sourcing risks Rerouting shipments to avoid problem areas Installing ISO/PAS 17712–approved seals on shipping containers (ISO/PAS 17712:2010 is the ISO publicly available specification [PAS] regulating classification and the use of seals on shipping containers.) Selecting safer transportation modes (e.g., rail is less vulnerable to hijacking than trucks) Preventive equipment-handling measures may involve finding ways to reduce lead times for perishable inventory, redesigning packaging to compensate for poor handling by third-party shippers, ensuring that containers are watertight, or regularly maintaining refrigeration equipment. One example of a preventive measure against risk of

loss from truck accidents practiced in Europe is to have the truck driver drive on to a railway flatcar and sleep while the truck and its goods are transported by rail, which reduces the likelihood of the driver falling asleep (and complies with regulations for drivers’ hours of operations while keeping the truck moving). This is also an example of a situation where one response can mitigate two risks, since railway travel also reduces the risk of hijacking. (The rail portion of the journey could be timed to occur in countries where hijacking risk is considered more significant.) Bribery A good preventive response for bribery is to invest in visibility. Cloudbased software can help headquarters arrange and supervise supplier selection, due diligence, ongoing contacts, approvals, and payments. These antibribery systems help with information gathering, regulatory compliance, and investigations and rate third parties by assessing and scoring their bribery and corruption risk. Fraud and Corruption Fraud and corruption can occur internally as well as with suppliers. Both internal and external risks need to be addressed by following best practices. The U.S. Conference Board and the Center for Responsible Enterprise and Trade have published a report that lays out a compliance program:

Due diligence: Examine both legal and financial records as well as government relations, policies, and ethics. Contractual rights: Specify compliance with laws, regulations, and anticorruption policies, using termination clauses as a penalty. Also include the right to inspect supplier records and perform audits. Monitor and audit: Search for criminal activity, review high-risk supplier payments, review supplier policies, re-certify suppliers regularly, and conduct visits and audits. Set and enforce policies: Provide policies and education to employees on anticorruption, internal and third-party reporting, and ongoing compliance. Set and enforce procedures: Use procedures to implement policies such as requiring signed employment agreements, team review of bids, third parties needing written policies, or multiple required approvals for third parties. Governance: Board-level governance sets the tone, and a committee reviews internal audits, legal, finance, and compliance. Procurement will often have governance duties over suppliers.

Another way to combat supplier fraud and corruption is to turn to supplier co-management, which involves using a third-party supplier vetting and monitoring organizations with expertise and mature processes and systems. Since these organizations specialize in managing supplier risk, they can invest heavily in controls, monitoring software, statistical analyses, and human expertise. These can be leveraged with many suppliers and on the behalf of many clients. Spending the same amount of time and money would not be cost-effective for just one organization. Similarly, the experts at these organizations will be up to date on the latest regulations and can provide early warning of issues. Abduction What are companies doing to protect their executives and sales representatives who frequently travel? Currently about 75 percent of Fortune 500 companies invest in kidnap and ransom (K&R) insurance for their key management. The existence of K&R insurance is kept secret so as not to encourage criminals. It may even be kept secret from those who are covered so they do not start taking unnecessary risks. Many companies are now offering their key contributors training on how to keep themselves safe and minimize the risk of abduction. The companies are also hiring protection services and consulting

firms to help with this goal. They recommend the creation of a written threat assessment and plan for each organization. Expatriate and other employees need to be made aware of local cultural and political situations that may put them at risk. They need to know how to avoid placing themselves in dangerous situations, such as varying their routes and regular schedules. They should avoid flashy behavior, certain neighborhoods or establishments, and carrying a corporate credit card or other ways to easily determine one’s ransom value. They also need to be taught what to do, and what not to do, if they are kidnapped. Executives should understand that negotiations will be handled by security consultants and insurance professionals. Executives should not attempt to escape or negotiate with the criminals. Unfortunately, the successful and dramatic escapes of kidnap victims often portrayed in movies do not reflect reality. Counterfeiting and Intellectual Property Infringement The key to reducing the impact of counterfeiting is to know when it is occurring. When an organization’s suppliers turn to grey markets to meet demand in excess of capacity, they are not only risking a loss of quality but are also performing an illegal act. A way to combat this has arisen in the marketplace. Franchised excess and obsolete (E&O) dealers are organizations that buy up excess or obsolete inventory and then sell it to suppliers if demand returns. Dealers who offer guaranteed product traceability can sell original inventory back

to suppliers in many cases. Requiring this traceability can reduce the risks of counterfeits being introduced. An organization that is taking the lead on anti-counterfeiting measures in the U.S. is the Nuclear Regulatory Commission (NRC), which faces such significant risk from counterfeits ending up in nuclear plants that it has promoted tough measures to combat counterfeiting. In addition to policies such as regularly auditing not only suppliers but also distributors, it also stresses ways to detect if parts are genuine and to trace products. Thermo-mechanical analysis and advanced scanning technologies are being used to scan parts as they arrive. For traceability, it is using advancements in blockchain, serialization, and product tags. Another example is a unique DNA marking produced by Applied DNA Sciences that is visible only in ultraviolet light and uses a plant-based electronic signature marking that can differ for each manufacturer. They also have methods of testing the makeup of various raw materials in textiles. In addition to testing and tagging goods, organizations can encourage their distributors to look for counterfeits and inform them when counterfeits are found. They can educate employees and channel partners regarding counterfeit problems. Research by Chaudry et al. indicates that these regular discussions with channel

partners can be effective. However, their research also states that advertising the inferiority or dangers of counterfeits to customers or providing rewards to distributors for not purchasing counterfeits has proven less effective. The research points to the following additional countermeasures for protecting intellectual property: Ensure that all trademarks and patents are registered in all countries where there is significant demand for the product. Do this quickly in foreign countries (e.g., the first to file a trademark in China owns it.) Create an enforcement team that finds counterfeits for sale and follows up with investigative work, legal action, and law enforcement contact. Pursue actions not only against manufacturers but also distributors and retailers offering counterfeit goods or using the organization’s brand. Create a database for tracking counterfeits and their resolution status. To protect intellectual property when traveling to certain high-risk countries, leaving sensitive data or even data storage devices at home may sometimes be the best protection.

Other protections against intellectual property infringement include the following: Develop internationally recognized contracts that adhere to the Convention on the International Sales of Goods (CISG) and check parties’ references thoroughly. Engage in trade dress protection, which protects against look-alike products with minor changes and is enforceable under the U.S. Digital Millennium Copyright Act for online materials. Learn which countries are high risk and avoid doing business in these places or take extra precautions when it is necessary. Consider establishing operations in foreign countries or at least gain access to local expert representation for greater control and business savvy. Local representatives can be given purchasing authority in the form of a purchasing office, which helps to evaluate suppliers. Whenever possible, directly pursue offenders in that country’s court system. If a government is failing to enforce its intellectual property laws and the organization is large enough to be considered an asset to that government, the organization can threaten to pull operations out of that country.

Responding to Lawsuit Risks

According to an article by Michael Metzger, a Kelly School of Business professor at Indiana University, following a number of basic rules can help reduce the risks of legal losses. These rules are paraphrased as follows: View your actions from the perspective of how a jury would see them. Adhere to the truth and ethical standards. Don’t seek trouble, but assume it is seeking you and watch for it. Invest in the details, because a small issue can sometimes end in a large cost. Always stay professional, unemotional, and imperturbable. (Emotional reactions can provide grounds for the opposition, and pursuing some cases can cost far more than settling.) Document everything. Don’t make policies unless you intend to enforce compliance. Pretending a problem doesn’t exist and trying to forestall the inevitable are futile and costly endeavors.

Preparing Contingency Plans Related to Business Continuity As defined in the APICS Dictionary, 16th edition, a business continuity management system (BCMS) is

part of the overall management system that establishes, implements, operates, monitors, reviews, maintains and improves the organizational capability of continuing to deliver products or services at acceptable predefined levels following a disruptive incident. It is based upon identifying potential threats to an organization and the impacts to business operations those threats, if realized, might cause and…provides a framework for building organizational resilience with the capability of an effective response that safeguards the interests of its key stakeholders, reputation, brand and value-creating activities. Contingency planning to ensure continued operations in the face of an emergency can be called a BCMS, business continuity planning, or disaster planning depending on the focus of the plan. While the terms are sometimes used interchangeably, in other cases continuity planning is used to restore business functions and workplaces while disaster planning is used to get IT and other business support systems back online. Both are usually needed and could be addressed together or separately. A business continuity management system encompasses both of these types of planning and includes a framework for plan implementation and continuous improvement. A relevant standard for business continuity management systems is ISO 22301. The Dictionary defines ISO 22301 as “an international

standard that specifies requirements for setting up and managing an effective business continuity management system.” This type of planning involves designating specific individuals to take on specific roles during an emergency, such as one person who is designated to contact persons on a list to give them further instructions. However, plans should be disseminated and practiced in advance so that if communications are disrupted, the organization’s contingency team members can work without needing further instruction. Contingency plans should include step-by-step instructions that indicate priorities for restoring services, such as getting communications back online first, followed by vital information systems and key production processes. A company should also have a designated spokesperson to work with the press so that a consistent message is delivered and the organization is not placed at further risk by an employee’s wellmeaning but poorly chosen words. When developing business continuity plans for the supply chain, business continuity can be called supply chain continuity. The Dictionary defines supply chain continuity as

the strategic and tactical capability of an organization to plan for and respond to conditions, situations, and events as necessary in order to continue supply chain operations at an acceptable predefined level. To make contingency planning a part of your supply chain strategy, consider the following tactics: Get support for contingency planning from the top. A governance structure should exist to verify proper preparation. Run a business impact analysis project to provide real data on risks, responses, and costs/benefits of funding contingency plans. This involves interviewing business process owners and assessing facilities, critical resources, processes, vital records/data, and internal/external dependencies. Critical recovery times are set as baselines. Be prepared. Develop contingency policies and plans and review them regularly. Make sure that specifically named supply chain professionals own the supply chain contingency plans and are responsible for keeping them current and implementing them as needed. Don’t rely only on extra stores of inventory. There can never be enough of it to cover all potential problems, and it, too, is

vulnerable. You need alternate processes to keep functioning after a disaster. Research best practices in your industry and globally. Use service contracts to require that supply chain partners follow best practices and submit written contingency plans. Like all other supply chain processes, contingency planning should cut across company and functional boundaries. While each organization will have specific responsibilities in a disaster, all the organizations’ activities will have to be coordinated. Develop a sourcing process that takes the loss of each key supplier into account and includes specific alternatives. When sourcing outside your borders, consider the total cost of the product or service being provided rather than just price. Rely on knowledgeable intermediaries when assessing foreign suppliers and customers. How likely are foreign partners to be disrupted by earthquake, flood, fire, famine, war, political interference, or economic uncertainty? In the world after terrorist attacks, tsunamis, hurricanes, floods, and pandemics, you have to plan as if the apocalypse were possible. Taking another look at sources closer to home may be advisable.

Pay special attention to maintenance of information flows. Telephone lines can go down and stay down for hours, days, and weeks. Power can go out for similar periods of time, and generators require fuel supplies that can also run out. Know how you’re going to communicate among supply chain partners to coordinate the disaster plan’s implementation. Track your shipments and assets with radio frequency identification (RFID), global positioning, the Internet of Things (IoT), and blockchain. Third-party event monitoring services can also be leveraged. (For example, Resilinc provides monitoring and filtering of news and social media, end-to-end supplier monitoring, and supplier scorecards.) You can’t implement a contingency plan until you know you have a problem. Purchase business continuity insurance, not just asset loss insurance. Test your plans, and train employees and managers to understand and implement them. Run drills or tabletop walkthroughs for specific events or portions of the plan such as data center recovery from backup. This helps prepare individuals and verify their level of preparedness.

Implementing Risk Response Plans

Preventive action plans that are never implemented are useless. However, many plans remain just plans. Failure to implement preventive (or contingency) plans is a risk in itself. Organizations need to assign an individual the responsibility of turning a plan into a project. This entails defining the goals for all stakeholders and setting expectations (e.g., setting improvement targets and what the plan will and will not address), winning final project approval and release of funds, and exercising project management to execute the project. The plan’s relative level of success against its goals must be measured. The risk response plans and risk register should be updated, for example, by removing irrelevant risks from the list, modifying probabilities/impact, or other appropriate action.

Coordinating Supply Chain Risk Management and Sharing Risks Part of implementing risk response plans is to ensure that others in the supply chain are dealing with risk on their end as well. It is important to decide how to share supply chain risks among partners. Transferring and/or sharing risk can be a reason to create some type of alliance in the first place, or it can occur after a risk coordination committee makes recommendations. Risk transfer should be made on the basis of which party is best suited to minimize the risk or

respond to a risk event. The goal should be to minimize overall system risk, not to minimize one’s own risk at the expense of other partners. A global multi-industry risk management project approved by the former Supply Chain Council devised a number of best practices for coordinating risk management in the supply chain, many of which are fundamentals of risk identification and assessment. For example, it advocated that risk management be a formal and systematic process coordinated among partners to reduce the negative impact of risk events on the supply network. It also advocated for visibility and quantification of risk between supply chain members through processes such as joint risk identification and contingency planning. Exhibit 7-20 lists some of the other best practices resulting from the study. (These practices also support SCOR®.) Exhibit 7-20: Risk Management Best Practices Risk Management Best Practices Best Practices: Coordinated Risk Management Risk management program’s coordination with partners

Coordinating risk management with supply chain partners by emphasizing cooperation among departments within a single company and among different companies of a supply chain to effectively manage the full range of risks as a whole; establishing a risk management coordination committee

Risk Management Best Practices Sourcing risk mitigation strategies

Includes strategies to address source risks, for example, multiple sources of supply, strategic agreements with suppliers, and supplier partnerships

Crisis communication planning

Creating joint contingency plans

Best Practices: Supply Chain Designed to Manage Risk Supply chain business rules

Establishing business rules (e.g., customer priority, supplier priority, production routing, transportation routing, etc.) based on minimizing supply chain risk

Supply chain information

Managing supply chain information networks to minimize supply chain risk; includes information sharing with partners as well as internal locations; helps all parties to be quickly informed of a real or potential disruption and respond quickly and appropriately to minimize the disruption impact

Supply chain network

Designing node locations, transportation routes, capacity size and location, number of suppliers, production locations, etc., in a fashion that mitigates potential disruptions to the ability to deliver product/service to the end customer

Source: Supply Chain Risk Management Team, Supply Chain Council, Inc., 2009.

Index A Abduction [1] , [2]

B Bribery [1] , [2] Business continuity [1] See also: Contingency plans Business continuity standards ISO 22301 [1]

C Contingency plans [1] See also: Business continuity Contingent action [1] , [2] , [3] Corrective action [1] , [2] , [3] Corruption [1] , [2] Counterfeiting [1] , [2]

D Damage [1] Data accuracy [1]

Data gathering/collection [1] Data integrity [1] Data quality assessments [1] Data reliability [1] Demand risks [1] , [2] , [3]

E EMV [1] Environmental risks [1] , [2] , [3] Expected monetary value (EMV) [1]

F Financial risks [1] , [2] Fraud [1] , [2]

H Hazard risks [1] , [2] Hedging [1]

I Incoterms [1] Incoterms trade terms [1] Insurance [1] Intellectual property (IP) [1] , [2] International Commercial Terms [1]

IP [1] , [2] ISO 22301 [1] ISO 28000 [1] ISO 31000 [1] ISO 31010 [1]

K Known risks [1] See also: Unknown risks

L Litigation risks [1]

M Malfeasance risks Abduction [1] , [2] Bribery [1] , [2] Corruption [1] , [2] Counterfeiting [1] , [2] Damage [1] Fraud [1] , [2] Theft [1] , [2] Vandalism [1] Managers

Risk managers [1] Monte Carlo simulations [1]

P Preventive action [1] , [2] , [3] Probability and impact matrices [1] Probability distributions [1] Process risks [1] , [2] , [3]

Q Qualitative risk analysis [1] Quantitative risk analysis [1]

R Risk acceptance [1] Risk analysis Qualitative risk analysis [1] Quantitative risk analysis [1] Risk appetite [1] Risk avoidance [1] Risk categories [1] See also: Risk identification Risk identification [1] See also: Risk categories

Risk management [1] , [2] , [3] Risk management frameworks [1] Risk management maturity levels [1] Risk management plans [1] Risk managers [1] Risk mitigation [1] Risk prioritization [1] Risk rating [1] Risk registers [1] Risk response planning [1] , [2] Risk responses Risk acceptance [1] Risk avoidance [1] Risk mitigation [1] Risk transference [1] Risks Demand risks [1] , [2] , [3] Environmental risks [1] , [2] , [3] Financial risks [1] , [2] Hazard risks [1] , [2] Known risks [1] Litigation risks [1] Malfeasance risks [1] , [2] Process risks [1] , [2] , [3]

Supply chain risks [1] , [2] , [3] Supply risks [1] , [2] , [3] Unknown risks [1] Risk standards ISO 31000 [1] ISO 31010 [1] Risk threshold [1] Risk tolerance [1] Risk transference [1]

S Security standards ISO 28000 [1] Sensitivity analysis [1] Simulations Monte Carlo simulations [1] Supply chain continuity [1] Supply chain risk management [1] Supply chain risks [1] , [2] , [3] Supply risks [1] , [2] , [3]

T Theft [1] , [2]

U

Unknown risks [1] See also: Known risks

V Vandalism [1]