ctl.sc2x - supply chain design key concept... · fall 2017・ctl.sc2x – supply chain design key...

Fall 2017・CTL.SC2x – Supply Chain Design Key Concepts・MITx MicroMasters in Supply Chain Management MIT Center for Transportation & Logistics・Cambridge, MA 02142 USA ・[email protected] This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.

CTL.SC2x-SupplyChainDesign

KeyConceptsDocument

ThisdocumentcontainstheKeyConceptsfortheSC2xcourse.Thedocumentisbasedonapastrunofthecourseanddoesnotincludeallthematerialthatwillbeincludedinthiscourse;pleasecheckbackfornewerversionsofthedocumentthroughoutthecourse.Thesearemeanttocomplement,notreplace,thelessonvideosandslides.Theyareintendedtobereferencesforyoutousegoingforwardandarebasedontheassumptionthatyouhavelearnedtheconceptsandcompletedthepracticeproblems.TheupdatedbyDr.AlexisBatemaninthefallof2017.Thisisadraftofthematerial,sopleasepostanysuggestions,corrections,orrecommendationstotheDiscussionForumunderthetopicthread“KeyConceptDocumentsImprovements.Thanks,ChrisCaplice,EvaPonceandtheSC2xTeachingCommunity


TableofContentsSupplyChainDesign 3

Demandforecastingmatrix 4References 7

NetworkModels 8IntroductiontoNetworkModels 8FacilityLocationModels 10SupplyChainNetworkDesign 15AdvancedSupplyChainNetworkDesignTopics 16PracticalConsiderations 20

ProductionPlanning 23FixedPlanningHorizon 23MaterialandDistributionRequirementsPlanning 28

ConnectingSalestoOperations 31AggregatePlanningModel 31MonthlySales&OperationsPlanningProcess 34DistributionandChannelStrategies 35

SupplyChainSourcing 45ProcurementStrategy 45ProcurementOptimization 49

SupplyChainFinance 51AccountingFundamentals 51CostingSystems 54SupplyChainCashFlows 58DiscountedCashFlowAnalysis 60DefiningSupplyChainFinance 64AnalyzingFinancialPerformance 69

Organizational,Process,andPerformanceMetricDesign 77

Fall 2017・CTL.SC2x – Supply Chain Design Key Concepts・MITx MicroMasters in Supply Chain Management MIT Center for Transportation & Logistics・Cambridge, MA 02142 USA ・[email protected] This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. 3

SupplyChainDesign

SummarySupplyChainDesignisasmuchanartasitisscience.Sciencebecausewecanquantifytheimpactofdifferentchoices,andfindtheoptimaltrade-offsbetweendifferentchoiceparameters.Butalsoanartbecausetheassumptionswemakearenevergoingtocompletelymatchreality,andbecausethedataweuseforourmodelsisnevergoingtobecompletelyaccurate.Thereisnosinglerightwayofmakingtheseassumptions–doingthisina“good”wayforaparticularproblemismoreartthanscience!Still,welearnedthattherearesomeframeworks,tools,andmethodstoaidthedesignprocess.Thecourseexaminestheflowsinasupplychain,witheachdesignissuediscussedinaseparatemodule:

• DesignofPhysicalFlows.Howshouldmaterialsflowthroughthesupplychain?Wewillmodelphysicalflowstakingintoaccountthecostsoftransportationandfacilities.WewillbalancecostsandserviceusingMixedIntegerPrograms.However,keyisinnotjustsolvingthemodels,butininterpretingtheresults.Remember,thetoolsaredecision-supporttools,theyareintendedtosupportdecisions,notmakethemforus!

• DesignofFinancialFlows.HowtotranslatesupplychainconceptsandactionsintothelanguageoftheCFO(ChiefFinancialOfficer)?Wewillgothroughactivitybasedcosting,cashflowanalysisandcapitalbudgetingtobetterunderstandhowsupplychaindesigndecisionstranslatetochangesintheincomestatementandthebalancesheet.

• DesignofInformationFlows.Forthismodule,wewillfollowtheSCOR-model’sthreephasesofSource,Make,andDeliver.Howshouldyouworkwithsuppliers?Howshouldinformationbecoordinatedbetweendifferentmanufacturers,internalandexternal?Andhowshouldyoucoordinateandcollaboratewithcustomers?Inthismodulestrategiesandproceduresforthisisdiscussed.

• Designingtheorganization.Howshouldasupplychainbeorganized?Wewillinvestigatesupplychainprocessesandhowthemeasuringoftheperformanceoftheprocessescreatedifferentincentives.Wewillalsodiscussorganizationalstructure.

KeyConcepts• SupplyChains-Twoormorepartieslinkedbyaflowofresourcesthatultimatelyfulfilla

customerrequest• SupplyChainFlows–physicalflows,financialflows,andinformationflows.Allare

importanttoconsiderwhendesigningasupplychain.


Demandforecastingmatrix

Forecastingtruisms:

• Forecastarealwayswrong–userangesandtrackforecasterror• Aggregateforecastaremoreaccurate–riskpoolingreducescoefficientofvariation• Shortertimeforecastsaremoreaccurate–postponecustomizationaslateaspossible

ContinuousreviewandperiodicreviewInventoryisgenerallymanagedusingoneoftwokeytypesofpolicies:policiesusingcontinuousrevieworpoliciesusingperiodicreview.

• Continuousreviewmeansthattheinventorypositioniscontinuouslysupervised(presumablybysoftware).Assoonastheinventorypositionreachesapre-determinedlevelsareplenishmentorderofQunitsisplaced.Consequently,thetimebetweenordersisuncertain.

• Periodicreviewmeansthattheinventorypositionisreviewedatcertainreoccurringpointsintime,suchaseveryeveningafteraretailerclosesthestore.Basedonthecurrentinventoryposition,areplenishmentorderisplacedtobringtheinventorypositionuptoapre-determinedlevelS.Consequently,theorderquantityisuncertain.

Bothpoliciesareusedwhendecisionsaremadeforalonghorizon,wheretheitemscanbestoredbetweenperiodsofreplenishment,butdemandineachreplenishmentperiodisuncertain.

TransportationoptionsThereareseveralwaysoforganizingthetransportationinasupplychain.Amongthem:


• One-to-one:directpoint-to-pointmovementsfromorigintodestination,e.g.dailyfullvanloadstoeachcustomer

• One-to-many:multi-stopmovesfromasingleorigintomanydestinations• Many-to-many:movingfrommultipleoriginstomultipledestinationsusuallywithahub

orterminal–thisdecoupleslinehaul(frome.g.asuppliertoaterminal)fromlocaldeliveryoperations(frome.g.aterminaltostores)

TotalcostequationThetotalcostequationspecifiesthetotallogisticscostforasystemforanarbitrarytimeperiod:Totalcost=Purchase(UnitValue)Cost+Order(SetUp)Cost+Holding(Carrying)Cost+ShortageCost

• Purchase:Costperitemortotallandedcostforacquiringproduct.• Ordering:Itisafixedcostandcontainscosttoplace,receiveandprocessa

batchofgoodincludingprocessinginvoicing,auditing,labor,etc.Inmanufacturingthisisthesetupcostforarun.

• Holding:Costsrequiredtoholdinventorysuchasstoragecost(warehousespace),servicecosts(insurance,taxes),riskcosts(lost,stolen,damaged,obsolete),andcapitalcosts,bothforunitsin-transit(pipelineinventory)andinwarehouse(cyclestock+safetystock)

• Shortage:Costsofnothavinganiteminstockincludingbackorder,lostsales,lostcustomers,anddisruptioncosts.

NotationD: Demandrate(units/time)Q: Orderquantity(units)L: Leadtime(time)σDL: Standarddeviationofdemandduringtheleadtimek: Safetystockfactorc: Purchasecost($/unit)ct: OrderingCosts($/order)h: Holdingrate–usuallyexpressedasapercentage($/$value/time)ce: ExcessholdingCosts($/unit-time);alsoequaltochcs: Shortagecosts($/unit)TC: TotalCosts–thesumofallfourcostelementsWegetthat

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D QTC cD c c k DL c P StockOutTypeQ

sæ ö æ ö= + + + + +ç ÷ ç ÷

è øè ø


Fromtheformulaweseethattransportspeedaswellasforecastaccuracyhasanimpactontotalcostthroughtheinventorycosts.

SCOR-modelForthedesignofinformationflows,wefollowtheSource-Make-DeliverprocessoftheSCOR-model.

Fisher’smodel:InnovativeversusfunctionalproductsWhendesigningasupplychain,thedesignneedstobeadaptedtothetypeofproductsitisintendedfor.InFisher’smodel,productscanbeclassifiedasbeingeithermoreFunctionalormoreInnovative.

• Functional:predictabledemand,longlifecycle,lowmargin,lowerrorinproduction,lowstock-outrates

• Innovative:unpredictabledemand,shortlifecycle,highmargin,higherrorinproduction,highstock-outrates

Asaruleofthumb,functionalproductsshouldhaveadesignfocusingmoreonefficiency,whereasinnovativeproductsshouldhaveasupplychaindesignfocusingmoreonmatchingsupplywithdemand.Rememberthatthesearenothardandfastrules.Inpracticethereare,ofcourse,manyproductsthatsharecharacteristicswithbothsegments.Mostfirmsaregoingtohaveaportfolioofsupplychains.Further,innovativeproductsoftenmoveintobecomingmorefunctionalastheirmarketsbecomemoremature.Thisrequiresadaptationofthesupplychaindesign.Forinstance,whenthepatentprotectionforthecholesterolloweringdrugLipitorwentout,Pfizerhadtoreducethepricetoprotectthedrugfromgenericcompetition.Withalowermargin,thesupplychainmustbedesignwithahigherfocusonefficiency.


LearningObjectives• Identifyphysical,financial,andinformationflowsinherenttosupplychains• RecapSC1x:demandforecasting,inventorymanagement,transportation• HowtoapproachSupplyChainDesignfordifferentproductsandcompanies• PresentaroadmapforthecourseSummaryofLesson

References• Arntzen,B.(2013)MITCenterforTransportation&Logistics,Hi-VizResearchProject.• Fisher,M.(1997)“WhatIstheRightSupplyChainforYourProduct?”HarvardBusiness

Review.• Olavsun,Lee,&DeNyse (2010)“APortfolioApproachtoSupplyChainDesign,”Supply

ChainManagementReview.AdaptedfromSheffi(2010)ESD.260CourseNotes


NetworkModels

SummaryNetworkmodelsareausefulclassofmodelsthatcanbeutilizedtoaidmanytypesofsupplychaindecisions.Wereviewthebasicnotationsofthesemodels,andshowhowtosetupasimplespreadsheetmodelinExcelorLibreOfficetosolvethemodel.Wefocusontwotypesofmodelsthatarerelativelysimpleyetpowerfulinderivinginsightstosupportsupplychaindesigndecisions:theTransportationProblemandtheTransshipmentProblem.Boththetransportationproblemandthetransshipmentproblemconsideranunderlyingnetworkofnodes(facilities)andarcs(transportflowsbetweenfacilities).Theobjectiveistominimizecostsforagivenperiod(day,week,year)bychoosingtheamountofunitstobeshipped/transportedondifferentarcsduringtheperiodtofulfilldemand,whilemeetingthecapacityconstraints.Bothproblemscanbeformulatedaslinearprograms(seebelow)andsolvedusingyourspreadsheetsoftwareofchoice(e.g.ExcelorLibreOffice).Fordetailsonhowtorunthesolver,pleaserefertotheseparateguideforhowtosetupandrunthesolver,whichisfoundinthecoursematerial.Wediscusssomeofthelimitationstothesenetworkmodels.First,inthemodelsreview,welimitedourselvestovariablecostsforthearcs(i.e.transportcostsperunit).Clearly,thecoststructureforanetworkis,inpractice,oftenmorecomplex,involvingcoststhatarebothfixedorvaryoverdifferentparameters.Wealsoconsideredasinglecommodity–allplantsproducedperfectlysubstitutablegoods.Thedemandwasdeterministic,thatis,weassumedthatdemandwasperfectlyknownfortheentireperiod.Finallywealsoassumedtherewasnocapacitylimitsonthearcs,sothatanyamountcouldbetransported.Clearly,alloftheseassumptionslimitourresults,sowehavetobecarefulwhatinferenceswemakefromthemodels.Inthecominglessonswewillrelaxsomeoftheseandalsodiscusshowtomakeinferencewhilestillusingarelativelysimplemodel.Also–wenotedthattransportationandtransshipmentproblemsmayhaveseveraloptima(thesamevalueoftheobjectivefunctionisfoundbydifferentvalueonthedecisionvariables).Dependingonthealgorithmandsoftware,differentoptimamaybethe“firstchoice”ofthealgorithm.

IntroductiontoNetworkModels

Networkterminology• Nodeorvertices–apoint(facility,DC,plant,region)• Arcoredge–linkbetweentwonodes(roads,flows,etc.)• Networkorgraph–acollectionofnodesandarcs


ThetransportationproblemThetransportationproblemconsiderstransportsfromisupplynodestojdemandnodesoverarcsij.Witheacharcisassociatedacostcij.Theamountofunitstransportedoneacharcijisdenotedxij.Thesexij’sareourdecisionvariables–wewanttofindtheamountsforeacharcthatminimizestotalcost.Letzbetheobjectivefunction(i.e.,thefunctionexpressingthetotalcostwewanttominimize).Notation

. .

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ij iji j

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Plants iRegions j

xij = Flow on arc from Plant i to Region j (tons) ∀i, j

Indices

Decision Variables

Si =Available supply of sand from Plant i (tons) ∀i ∈ SDj =Demand for sand in Region j (tons) ∀j ∈ D

Input Data

cij =Cost for sending sand from Plant i to Region j ($/ton) ∀i, j

Thesearethesupplyconstraints–thetotalnumberofshippedunitsfromasupplynodeitoalldemandnodesjmustbelessthan(orequalto)thesupplycapacityofnodei.

Thesearethedemandconstraints–thenumberofshippedunitstoademandnodejfromallsupplynodesimustbeatleastthedemandatnodej.

Thesearethenon-negativityconstraints–wedonotallownegativevolumesonanyarc


ThetransshipmentproblemThetransshipmentproblemissimilartothetransportationproblem.Thedifferenceisthatwenowintroduceasetofnodesthatareneithersupplynodesnordemandnodes,buttransshipmentnodes,meaningthatoveraperiod,anythingthatgoesintothetransshipmentnodeneedstocomeout.Notation

Notethatwehavethesameformulationasforthetransportationproblembutwithonedifference:athirdconstrainthasbeenadded(highlighted).Thisconstraintistheconstraintforcingthetransshipmentnodetobe“empty”–theconservationofflowconstraint.Considertransshipmentnodej.Thefirstsumintheconstraintisthenthetotalnumberofunitsshippedtonodejfromallothernodesi.Thesecondsumisthetotalnumberofunitsshippedfromnodejtoallothernodesi.Theconstraintsaysthatthisdifferencemustbezero.

FacilityLocationModelsInthepreviouslyintroducemodelsweassumedthateveryfacilityinthenetworkwasused.Wenowrelaxthatassumption.First,wereviewwheretolocateafacility,giventhatweneedasinglefacility.Wetheninvestigatehowmany(andwhich)facilitiestouse,givenasetofcandidates.Lastly,wereviewhowtoincorporateexplicitLevelOfService(LOS)constraintsinourmodels,toidentifycertaincostandservicetrade-offsinmoredetail.

Origin iDestination j

xij = Flow on arc from i to j (tons) ∀i, j

Indices

Decision Variables

Si =Available supply of sand from Plant i (tons) ∀i ∈ SDj =Demand for sand in Region j (tons) ∀j ∈ D

Input Data

cij =Cost for sending sand on arc from i to j ($/ton) ∀i, j


Forthesinglefacilitycasewelookattwofundamentallydifferentwaysofapproachingthedecision.ThefirstwasbyconsideringallpointsintheEuclidianspaceaspotentialcandidates,andsearchforanoptimallocationforafacilityanywhereinthisspace.Forthisweuseboththecenter-of-gravity-methodandtheWebermethod.Whiletheformerhasanintuitiveappeal,theWebermethodismoreappropriateasitminimizestheactualtransportationcosts.Thefundamentalproblemofrelyingoneitherofthesemethods,though,isthattheoptimalsolutionmayendupinplacesthatarenotfeasibleforawidenumberofreasons:lackofinfrastructure(wecouldendupinalake!),highconstructioncosts,difficultyofgettingpermitsetc.Sowhilethesemethodsareusefultogetaballparkfigureofwheretolocatethefacility,theyprovideonlyaregiontotarget.Wereviewanotherapproachwhere,insteadofconsideringthefullEuclidianspace,thereisonlyafinitesetofcandidatelocations.ThisproblemcanbeapproachedusingaMixedIntegerLinearProgram(MILP),forwhichwecanuseaspreadsheetsolvertofindthesolution.MILPusedtosolvethesinglefacilityproblemcouldbeeasilyextendedtoinvestigatethecaseofmultiplefacilities.Themodelcouldthenbeusedtoanswerbothhowmanyfacilitiestouse,andwhichfacilitiestouse.Finally,weincorporateexplicitLOSconstraintsinourmodels.Twotypesofserviceperformancewereconsidered:theaverageweighteddistancetocustomers,andtheamountofdemandwithinacertaindistancefromaDC.WecanspecifyboundsfortheseperformancemeasuresandincludethemintheMILP,toensurethattheoptimalsolutionmettheLOSrequirements.

ContinuoussinglefacilityproblemWithacontinuoussinglefacilitymodel,theaimistofindoneoptimalpointintheEuclidianspace.Centerofgravity.Withacenterofgravitymodel,welettheoptimalpoint’scoordinatesbegivenbyweightedxandycoordinates,wheretheweightgiventoeachnodekisgivenbythedemandinthatnode.Forinstance,ifwewanttofindtheoptimallocationforaDCthatwillsupport3stores,theoptimallocationwillbegivenbytheweightedcoordinatesofthestores,whereeachstore’scoordinatesareweightedbythedemandatthestore.

k kk K

k kk K

x w x

y w yÎ

Î

=

=

åå

Webermethod.WiththeWebermethod,insteadoftakingtheweightedcoordinatesofthenodes,wetrytominimizetheweightedEuclidiandistancesbetweennodeskandlocation(x,y).Theweightsarestillgivenbythedemandatthedifferentnodes.(Wherezisoptimizedbychangingthedecision-variablesxandy.)


( ) ( )2 2( , )k k k k kk K k KMin z w d x y w x x y y

Î Î= = - + -å å

NetworkfacilitylocationWhenwehaveanumberofcandidatelocationstochoosebetween,wecancreateanetworkflowmodeltofindwhichofthecandidatelocationsprovidethelowestcost.Todothis,weformulateaMixedIntegerLinearProgram(MILP).OurproblemisMILPbecauseithasalinearobjectivefunctionandlinearconstraints,butwithsomevariablesbeingintegersinsteadofcontinuous.TheintegervaluesaretheYi’sthatdescribewhetherfacilityiisused(Yi=1)ornot(Yi=0).Associatedwitheachfacilityisafixedcostforthetimeperiod,fi.Aswiththetransportationproblem,thenumberofunitsshippedbetweentwonodesaregivenbythexij’s.NotationMij:Anarbitrarylargenumber,specifictoeacharc(butthevaluecouldbethesamebetweenarcs)Pmin:MinimumnumberoffacilitiesPmax:Maximumnumberoffacilities.Withzbeingtheobjectivefunction,theproblemisformulatedasfollows:

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ij ij i

i MINi

i MAXi

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Y i

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Notethatforasinglefacilitylocationproblem,weletPMIN=PMAX=1.

MultiplelocationselectionmodelForthisweusethesameMILPasforthenetworkfacilitylocationproblemabove.Ifwehaveagivennumberoflocationswewanttochoose,weletPMIN=PMAX=k,wherekisthenumberoflocations.Ifweinsteadwanttofindtheoptimalnumberoflocations,weremovetheconstraintonthesumofY,sothatthissumcanbeinfinitelylarge(orlessthansomelargenumber).Note

Thesearethesupplyanddemandconstraints

Thesearethelinkingconstraints–toensurethatwedonotallocateshipmentstoalocationthatisnotused,theunitsshippedonanarcmustbelessthan(orequalto)alargenumbertimestheYassociatedwiththenodewherethetransportoriginatesTheseareconstraintsonthenumberoffacilitiestouse–thesumoftheY-variableswillbethetotalnumberoffacilitiesinuseThesearethenon-negativityconstraints(forx’s)andthebinaryconstraints(fortheY’s)


thatwewanttokeepaminimumconstraintonthesumofY,otherwisethemodelwillchooseallYi=0.

EnforcingLOSTocreateenforcingLOS,weusethesamebasicsetupasbefore,withthehighlightedaddition:

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Si =Available supply at DC i (units) ∀i ∈ SDj =Demand by Customer j (units) ∀j ∈ Dcij =Cost to serve Customer j from DC i ($/unit) ∀i, jfi = Fixed cost for opening DC i ($) ∀i ∈ SPMIN = Minimum number of DCs required to openPMAX = Maximum number of DCs allowed to openM = A really big number, but not too big!dij =Distance to Customer j from DC i (miles) ∀i, jaij =1 if Customer j to DC i ≤ 50 miles, =0 otherwise ∀i, jMaxAvgDist = Max allowable average distance DCs to CustomersMinPctIn50 = Min allowable demand within 50 miles of a DC


Notethattwoconstraintswereadded(highlighted).• Aconstraintontheaverageweighteddistance:Thisconstrainttakesthe(demand)-

weightedaveragedistanceandensuresthatitislessthanorequaltosomecriticallevelMaxAvgDist,themaximumallowedaverageweighteddistance.Consequently,themodelwillmakesurethattheaveragecustomerisnot“toofaraway”.

• Aconstraintontheamountofdemandwithinacertaindistance:Thepreviousconstraintconsidersonlytheaverage,whichmeansthatwedonotknowhowmuchofourdemandthathasanLOSbelowacertainthreshold.Forinstance,evenifweknowthattheaveragedistanceislessthan50miles,wemaybeinterestedinensuringthatatleast75%ofourdemandislessthan50milesfromaDC.Thisconstraintensuresthat.Forthisweneedtospecifyadistance(say50miles).Thebinaryvariableaijthendenoteswhetherornotacertainlinkisshorter(aij=1)than50milesornot(aij=0).Thatis,theconstraintensuresthatnot“toomany”customersarefaraway.

Itisalsoimportanttonotethatwhenweintroduceserviceconstraints,wemayneedtointroducebindingconstraintsonthedemand.Ifnot,themodelmaytrytoenforcetheserviceconstraintbydeliveringmorethandemandedtocertaindemandnodes.Thiswillhoweverbeartificial(andunsold)demand.Toensurethisisnotthecase,letthedemandconstraintbegivenbyequality,insteadofthecomputationallymoreefficientinequality.


SupplyChainNetworkDesignWenowcombinethedifferenttechniqueslearnedintoonemodel.Wetakenetworkoptimizationandcombineitwiththefacilitylocationmodelstogetherintowhat'sknownasasupplychainnetworkdesignmodel.

Datacollection:TransportationDataThefirststepinbuildingthemodelistocollectdata.Fortransports,wewanttoknowthecostsandcapacitiesassociatedwithbothinboundandoutboundtransportation.WiththeSupplyChainNetworkDesignModel,transportationcostsareassumedlinearintransportvolumes.Clearly,thisisnotalwaysthecase:theremaybeminimumcharges,fixedcosts,ormanyothertypesoffixedandvariablecostcomponents.However,inordertobuildthemodel,alinearapproximationmustbefound.Thiscouldbedoneinseveraldifferentways:

• Takeaveragetransportcostfromhistoricaldata• Uselistprices• Useregressionanalysistofindthecosts• Usebenchmarkratesfromothersources

Whicheverwayyouusetouncoverthesecosts,youneedtobeawareofhowyourlinearapproximationaffectsthereliabilityofthemodel.Forabrush-uponlinearregression,pleaserefertotheKeyConceptsdocumentfromSC1x.

Datacollection:FacilityDataTheSupplyChainNetworkDesignModelallowsfacilitycoststobebothfixedandvariableinvolume.Therewillalwaysbepeoplearguingthat“allcostsarefixed”or“allcostsarevariable”,butwhatyouneedtoconsiderishowfixedandvariablecostcomponentsaffectthesolutionyourmodelsearchesfor.Fixedcostswillmakeitexpensivetohavemanyfacilities,sothemodelwilltrytoreducethenumberoffacilities.Variablecostswillmakeitcostlytohavelongdistances,andthemodelwillthereforetrytoincreasethenumberoffacilities(oratleastreduceaveragedistances).Iffacilitiesareownedand/oroperatedbyathird-party,findingthefixedandvariablecostsisnormallystraight-forward–theyaregiveninthecontract.Ifafacilityisoperatedin-house,othertechniqueshavetobeused.Amongthem:

• Activity-basedcostingtofindvariablecosts• Regressionanalysisovervolume(notethattheinterceptisthefixedcostcomponent)

Forfacilitieswealsoneedtounderstandthecapacity.Thecapacityisthemaximumthroughputoveraspecifiedunitoftime(e.g.aweek).Notethatthiscanbeverydifficulttomeasureinpractice,sinceshiftscanbeadded,whilecapacityalsodependsonplanningandscheduling.


NetworkDesignBaselinesYoushouldbecarefulinwhichbaselineyouuseforcomparingyourresults.Threebaselinesareimportanttoconsider:

• Baseline1–Actualcosts:whatcostdoesthemodelgiveusifweusetheactual,currentflows?Wewanttoknowhowwellthemodelmatchesreality.Youusethisbaselinetocalibratethemodel.

• Baseline2–Adheretopolicy:theremaybeapolicyinplacethatyouaresimplynotadheringtoinyouroperations.Withthisbaselineyouwanttoknowhowothersolutionscomparetowhatyououghttobedoingaccordingtothepolicyinplace.

• Baseline3–OptimalDCassignment:ifyouweretousetheoptimalassignmentfortheDC–whatwouldthesolutionlooklike?WiththisbaselineyoucanisolatetheeffectofnumberofDCssinceyouoptimizeallocation.

Itisimportanttokeepinmindthatyoucomparedesignchangestotherightbaseline.Forinstance,ifyouusethemodeltofigureouthowmuchyoucouldreducecostsbyreducingthenumberofDCs,youneedtobeawarethemodelwilltellyouthiswhile,atthesametime,optimizingtheallocationgiventhenumberofDCs.Henceyoushouldcompareyoursolution-the“optimalnumberofDCsunderoptimalallocation”-toBaseline3,whereyouhavethe“currentnumberofDCsunderoptimalallocation”.Why?Becauseotherwiseyoucomparesolutionsthathaveoptimalallocationstosolutionsthatdonothaveoptimalallocations–youdonotisolatetheeffectofchangingthenumberofDCs.

RunScenariosOneofthekeybenefitsoftheSupplyChainNetworkDesignModelisthatitiseasyandfasttorundifferentscenarios.Scenarioscaninvestigateuncertainparameters(sensitivityanalysis)orexplorehowdifferentconstraintsaffecttheoptimalsolution.Whilethisisagreatbenefit,itisimportantnottoget“analysisparalysis”–justbecauseitispossibletorunmanyscenariosdoesnotmeanitisthewaytogo.Itisimportanttounderstandwhichscenariosthatarerelevantand,mostimportantly,howtointerprettheresults.Forinstance,whichbaselineshouldbeusedforcomparingtheresultsofthescenario?

AdvancedSupplyChainNetworkDesignTopicsTherearemanyadvancedsupplychainnetworkdesigntopicsandweintroduceseveralhere.Thefirstisrobustoptimizationusingsimulationalongwithoptimization.Thisisarelativelysimpleandquickwaytogetahandleontheimpactofthevariabilityofdemand(orotherfactors)onfacilityselection.Wealsocovermulti-commodityflowproblems,whichsignificantlyincreasesboththecomplexityandsizeofthemodels.Whilemorecomplicated,multi-commodityflowmodelsarestillverysimilartothetransshipmentandfacilitylocationmodelsexploredpreviously.TheconceptofFlexibilitywasintroducedfollowingtheapproach


developedbyJordanandGraves(1995).Formingchainsbetweenplantsincreasestheoverallflexibilityatamuchlowercostthanifweprovidedfullflexibility.Thefinalexpansionofthemodelcoversmultipletimeperiods.Thisismeantformoretacticalplanningperiods–butagain,themodelswereverysimilartothesimplersinglecommoditytransshipmentmodelswiththeadditionofinventorybalanceequations.Thefinalsectionreviewshowpipelineinventory,safetystock,andcyclestockcanbeincludedinstrategicnetworkdesignmodels.

Robustnessinsupplychainnetworkmodels–demanduncertaintySupplyChainNetworkDesign(SCND)modelsaredeterministic.Theyassumethateachinputvalueisknownwithcertaintyandexhibitsnovariability.Weknowthisisnotthecaseinreality.So,whiletherearemanymoresophisticatedmathematicaltechniquesthataddressthisshortcoming,wecanusesimpleMonte-Carlosimulationtotrytounderstandhowrobustoursolutionsare.Essentially,themethodinvolvesre-solvingthemodelwithnewinputinformationeachtime.Thenewinputdataisrandomlyselectedusingestimatesofthedistributionofthevariables.TheeasiestwaytosimulaterandomvariablesinspreadsheetsistousetheRAND()function.Itreturnsanumberbetween0and1.00followingauniformdistribution.

• TosimulateauniformdistributionwithmeanofX,plusorminusY%,wewouldsetthevalueto: =X*(1+(RAND()-0.50)*(2*Y))

Sothatifwewanted250+/-20%,we’duse=250*(1+(RAND()-0.50)*0.40)returningvaluesfrom~200to300.• TosimulateaNormalDistributionwithameanofXandastandarddeviationofY,we

woulduse: =NORM.INV(RAND(),X,Y)Soformeanof300withstandarddeviationof45we’duse=NORM.INV(RAND(),300,45)returningvalues~N(300,45).

Aftereachnewsimulationofinputvalues,themodelisrunandtheresultsarestored.Theanalysisoftheresultingrunscanhelpdeterminewhichfacilities,forexample,aremorelikelytostayopenunderavarietyofdemandoutcomes.Thisisnotanexhaustivemethod–simplyoneapproachtogaugetherobustnessofthedesign.

Multi-commodityflowsMulti-commodityflowmodelsintroducemultipleproducts.Eachproductwillhaveitsowndemand,supplyandothercharacteristics.Ifeachproductisindependentandtherearenointeractions,thenwecansimplymodeleachcommodityindividually.Wheneverthereisa


sharedresource(commoncapacityconstraint,forexample),thenamulti-commodityflowmodelisneeded.Theformulationisshownbelow.Theprimaryadditiontotheoriginalformulationistheadditionalsubscriptofkforthedifferentcommoditiesforthecosts,decisionvariables,demand,andsupply.Weadded,inthisformulation,twotypesofsupplycapacityconstraints:onethatislocation-commodityspecificandonethatislocationspecificforallcommoditiesthere.Thesearequitecommoninpractice.

SolvingtheMCFmodelsarethesameasthesinglecommoditymodels–theyaresimplylargerandmoredifficulttointerpret.Themultiplelayersofconstraintsmakethecalculationofindividualcostsdifficult–thisiscoveredinactivitybasedcostingandmanagerialaccounting.

ChainapproachtoflexibilitySCNDmodelsdonotconsidervariabilityofdemand.AMILPsolution,whileoptimal,canoftenbequitefragile.Thismeans,thatifanyoftheinputvalueschange,thetotalcostscouldchangedramatically.WemightwanttofindaSCNDthatismoreflexibleinitsabilitytohandlechangesindemand–inparticularsuddensurgesorpeaksindemandforcertainproductsorcommodities.Fullflexibilitycanbeachievedbyforcingeachplanttomanufactureeveryproduct.Thisprovidescompletedemandflexibilityascapacitycanbedivertedfromanyplanttohandlesurgesofacertainproduct.Thisisveryexpensive,however.Theoppositeextremeistocreatededicatedplantsthatonlymanufactureasingleproduct.Dedicatedplantsareabletoleverageeconomiesofscaleandtendtoincreasethelevelofexpertise,however,theyalsoincreaseriskexposureandlimitflexibilitytorespondtosurges.Acleverdesigncalledchainingallowsmanufacturingnetworkstoachievemostoftheflexibilityallowedinfullyflexibledesigns,butatafractionofthecost.

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Time-expandednetworksUptothispoint,eachmodelassumedasinglebucketoftime.Wehaveexpandedthisnowtoconsidermultipletimeperiods.Thisismorecommonwithtacticaltimeframe(weekstomonths)models.Tomodelmultipletimeperiodsweneedtointroducetheideaoftheinventorylevelatalocation,j,attimet,Ijt.Thisisthequantityavailableatlocationjattheendoftimet.Thisallowsustochargeaninventoryholdingcharge(h)foreachtimeperiod.Wealsoneedtoincludeaninventorybalanceconstraint–similartotheconservationofflowconstraintsintransshipmentmodels.Thisisthe3rdconstraintintheformulationbelow,whichstates,thesumofallflowintonodejduringtimet,minusthesumofallflowoutofnodejduringtimet,plustheinventoryavailableatnodejattheendoftimet-1,minustheinventoryavailableatnodejattheendoftimetiszero.

InventoryconsiderationsinsupplychainnetworkmodelsThusfar,inventoryhasnotbeenconsideredinthedesignofthesupplychains!Surprisingly,itisverycommontoignoreinventoryconsiderationswhendesigningasupplychain.Thisisduetoacoupledifferentreasons.First,inventorypoliciesarebasedonprobabilisticmodelsthatdonotcombinewellwithdeterministicMILPoptimizationmodels.Second,mostofthekeydeterminantsofinventorylevels(demandvariability,leadtime,servicelevel,ordersize,etc.)areonlyknowntacticallynotstrategically.Finally,inventorybalanceequations,whichwouldbeneededtomodelinventorycosts,cannotbeusedtotrackandoptimizestrategicinventorydecisionsthataremadeatyearlongincrements.Instead,weofferanapproachthatleveragesthenon-linearempiricalrelationshipbetweeninventoryandthroughput.Ithasbeenfoundthataverageinventoryforaspecifiedtimeperiodisequalto:αTβwhereTisthethroughputinitemsorvalue,andαandβareestimatedcoefficients.Theβparameteristypicallybetween0.5and0.8.Onecansimplyaddthisquantitytodifferentrunsasapost-hocanalysisorincorporateitintothemodelwithbinaryvariables.

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PracticalConsiderationsWhileSCNDproblemsarehighlymathematicalanddependonoptimization,themajorityoftheproblemsthatoccurinpracticehavenothingtodowiththeactualmodels!Itisusuallyaproblemwiththepeopleinvolved:theobjectiveswerenotagreeduponorclearlystated,thescopekeptchanging,thewrongproblemwassolved,etc.ItisimportanttorealizethatSCNDisjustoneprobleminalargersetofsupplychainproblemsthatneedtobesolved.Asshowninthefigurebelow,SCNDisastrategicdecisionthatisconductedwithmultipleyeartimehorizonsandhasaveryhighpotentialimpactonReturnonAssetsorInvestment.Thetransactionalandtactical/operationalproblemsareconductedmorefrequentlybuthavealowerpotentialimpact.Alloftheselowerlevelsolutionsshouldalignwiththeoverallsupplychainstrategyandnetworkdesign.

Source:ChainalyticsKnowThyProject–Itisimportantthatyouhaveasolidunderstandingofnotonlythephysicalsupplychain(sources,facilities,products,flows,etc.),butalsothepeopleinvolved.Youneedtoknowthestakeholdersbutalsotheultimatedecisionmakers.ThereisanexcellentarticleintheHarvardBusinessReviewcalled“WhohastheD?”thatdiscusseshowthedecisionmakingprocessinafirmcanbeimproved.Itisimportantthatyouknow“whohastheD”–thatis,theultimatedecision–foryourproject.Scopingmeetingswithallstakeholdersareverycriticalheretoestablishtheboundaries,objectives,andotherrulesoftheroadforalargeprojectlikeaSCND.FocusontheProblem-ThereisalwaystremendouspressureinaSCNDengagementfromthedifferentstakeholderstoexploreeveryexceptionandessentiallyboiltheoceantoexploreeverypossiblesolution.Thisisimpossibletodoinreality.So,youneedtoknowhowtoseparatetheimportantaspectsfromthetrivialusingsegmentationanddataaggregationasmuchaspossible.Identifyingthefewestpossiblenumberofproductstomodeliscritical–besuretothinkofsupplychaindistinctionsforproducts–notjustmarketingdistinctions.Manymanagers(andyourfuturestakeholders)willnotunderstandthatthemodelisacaricatureofthesupplychain,notahigh-definitionphotograph!Youhaveavarietyofdifferentanalysistoolsandtechniquestoaddressquestionsofvaryingimportance:fromlarge-scaleMILPmodels


toSideScenarioRunstoQuickHeuristicAnalysis.Usethemappropriately–ifeverythingisequallyimportant,thennothingisimportant!BeExperimental–Therearetwoaspectstothissuggestion:buildingthemodelandusingthemodel.WhenbuildingtheSCNDmodelitself,werecommendusingaspiralmethod(startsmall,testit,evaluate,adaptit,andrepeat)versusthetraditionalwaterfallmethod(collectallinput,developcompleterequirements,buildthefullmodel,testthecompletemodel,releasetousers).Bycreatingthemodeliterativelyyoubuildconfidenceinit,identifypotentialoutliers,keepstakeholdersengaged,andmightendupwithanearlyandunexpectedsolution.Whenrunningthemodelwerecommendyoutryasmanydifferentscenariosandoptionsaspossible.Thisiswhyyougothroughthepainofcreatingthesecomplexmodels!Runningmultiplescenariosallowsyouto:testandcostoutcompetingideasandstrategies,understandinternaltrade-offswithinthenetwork,uncoveropportunitiesforserendipitousdiscovery,andbettercommunicatewithstakeholders.SeparatetheMathfromtheDecision–Thefinalsuggestiondealswithunderstandingthevirtuesofamathematicalmodelversushumans.Mathematicalmodelsareexceptionallygoodatmakingtrade-offsbetweenaccuratelyquantifiedoptions.However,modelswillNEVERconsiderallfactorsandcannotfullyrepresentreality.Humansareneededtodeterminewhataspectsareimportantandtoprovidetheoptionsandinputforthemodeltoconsider.Also,becauseoptimizationmodelswilldoanythingforadollar(penny,euro,ruble,peso,oranyothercurrency)theresultsshouldbescrutinized.Theabsolutelowestcostsolutionisrarelytherightbusinesssolution.ThekeypointisthatmathematicalmodelsshouldbeusedforDecisionSupportnotfortheDecisionitself.Executivesandmanagershaveadditionalexperienceandinsightsintothelargerenvironmentthatneedtobeconsideredwhenmakinglargeandimportantdecisions,likesupplychainnetworkdesign.

LearningObjectives

• Introducenetworkmodels• Reviewhowformulatethetransportationproblemandthetransshipmentproblem• Learnhowtoformulatethecontinuoussinglefacilityproblem• Formulateandsolvenetworkfacilitylocationproblems(discretecandidateselection)• Usenetworkflowmodelstoevaluatethenumberoffacilitiesinanetwork• IncorporateLevel-Of-Service(LOS)constraintsinthenetworkmodels• IdentifyhowtocombinepreviousmodelstoaSupplyChainNetworkDesignModel• Constructrelevantbaselinesfortheanalysis• Performrobustoptimizationusingsupplynetworkmodels• Constructmulti-commodityflowmodels• Reviewhowtoexpandthemodelintoseveraltimeperiods• Understandwhentoincorporateinventorycostsintothenetworkmodels


• GainanappreciationandunderstandingofpracticalconsiderationswhenconductingSCNDengagements

References

• Watson,Michael,SaraLewis,PeterCacioppi,andJayJayaraman,SupplyChainNetworkDesign,1stEdition,FTPress,2013

• Chopra,SunilandPeterMeindl,SupplyChainManagement,Strategy,Planning,andOperation,5thedition,PearsonPrenticeHall,2012

• Ellet,Steve,ConversationsandPresentations,Chainalytics,2005-2015.• JordanandGraves(1995),“PrinciplesontheBenefitsofManufacturingProcess

Flexibility,”ManagementScience,41,(4),p577-594.• Rogers,PaulandMarciaBlenko,“WhoHastheD?:HowClearDecisionRolesEnhance

OrganizationalPerformance,”HarvardBusinessReview,January2006.• Shapiro,Jeremy.ModelingtheSupplyChain,2ndEdition,DuxburyAppliedSeries,2007.


ProductionPlanning

SummaryWenowreviewtheinformationflowwithinafirm,andthecoordinationandplanningofproduction.Whatisbeingcoordinated?Well,whatwewanttoachieveistomatchthedemandofourcustomerswiththesupplyfromourfirm,whichrequirescomponentsfromoursuppliers.Forthismatchtobepossible,informationaboutfuturedemandshouldbeusedforthecreatingofthemasterproductionschedule,whichisthenusedtodeterminethematerialsrequirements.

KeyConcepts

FixedPlanningHorizon

MasterProductionSchedule(MPS)TheMPSisthebasiccommunicationbetweenthemarketandmanufacturing.Itisastatementofproduction–notdemand.Itisaplantomeettheforecasteddemand,notaforecastofdemand.ThereareseveralmanufacturingorproductionstrategiesthatdeterminewhattheMPScanlooklike:

• Levelproductionstrategy.Thisisastrategyaimingatevenproductionlevelsovertime.Themajorbenefitisasmoothandstableoperationswhichreducesswitchingcostsandminimizestheneedforoutsourcing,overtime,orotherflexibilitymeasures.Thedownsideisthatisleadstoheavyinventorybuild-upwhendemandislow,andpossibleshortagewhendemandishigh.

• Chasedemandstrategy.Withthisstrategytheaimistoletproductionquantitiesfollow

demandascloselyaspossible,sothatmoreisproducedintimesofhighdemandandviceversa.Thebenefitofthisisthatinventoryiskeptataminimum,andsoisobsolescence.Ontheotherhand,ittendstoleadtolargeswingsinproductionquantitiesandlaborneeds.

• t=Pt=Ft

• Hybridstrategy.Ahybridstrategytriestocombinethebenefitsofthelevelproductionstrategyandthechasedemandstrategy,bybalancingthecostsassociatedwiththestrategies.Thiscanbedoneinseveralways.Belowwereportinmoredetailhowthisishandledwhenthereisafixedplanninghorizon.


Fixedplanninghorizon(FPH)problemTheFPHproblemconsiderstheproblemoffindingthelowestcostproductionplanoverafixedhorizonwithmultipletimeperiods.Demandisconsidereddeterministicbutcanvarybetweenperiods.

ThereareseveralwaystosolvetheFPHproblem:Simpleheuristics.Thesearesimpledecisionrules,forinstancethatyourunonlyoneproductionrun(Onetimerunheuristic),thatyouproduceineveryperiodexactlywhatisdemanded(lotforlot),orthatyouproduceeitherafixed“optimal”quantityoraccordingtofixed“optimal”intervals.Theseheuristicsaresimplemakingdecision-makingfast,althoughtheresultsarenotnecessarilyparticularlygood.Specializedheuristics.ThereareseveralmoresophisticatedheuristicdevelopedfortheFHP,includingtheSilver-Meal(SM)heuristic,theleastunitcostheuristicandthepart-periodbalancingheuristic.InthiscoursewefocusontheSMheuristic.Thisheuristicsearchesthroughtheperiodstofindthelowestcostperperiod.Iffirsttestsifitislesscostlyperperiodtoproducenextperiod’sdemandinthisperiod.Ifitis,itseesifitalsolesscostlytoincludetheperiodafternextperiodinthisperiod’sproduction.Itcontinuesthisprocessuntilthecostperperiodincreases.Whenitdoes,sayinperiodk,itstartsoverbyconsideringproductioninperiodk,andseesifcostperiodisreducedbyincludingalsothedemandfromk+1intheproductionofperiodk.Itcontinueslikethisuntiltheendofthehorizon.Whilemoresophisticated,itisnotguaranteedtofindaverygoodsolution.


Optimalmethods.TheWagner-Whitinalgorithmprovidestheoptimalsolutionbyrelyingondynamicprogramming.Thisisanefficientmethodforlargeproblems.Forsmallerproblems,aspreadsheetMILPmodelisaquickwaytofindtheoptimalsolution.(seefurtherbelow)Insummary-therearemanymethodsavailable.Heuristicsarefastandeasytoimplement,butarenotalwaysgoodinthesensethattheyprovideanear-optimalsolution.Specialtyheuristicsaremoresophisticated,abithardertosetup,buttendtoprovidebetter“real-world’results.Optimalmethodsrequiremoretimeanddata,allowforseveralconstraintsandgivetheoptimalsolutions.However,keepinmindthattheinformationfedintothemodelisoftennotexact.

ApproachesforSolvingtheFPHProblemSimpleHeuristicsOneTimeRun–ManufactureallinonerunforthatmonthExample:

LotforLot(Chase)–EachmonthmanufactureproductforecastedforthatmonthExample:


FixedEOQ(FOQ)–OrderQ*ifFt>IOH(QisStable,Tvaries)Example:

ReviewofEOQTheEconomicOrderQuantityorEOQisthemost influentialandwidelyused(andsometimesmisused!)inventorymodelinexistence.Whileverysimple,itprovidesdeepandusefulinsights.Essentially, theEOQ isa trade-offbetween fixed (ordering)andvariable (holding)costs. It isoftencalledLot-Sizingaswell.TheminimumoftheTotalCostequationistheEOQorQ*.TheInventoryReplenishmentPolicybecomes “OrderQ*everyT* timeperiods”whichunderourassumptionsisthesameas“OrderQ*whenInventoryPosition(IP)=0”.

EOQModel• Assumptions

o Demandisuniformanddeterministic.o Leadtimeisinstantaneous(0)–althoughthisisnotrestrictiveatallsince

theleadtime,L,doesnotinfluencetheOrderSize,Q.o Totalamountorderedisreceived.

• InventoryReplenishmentPolicyo OrderQ*unitseveryT*timeperiods.o OrderQ*unitswheninventoryonhand(IOH)iszero.

• Essentially, the Q* is the Cycle Stock for each replenishment cycle. It is theexpecteddemandforthatamountoftimebetweenorderdeliveries.

Notationct: OrderingCosts($/order)ce: ExcessholdingCosts($/unit/time)D: Demand(units/time)Q*: OptimalOrderQuantityunderEOQ(units/order)T: OrderCycleTime(time/order)T*: OptimalTimebetweenReplenishments(time/order)


OptimalOrderQuantity(Q*)RecallthatthisistheFirstOrderconditionoftheTRCequation–whereitisaglobalminimum.

𝑄∗ =2𝑐&𝐷𝑐(

OptimalTimebetweenReplenishmentsRecallthatT*=Q*/D.Thatis,thetimebetweenordersistheoptimalordersizedividedbytheannualdemand.Similarly,thenumberofreplenishmentsperyearissimplyN*=1/T*=D/Q*.PluggingintheactualQ*givesyoutheformulabelow.

𝑇∗ =2𝑐&𝐷𝑐(

PeriodicOrderQuantity(POQ)–ordersumofforecastsevery~T*periods(Tisstable,Qvaries)

Example:

ProductionplanningMILPTheFPHcanbesetupasaMILPproblem,similartotheproblemsdiscussedinthefirstthreeweeksaswellaslastweek.WithaMILPformulation,theobjectiveistominimizethetotalcosts,whichconsistofsetupcostsforeveryproductionrun/batch,andholdingcostsfromfinishedgoodsinventory.Indexdenotestimeperiod.WeletZtbeabinarydecisionvariableindicatingproductioninperiodt,andQtbethedecisionvariabledeterminingproductionquantityinperiodt.Wethushavethat


wherecsetupisthesetupcost,histheholdingcostperunitandtimeperiod,Itisinventorylevelattheendofperiodt,Dtisthe(forecasted)demandinperiodt,Misalargenumber,andCAPtistheproductioncapacityinperiodt.Intheaboveformulation,theinitialinventoryiszero.Asbefore,wehaveaconservationofflowconstraintaswellasalinkingconstraint.Theconservationofflowstatesthatthedifferenceininventorybetweentheendandthestartoftheperiodmustbeequaltothedifferencebetweendemandandproductionquantityinthatperiod.ThelinkingconstraintforcesQtobezeroifZiszerointhesameperiod.

MaterialandDistributionRequirementsPlanning

AvailabletoPromise(ATP)Theportionofexistinginventoryand/orplannedproductionthatisnotcommittedorconsumedisconsideredtobeAvailabletoPromise.Thismeansthattheseunitscanstillbesoldtocustomers.Therearetwoslightlydifferentwaystocalculatethis:

• Discrete–meaningthateachproductioncycleisplanningindependently.Inventoryfromoneproductionrunisnotcarriedovertothenextrun.

• Cumulative–meaningthatinventoryiscarriedoverbetweenperiods.Thatis,inventoryfromthefirstproductionrunwhichisunsoldatthestartofthesecondproductionruncanstillbesoldduringandafterthesecondproductionrun.

TimeFencingisoftenusedtostabilizeproductionplanning(demandandplanning)

• ift<Demand_FencethenuseonlycommittedordersforMPS • ifDemand_Fence<t<Planning_FencethenlimitedMPSoverrides • ift>Planning_FencethenallMPSchangesallowed(withinlimits)

MaterialsRequirementsPlanning(MRP)

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MaterialRequirementsPlanning(MRP)systemsensurethatallcomponentsandpartsrequiredforanenditemareonhandwhenneeded.Thesesystemsareintendedtoanswerquestionsaboutwhatshouldbeorderedormanufactured,howmuch,andwhen.ThesequestionsareansweredbyfeedingtheMRPwiththeMPS,inventoryrecords,andtheBillofMaterials(seebelow).

• BenefitsofMRPo Leadstolowerinventorylevelso Fewerstockoutso Lessexpeditingo Fewerproductiondisruptions

• LimitationsofMRPo Scheduling,notastockage,algorithmo Doesnotaddresshowtodeterminelotsizeo Doesnotinherentlydealwithuncertaintyo Assumesconstant,knownleadtimeso Doesnotprovideincentivesforimprovement

BillofMaterials(BOM)TheBillofmaterials(BOM)showswhichparts,subassemblies,andcomponentsthatmakeupagivenproducttobeproduced.Forillustrativepurposes,theBOMcanbeshownasatree-diagram,withthecompletedproductatthetop,andallpartsandcomponentsbeingtheroots.Oneexampleforabicycleisshownbelow.

MRPcoordinationTherearedifferentwaytocoordinatetheMRPbetweenafirmandits(independent)suppliers.Inthislessonwewentthroughthreedifferentapproaches:

• SimpleMRPrules.Thismeansusingsimplerulesalsoforcoordinationwiththesupplier.Forinstance,ifthereisaleadtimeofxweekstogetacomponentfromthesupplier,orderreleaseisscheduledxweeksbeforetheunitsareneededfortheassemblyatthefirm.Thesupplierusesthisasthedemandinputforitsownproductionplanning.

• Sequentialoptimization.Withthisapproach,thefirmoptimizeshisproductionfirst,and

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thenfeedstherequirementstothesupplierwhooptimizeshisproduction.• Simultaneousoptimization.Withthisapproach,thefirmandthesupplier’sproduction

isoptimizedsimultaneously.Thismeansthatfirm’sorthesuppliers’costsmayincrease,whiletotalcostswilldecrease.

DistributionRequirementsPlanning(DRP)DRPcanbethoughtofastheapplicationoftheMRPprinciplestodistributioninventories.Itisusedforinventorycontrolinadistributionenvironmentwithmanyproducts,manystockagelocations,andmultipleechelons.Inpractice,itisanalgorithmforschedulingandstocking,however,itdoesnotdeterminelotsizeorsafetystock.

LearningObjectives• Identifyhowcoordinatetheinternalinformationflowofafirm• Learnhowtousedemandinformationtocreatethemasterproductionschedule(MPS)• Howtosolvethefixedplanninghorizonproblem(FPH)usingseveraldifferent

algorithms• Determineavailabletopromise(ATP)• Understandhowmaterialrequirementsplanning(MRP)anddistributionrequirements

planning(DRP)work• Understandthebillofmaterials(BOM)• UnderstandbenefitsandlimitationsofMRPandDRP

ReferencesJacobs,F.R.,Berry,W.L.,Whybark,D.C.,Vollman,T.E.(2011).Manufacturingplanningandcontrolforsupplychainmanagement.McGraw-Hill.


ConnectingSalestoOperations

SummaryWereviewhowtheSales&OperationsPlanning(S&OP)processwithinafirmcanbeusedfindtherightbalancebetweenoperationalcapacityanddemand.Theaggregateplanningmodelallowsafirmtosetvariousoperationalandsalesleversinordertodeterminethebesttrade-offstomaketomaximizeprofitability.Theprimaryleversontheoperationalsideare:workforce,outsourcedproduction,inventory,internalproductionlevels,backlogs,andovertimehours.Theremightbemoreleversforspecificsituations,ofcourse.Onthedemandside,wediscussedhowsaleschangesandpromotionscanbeusedtoshapedemandandhowtheaggregateplanningmodelcanhelpdeterminetheoperationalimpact.Theoptimizationmodelcanalsobeusedtotestoutdifferentstrategiesandpotentialpolicies.

KeyConcepts

AggregatePlanningModelTheaggregateplanningmodelisusedtoplanforthemid-term3-18monthtimeframe.Ittakesasinputtheproposeddemandaswellasstartinginventory,workforce,andcostsfordifferentoptions.Thelongerhorizonplanninginvolvesmorestrategicdecisions–suchasnetworkdesignetc.–whiletheclosertimeframeisplannedusingtheMasterProductionSchedule.TheplanningunitfortheaggregateplanningmodelistypicallynottheindividualSKU,butratherafamilyorrelatedSKUsorgeneralflowunit–suchastons,orcompositeunits.ThemodelisusedtofindthebestmixofProduction,Inventory,Workforce,Outsourcing,andCapacityLevelsinordertomaximizethefirm’sprofitoverthe3-18monthplanninghorizongiventheforecasteddemandovertheplanninghorizonbychanging:

• ProductionRate–howmuchproduceeachmonth• Workforce–howmanyemployeestohireorlayoffeachmonth• Overtime–howmanyovertimehourstoplanforeachmonth• Machinecapacity–howmuchcapacityshouldbeallocatedtoproductionlineseach

month• Outsourcing–howmanyitemstoproduceusingcontractoroutsourcedmanufacturing

eachmonth• Backlog–howmanyunitseachmonthshouldweallowtobebacklogged• Inventoryonhand–howmuchinventoryshouldweplanonholdingeachmonth• Pricing–howshouldtheproductpricingbechanged(promotions,discountsetc)each

month

Theoutputfromtheaggregateplanningmodelisessentiallytheproduction(andpricing)plan.Twobasicstrategiesthatcanbeimplementedare:ChaseandLevel.Thechasestrategyimplies


thatproductionismadeasclosetothepointofdemandaspossible.Thisleadstolowinventorycostsbutgenerallyhigherproduction(overtime,workforce,outsourcing)costsneededtoadjusttheproductiontomeetdemandpeaks.Thelevelstrategyattemptstokeeptheproductionlevelfortheentiretimeperiodandlettheinventorybuilduptocoveranydemandpeaks.Thehybridstrategythatcombinesthesetwoextremesolutionsisgenerallyused.

ModelFormulation

Decisionvariables

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InputData:

AggregatePlanningModelLeversTheaggregateplanningmodelismainlyusedtodeterminethebestmixorbothoperationalandsalesbasedstrategies.Theoperationalleverscontrolthesupplywhilethesalesleversinfluencethedemand.Ontheoperationalside,wecanmanageSupplybycontrollinginventory(CommonComponentsandPre-buildInventory)and/orcapacity(WorkforceFlexibility,SeasonalWorkforce,Outsourcingproduction,orProductFlexibility).ManagingDemandisalittlelessdirect.Theobjectivesonthedemandsideareto(1)GrowMarket,(2)StealMarketSharefromcompetitors,or(3)ShiftBuyingPatternsofthecustomers.Theleversavailableare:

• Pricing–incentives(discounts,MOQ’s,etc.),• Advertising–increasingbrandawareness,and• Promotions–pricereductionovershortperiodoftime.

DemandElasticityTheconceptofDemandelasticitywithrespecttopriceisusefulindetermininghowachangeinpricewillimpactthedemand.

son)(hours/permonth per employeeper allowed overtime of hours Maximumson)(hours/permonth per can work employeeeach hours ofNumber

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MonthlySales&OperationsPlanningProcessTherearemanyflavorsofS&OPoutthere.Mostfeatureasetofstructuredmeetingswherespecifictasksareperformedbydifferentfunctionswithinthefirmandeventuallyarepresentedwithrecommendationstoseniorleadershiptomakeafinaldecision.Wedescribedafive-stepprocessasfollows:Step1:DataGathering–thecoredataonthemostrecentmonth’sdemand,inventory,productionlevels,sales,etc.isgathered,cleaned,andmadereadytodistribute.Thisshouldbeaccomplishedinthefirstfewdaysofanewmonth.Step2:DemandPlanning–Thedemandplanningteamfromthesales/marketingorganizationdevelopstheinitialsetofforecasts.Theseincludetheirexpertopinionsonmodificationstoanynumericforecaststhatweremade.Step3:SupplyPlanning–Thesupplyplanning/operationsteamreceivestheinitialforecastandthemostrecentsetofdataanddeveloparesourceplantomeettheproposeddemandforecast.Anyconflictsorrestrictionsarenoted.Step4:Pre-Meeting–Thesupplyanddemandplansarebroughttogetherandcompared.Thislargergroupmakessuggestionsandrecommendations.Anyconflictsthatcannotbesolvedatthislevelareidentified.Step5:ExecutiveMeeting–Theseniorteammakesdecisionsonanyoutstandingconflicts–theyhaveagonogodecisionauthority.

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DistributionandChannelStrategiesInthislessonwecoverdistributionandchannelstrategies.ADistributionChannelisthepathbywhichallgoodsandservicestravelfromtheoriginalvendortotheendconsumerandthepathwaythatpaymentsmakefromtheendconsumertotheoriginalvendor.Wedivdedeeperintothistopicbyexploringe-commerceandomni-channelstrategiesandomni-channelnetworkdesign.Weconcludewithadiscussionofreverselogisticsandreverselogisticsnetworkdesign.Therearefourtypesofplayersindistributionchannelsthatincludemanufacturer,wholesaler/distributor,retailer,andconsumer:

• Manufacturer:MakesProducts• Wholesaler/Distributor:Traditionalmiddleman.Purchasesproductsinlargequantities,

consolidates,assembles,andresellstoretailers&others.• Retailer:Sellsgooddirectlytotheconsumer• Consumer:Personwhobuystheproduct

Thedifferenttypesofdistributionchannelsincludewholesalerchannel,directtoretailer,anddirecttoconsumer(seefigurebelow).ChannelTypes


DistributionChannelStrategiesToaddressthedifferentdistributionchanneltypes,therearevariousstrategiesthataddressneedsofthebusinessandtheactorspresentinthechanneltoensureanefficientflow.Typesofstrategiesincludethetraditionalretailmulti-echelon,mix/consolidationcenter,distributor/wholesaler,directtostoredelivery,anddropshipfrommanufacturer(seefigurebelow).Wefurtherarticulatethesestrategiesbelowbydescribingtheproductflowandthepros/consofeach.

TraditionalMulti-TieredDistributionProductFlow

• Retailerplacesorderstoeachmanufacturer,• ProductflowsfrommanufacturertoretailDCs,• RetailDCsreceiveproductfrommultiplevendors,• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.

Pros/Cons• Flowleveragesretailereconomiesofscalebutwithlotsofhandling• Ontheinbound,DCsneedtobeabletojustifyfullloadsfromvendors• Ontheoutbound,DCsareabletomixproductfrommultiplesources• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodforfastmovingitems• Shortertransittimesfromvendorstostores

MixingCenters/HubsProductFlowRetailerplacesorderstoeachmanufacturer,

• ProductflowsfrommanufacturertoMixingCenter,• No(orverylittle)inventoryisheldattheMixingCenters–In-transitMerge,• RetailDCsreceivefullTLofgoodsfrommultiplemanufacturersfromtheMixingCenter,


• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.

Pros/Cons

• Flowleveragesretailereconomiesofscalewithlotsofhandling• OnbothIBandOB,DCsareabletomixproductfrommultiplesources• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodforslowermovingitems• Longertransittimesfromvendorstostores

DistributorsProductFlow

• Retailerplacesorderstodistributor,• Productflowsfrommanufacturertodistributor,• Inventoryisheldbythedistributor,• RetailDCsreceivefullTLofgoodsfrommultiplemanufacturersfromthedistributor,• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.

Pros/Cons• Flowleveragesthedistributor’seconomicswithlotsofhandling• OnbothIBandOB,DCsareabletomixproductfrommultiplevendors• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodformuchslowermovingitems• Muchlongertransittimesfromvendorstostores• Highercostdueto3rdpartyinvolvement

DirecttoStoreDeliveryProductFlow

• Retailerplacesorderstoeachmanufacturer,• ProductflowsfrommanufacturerdirectlytotheretailstoresbypassingtheDCs,• Vendoroftenmerchandises,orders,andmanagestheretailer’sshelf,• Consumers/Customersview,select,receive,andpayforgoodsatstore.

Pros/Cons• Flowleveragesthevendor’seconomics• BypassingtheretailDCreducescongestion• Vendorcantakeoverordering,merchandising,etc.• Canleadtocongestionandaddedcostsattheretailstores• Lossofcontrolofproductflowandavailabilitybytheretailer• Usedforselectitems(beverages,newspapers,snackfoods)


DropShiptoCustomerProductFlow

• ConsumerordersfromRetailer,• RetailerpassesordertoManufacturer,• Manufacturersendsproductdirectlytoconsumer.• ManufacturerandRetailercouldbesamefirm.

Pros/Cons• Veryslowresponsetimetoconsumer• Verystrongproductavailabilitywhilekeepinginventorylevelslow• BypassingretailDCandstorereducescongestion• Transportationcostcanbehigh–smallshipmentsizetoconsumer• Allowsforhighlevelofcustomization• Consumerplacesorder–triggerspulloperation

Distributionchannelstrategiesarenotmutuallyexclusive.Mostfirmsusemultiplechannelsforproducts.Selectionofthestrategyisbasedonseveralneedsincluding:velocity(demand)oftheproduct;desiredresponsetimetoconsumers;physicalandothercharacteristicsofproducts,supplier,andcustomers;andvalueofproducts.

Omni-ChannelDistributionFromaround1995to2000atitsearlieststage,e-commercewaslargelymadeupof“pureplayers”.Thesemadeupoffirmsthatallowedcustomerstobuygoodsandservicesovertheinternetusingawebsite(ebayorAmazon).Thesefirmsalsodidnothaveaphysicalpresence.Thisbeganearlydiscussionsthatmaybetraditionalstoresmightbeunnecessaryinthefuture.Around2000–2010,multi-channelbecamethenextwave.Inthiscase,firmsusemultipleonlineandtraditionaldistributionchannels.Inmostcases,traditionalandonlinechanneloperationswerekeptseparateanddistinct;referredtoas“BricksandClicks”.Thiscausedinefficienciesintraditionaldistributionchannelstrategies.Withthereleaseofthesmartphonearound2007andconsumerabilityusetheinternetonthephone,e-commercegrewatafasterraterthaneverbefore,andwiththatadesireforeaseofaccessacrossonlineandbrickandmortarpurchaseandreturns.Asof2010on,thenewpathforwardformanyfirmshasbeenOmni-Channel.Thisismulti-channelretailingstrategywherefirmsprovideaseamlessretailingexperiencethroughallavailableshoppingchannels(online&offline).Operationsaremixedbetweenchallengesandconsumershavemultipleoptionsforresearching,ordering,receiving,paying,and/orreturningproducts.RetailPerspective:Wheretopreparetheorders?

• DistributionCentervs.FulfillmentCentervs.Store• Tradingoffdistancevsefficiencyvs.effectiveness• Changesinpackagingrequirementsandusability• Adaptingworkforce,facilities,andsystemstonewtasks


• Maintaininginventoryvisibilityacrossthechannels&facilitiesWhereandhowdoestheordermeetthecustomer?

• Storesvs.Homevs.3rdPartylocations(work,lockers,gasstation)• Attendedvs.UnattendedDelivery• Ownfleetvs.Parcelvs.Crowdsourcingvs.Mobilelockers

Howtohandlereturns?• Productreturns~30%foronlinevs.8%fortraditional• Atlocationofpurchasevs.Droppointsvs.Everywhere• Allowablereasons:Damaged,Wrongsize/color/style,etc.

Omni-ChannelNetworkDesignAnomni-channelretailingexperiencerequiresflexibledeliverynetworks.Omni,meansin“allplaces”,“allways”,“withoutlimits”.Omni-channelstrategiesaffectordering,fulfillmentandreturns.AnOmniChannelNetworkDesignmodelformulationisillustratedinthefigurebelow.


ReverseSupplyChains(ReverseLogistics)Reversesupplychainisalloperationsrelatedtothereuseofproductsandmaterials.Itinvolvescollectingitemsattheir“endoflife”forcapturingvalueorproperdisposal.Reversesupplychainsaremosteffectiveforreusableitems.Reusableitems:DurableproductsintendedtobeusedmultipletimesbydifferentusersindifferentlocationsofasupplychainnetworkReversesupplychainsarebecominganincreasingfocusforconsumersandcompaniesalikebecause:Increasingamountofwastegenerated:

• Over300,000cellphonesdisposeddailyinUnitedStates• EachEUcitizenproduces17-20kgoftechnologicalwasteperyear

Manymodernproductscontaininghazardousmaterials:• Electronicdevicescontainlead,cadmium,mercury…

Manyproductshaveshrinkingproductlifecycles:• Lifecycleofcellphonesis18months;laptops24months,etc.

Thereareareemergingregulations:• Insomeregions,producersareresponsiblefortheenvironmentallysafedisposalof

products.ExtendedProducerResponsibility(EPR)• EndoflifewasteframeworkdirectivesintheEUforbatteries,vehicles,tires,etc.

ProductRecoveryOptionsTherearedifferenttypesofproductrecoveroptions.Seefigurebelowthatbuildsoutthetraditionalsupplychainwithrecoveryoptionsateachphaseofthesupplychain.


Therearedifferentformsofreversesupplychainsbasedonconditionofthematerial:DirectReuseorResale:ThisincludesbothReusableArticles(containers,totes,pallets,books,etc.)andnormal(non-reusable)products.ReusableArticlesareinspectedand,ifneeded,sterilized/cleaned/preparedforredeploymentwithinfirmoracrossnetwork.Non-reusableProductsareinspectedanddeemedreadyforre-useorresaletoothercustomerswithoutanyrepairorrefurbishing.e.g.,Wrongsize/color/styleapparelRepair:Usedproductsreturnedtoworkingorder.Typicallyinvolvesfixingand/orreplacingbrokenparts.e.g.,computers,phones,electronicdevices.Refurbish:Usedproductsbroughtuptospecifiedqualitylevel.Criticalmodulesareinspectedandfixedorreplaced.Sometimesincludestechnologyupgrading.e.g.,aircraftRemanufacture:Usedproductsbroughtuptoqualitystandardsasrigorousasnewproducts.Completedisassembly,inspection,andpart/modulereplacementasneeded.e.g.,automotiveenginesCannibalization:Thereturnedproductisusedtorecoveralimitedsetofreusablepartsandcomponentsforuseinotherproducts.Onlyasmallproportionoftheusedproductistypicallyreused.Theremainingpartsarerecycledordisposedof.e.g.,integratedcircuitsfromcomputers.Recycling:Materialsfromusedproductsandcomponentsareprocessedandcanbereusedinproductionoforiginalorotherparts.e.g.,metals,paperandcardboards,plastics,etc.


DifferencesBetweenForwardandReverseLogisticsThefollowingfigureillustratesthedifferencesbetweenforwardandreverselogistics.Itillustratesthatreverselogisticscanbeconsiderablychangedduetoinconsistency,non-uniformity,anduncertaintyembeddedinreversesupplychains.

NetworkDesignThefollowingnetworkdesignexampleillustratesaMILPforreverselogistics.


LearningObjectives• UnderstandthefundamentalconceptsofSales&OperationsPlanninginbalancing

supplyanddemand• Formulateandsolveanaggregateplanningmodel• Understandtrade-offsandleversavailableformakingaggregateplanningdecisions• Appreciationforthetrade-offsthatcanbemadebetweensalesandoperationsinterms

ofsupplyversusdemandandvolumeversusproductmix• Understandwhatdistributionschannelsareandwhotheplayersare.• Reviewflowpathsforproductsthatareafunctionofsuppliers,customerandproduct• IntroductiontoOmni-Channelandhowitisimpactingthesupplychain.• Understandtheimportantofreverselogisticslogistics.• Recognizethevarietyofrecoveryoptions.• Reviewnetworkdesignforreverselogistics.


References• "Sales&operationsplanning:thehow-tohandbook"ThomasF.WallaceandRobertA.

Stahl.,2008,T.F.Wallace&Co.,Cincinnati,Ohio• "Salesandoperationsplanning-bestpractices:lessonslearnedfromworldwide

companies"JohnR.DoughertyandChristopherD.Gray.,2006,PartnersforExcellence,Belmont,N.H.

• "Manufacturingplanningandcontrolforsupplychainmanagement"F.RobertJacobs,WilliamBerry,D.ClayWhybark,ThomasVollmann2011,McGraw-Hill,NewYork


SupplyChainSourcing

SummarySourcingisanimportantpartofasuccessfulsupplychain;itoftenhelpsabusinessmaintainacompetitiveedge.Effectivesourcingkeepsthecostsdown,whileprovidingqualitygoodsandservicesontimeandefficiently.Sourcingisdrivenlargelybytherelationshipbetweenthebuyerandsupplier.Wereviewsomeofthemaincomponentsofsupplychainsourcing.

ProcurementStrategyTofurtherourdiscussiononSupplyChainSourcing,wereviewthebasicsofprocurementandsourcing-whicharetheprocessesforbuyingthematerialsandservicesneededforthecompanytoconductitsbusiness.

ThePriceIcebergWhilemanypurchasersfocusonthepriceofacomponentorrawmaterial,thisisonlypartofthetotalcostofthepurchase.Thisisillustratedbythe“priceIceberg”–whilewetendtoonlyseethepricepaidupfront,therearemanyaspectsthatdeterminethetotalcosttoourbusinessofmakingthepurchase.

ValueandRiskMapping(risk-spendframework)Onewaytodifferentiatethepurchasingportfolioisbyconsideringwhereanitemfallsalongtwodimensions:1)thesupplyriskand,2)theannualspend(orprofitimpactonbusiness).Basedonthis,atwo-by-twomatrixcanbecreatedtodescribeallitems:

Price

Delivery Delays

Handling Defects

Inspection

Consumables Training Service

Handling

CSR risks

Financial stability


Foreachquadrant,differenttypesofprocurementstrategiesaresuitable.

TheSourcingProcessOnagenerallevel,thesourcingprocessconsistofthefollowingsteps:

• Internalassessment.Thisistoconfirmcategorydefinition,validatebaselineinformationandunderstandthekeyconstituents.Thatis,focusisontheownbusiness.

• Marketassessment.Thisistoanalyzemarketdynamicsandidentifywhichpotentialsuppliersthatmaybeofinterest.Italsoincludesunderstandingwhatcompetitorsdo.

• Collectsupplierinformation.Inthisstepinformationiscollectedtounderstandwhichcriteriatouseintheprocessaswellastounderstandcurrentspend.

• Sourcingstrategy.Aftertheinitialassessments,thesourcingstrategyisdeveloped.Thisspecifiestheapproach,thespecifications,andhowtoapproachthesubsequentsteps.

• Biddingprocess.Inthebiddingprocess,RFPsaredevelopedandsentout.Thebuyingfirmdecidesonabiddingformatandshort-listsuppliers.

$$$

Risk/Impact

High

Low

High Low

Tactical

Critical

Leverage

Strategic

Common items Generics

Potential problems

Competitive advantage

$$$

Risk/Impact

High

Low

High

Low

Tactical

Critical

Leverage

• Streamline acquisition process

• Reduce activity• Minimize # of

transactions• VMI

• Reduce risk• Eliminate• Substitute• Simplify

• Strategic alliances• Shared cost

reductions• Partnerships• Limited active

sourcing• Supplier development• Maximize leverage• Standardization• Consolidated volumes• Reduce transaction costs• Global sourcing• Active sourcing

Strategic


• Negotiate,select.Afterthebiddingprocessisover,thebuyingfirmnegotiateswithselectedshort-listedsuppliers.Thisstependswithaselection.

• ContractImplement.Thisinvolvesdevelopingcategoryimplementationplan,communicationsplanaswellasmeasurementsandauditplans.

Thereisalsoafeedbackloop,consistingof• Measureandreport• Capturelessons• Ensurecompliance

Value-BasedSourcingValuebasedsourcingisthenamegiventothepracticeofgoingbeyondthepurchasepriceinaprocurementevent.Forinstance,insteadoffocusingonprice,focusisonvalue;insteadoffocusingontotalcostofownership,focusisontotalcontribution.

FinancialHedgingThereareprimarilythreewaystohedgefinanciallywhenbuyingmaterialswithhighpricevolatility:

• Simplehedge:Negotiatelongterm,fixedpricecontractinthecompany’spreferredcurrency

• Forwardcontract:buy/sellthecommodityorarelatedoneforfuturedeliveryonagivendateatagivenprice

• Option:acall/putoptionistherighttobuy/sellatacertainpriceatacertainfuturedate

PhysicalHedgingApartfromfinancialhedging,afirmcanusephysicalhedgingtohandlevolatility.Createconditionsinwhichthefluctuationsaremitigated“naturally.”(usedmainlyforcurrencyhedging)Examples:

• Buildaplantincountrieswherelaborratesandcurrencyarenotexpectedtoappreciate• Manufactureandsellinthesamecountry• Actuallybuyacommoditywhenthepriceislow

CapitalGoodsPurchasingSourcingofcapitalgoodsgobeyondstandardpurchasinginseveralways.First,onemustfocusmuchmoreonthetotallifecycleofthegood.Onemustalsomoreexplicitlyconsidertheexpectedvalueofthegoodattheendofitsusefullife.Further,aspectssuchastraining,trials,andsubsidiesmayhavealargeimpactonthetotalcostofthegood.Thelifetimecostofcapitalitemsaresummarizedinthefigurebelow(source:ATKearney).


OutsourcingThereareseveralreasonswhyfirmsoutsource.Theseinclude:

• Externalsupplierhasbettercapability• Externalsupplierhasgreaterormoreappropriatecapacity• Freeingresourcesforotherpurposes• Reductioninoperatingcosts• Infusionofcashbysellingassettoprovider• Reducingorspreadingrisk• Lackofinternalresource• Desiretofocusmoretightlyoncorebusiness• Economiesofscaleofsupplier

Whenoutsourcing,thecontractisextremelyimportant.Awellwrittencontractmakessuretonotjusthavecleardecisionsabouthowtohandledisputesandhowtomeasureandreward,butalsohowtohandleIP,howtodefinetheservicetobeperformed,andhowtohandletheevolutionoftherelationship.Outsourcingissubjecttoconsiderablerisk.Someofthekeyrisksare:

• Creatingacompetitor• Losingcontrolofthechanneltoasupplier• Losingcontrolofthechanneltoacustomer

PurchasingSocialResponsibilityCorporatesocialresponsibilityhasawiderangeofunderlyingobjectives.Theseincludephilanthropy,brandimage,HRattraction,missionsupport,socialbusinessandprofitable


business.Basedonthese,companiesworkindifferentways,includingusingextensivecodesofconduct,auditsuppliers,trainsupplierorworkhardtoensuresupplychaintransparency.Independentlyofactivity,thereisahierarchyforthedifferentresponsibilitieswithinCSR.Thetopresponsibilityforallfirmsistheeconomicresponsibility–afirmcannotsurviveinthelongrunifitdoesnotmeetthisresponsibility.Aftertheeconomicresponsibilityfollows,inthefollowingorder:Legalresponsibilities,ethicalresponsibilities,anddiscretionaryresponsibilities.

ProcurementOptimizationInaway,eachprocurementisanoptimizationprocessinthesensethattheprocurementdepartmentorthecompanytriestogetthebestsetofsupplierstoserveyou.

Item-supplier(lane-carrier)specificconstraintsItem-supplierspecificconstraintsareconstraintsthatapplytooneoftheproductsatoneofthesuppliers.Forinstance,whenprocuringtransportservicesforanumberoflanesinanetwork,eachcarriermayhavecapacityrestrictionsforagivenlane.IntheMILP-formulationoftheproblem,theseconstraintsareeasilyimplementedasaseparatematrix.

OptimizingwithserviceattributesServiceattributesareoftenassociatedwithanindividualitematagivensupplier.Forinstance,“ontimedeliveryperformance”mayvarybetweendifferentsuppliersforagivenitemaswellasbetweendifferentitemsfromthesamesupplier.Therearemanytypesofserviceattributesthatmaybeimportantevaluationcriteriaintheprocurementprocess.ThesecanbeincorporatedintotheMILP-problem,eitherasconstraintsorbyattachingadollarvaluetotheservicelevel.Forinstance,ifacertainservicemeasureisbelievedtorepresent$10per%-unitofservice,anLOS-adjustedcostcanbeminimized.

Systemattributes/constraintsSystemattributesarenottiedtoaspecificitem.Suchconstraintsareusuallyconcernedwithconstraintsonthesuppliersasagroup.Thesearenotasstraight-forwardtoimplementintheMILP-formulationastheitem-supplierspecificconstraints.Onehastoinvestigateeachcaseindividually,andmayneedtointroducebinaryvariablesfordifferentsuppliersand/oritems.Implementingcertainsystemconstraintsinthemodelisalsousefulformakingsensitivityanalyses.Forinstance,itenablesananalysisofhowreducingthesupplierbasewouldaffecttotalcost.

EconomiesofscopeInmanycasesthebidonereceivesforanitemdependsonwhetherornotthesupplierbelievesitwillbesupplyinganotheritem.Forinstance,whenbuyingtransportservices,asuppliermaybewillingtoofferalowerpriceforalaneifhealsogetsthereturntransportonthelane.Similareconomiesofscopemayappearinallprocurementsituations.


CombinatorialauctionsCombinatorialauctionsisawaytocapturethepotentialeconomiesofscope.Inessence,theideaistoletallsuppliersbidforallpossiblecombinationsofrelatedproducts.

LearningObjectives• Reviewhowtomapitemsbasedonriskandspend• Differentiateprocurementstrategybasedonthemapping• Understandthestructuredsourcingprocess• Reviewcapitalgoodspurchasing• HighlightimportanceofCSRinprocurement• Introduceprocurementoptimizationwhenoneevaluatesbidsformanyitemsfrom

severalpotentialsuppliers• Identifyhowtotakeservicecriteriaandsystemsattributesintoaccount• Introductiontocombinatorialauctionsinpresenceofeconomiesofscope

ReferencesCachon,G.P.(2003).Supplychaincoordinationwithcontracts.Handbooksinoperationsresearchandmanagementscience,11,227-339.


SupplyChainFinance

SummaryThisreviewcoverssomeofthemostimportantconceptsofaccountingandfinancefromasupplychainmanager’sperspectiveincludingashortdiscussionoftheroleofaccounting,thechoicesandaccountantcanmake,theroleanddifficultiesofdepreciation,andanoverviewofbasicaccountingconcepts.

KeyConcepts

AccountingFundamentals

TheIncomeStatementTheIncomeStatementprovidesasummaryoftheflowsin(revenue)andout(expenses)ofthefirmoveraperiodoftime;thenetdifferencebetweentherevenueandexpensebeingtheprofitorlossofthefirm.Putinanotherway,theincomestatementdescribeshowtheassetsandliabilitiesareusedduringaparticularperiod.Youcouldalsothinkofitasthesumofincome-generatingtransactions,financialtransactionsoverastatedperiodoftime.Thethreemaincomponentsare:

• Revenues(turnover,sales,proceeds,‘topline’)–theincomingflow• Expenses(costs)–theoutgoingflow• Profit(income,earnings,‘bottomline’)–thedifferencebetweenincomingandoutgoing

flow

Forasupplychainmanager,thereareseveralcomponentstoExpensestobeawareof:• COGS(CostOfGoodsSold,Costofproductssold)–thesearethedirectcostsof

producingthegoods/servicesthataresoldtogeneraterevenues.• CostofRevenue(costofsales)–SimilartoCOGS,butincludesalsocostsoutsideof

production,e.g.marketingexpenses• Depreciation–thesearenon-cashexpensesassociatedwiththeuseofcapital

equipment(formoreaboutthis,seebelow).Relatedisamortization–thisareductioningoodwill(goodwillisanintangibleassetthatariseswhenthefirmacquiresanotherfirmatapricehigherthanthebookvalueoftheacquiredfirm)

• SG&A(Sales,General,andAdministration)–overheadcostsassociatedwithgeneratingrevenue,includingthesalesforce,

• OperatingExpenses–thesumofCOGS,Depreciation,andSG&A.


TheBalanceSheetTheBalanceSheetpresentsthefinancialconditionofthefirmatonepointintime.Itliststheassets,whichissomethingthatisownedbythefirmandhasmeasuredvalue.Italsoliststheliabilities,whichareclaimsagainsttheassetsbyotherparties.Youcouldalsothinkoftheseasdebtsorobligationsthatthefirmhastopayotherpeople.TheBalanceSheetgivesasnapshotoftheassetsandobligationsofthefirmatasinglemomentintime.Assetsalwaysequalliabilities.Remember,thebalancesheetreportBookvalue,notMarketvalue.Thesecouldbeequal,butaswewillseeinthenextlessontheymaynotbe.

• Assets.YouwanttoseparateCurrentAssetsfromLongTermAssets.Currentassetscanbeusedonshort-termtopayforobligations(e.g.cash,accountreceivables,inventories),whereaslong-termassetsare,asthenameimplies,longterm(e.g.facilities,equipment–sometimesabbreviatedPPEforProperty,PlantandEquipment)

• Liabilities.NormallyliabilitiesaredividedintoCurrentLiabilities,Long-termLiabilities(Dept),andEquity.Currentliabilitiesgenerallyhavetobepaidinthenextaccountingperiodandinclude,e.g.,accountspayables.Long-termliabilitiesincludee.g.loans,bonds,ormortgages.Equityisthecapitalthatownershaveputintothefirm.

TheRoleofAccountingTheroleofaccountingistorecordthetransactionsofabusiness.Theaccountantclassifiesthesourcesanduseoffunds.Thereareprimarilythreetypesofreportsprepared:

• Financialreports.Theseareintendedforthefirm’sinvestors,includestheincomestatementandthebalancesheet.

• Taxaccountingreports.Theseareprovidedforthegovernment,intheUSfortheIRS.• Productcostingreports.Theseareusedformanagementdecisionmaking.

Therearecertainchoicesthatcanbemade,aslongastheaccountfollowgenerallyacceptedaccountingpractice.Notethatthefinancialreportsprovidedtoinvestorscandifferfromthetaxreports.Theyservedifferentpurposes.Financialaccounting’sobjectiveisto“presentfairlytheresultsofoperationsandthefinancialconditionofthecompanytoitsstockholders”,whereascorporatetaxaccounting’sobjectiveisto“minimizecurrenttaxliabilityanddeferpaymentofliabilityaslongaspossible”Thismeansthat”thetaxcodeallowscompaniestodeviatefromfinancialaccountinginspecificareaswhencalculatingtaxableincomewithouthavingtochangethecorporatefinancialreportsissuedtostockholders”

DepreciationDepreciationisanon-cashexpensetothebusiness.Itcanbethoughtofastheestimatedcostofusinganasset.Forinstance,ifamachineispurchasedtobeusedinamanufacturingsetting,


thedepreciationofthemachinerepresentsthereductioninthevalueofthemachineovertheaccountingperiod.Thismeansthatwhiledepreciationisanexpense,thevalueofthecorrespondingassetreducesbythesameamount.Soifthedepreciationofamachineis$10,000inayear,thiswillimpacttheincomestatement($10,000expense)aswellasthebalancesheet(-$10,000inlong-termassets).Therearedifferentwaystoconstructtherateofdepreciation.Mostcommonisstraight-linedepreciation,wheretheassetisreduceswiththesamevalueeachaccountingperioduntilitreachesitsresidualvalue(itsscrapvalue).Sincedepreciationisanexpenseitwillaffectthetaxableincomeofthefirm.Thiswillaffectcash-flows,eventhoughthedepreciationitselfisnon-cashexpense.

BasicAccountingConcepts• DualAspectConcept-assetsalwaysequalliabilities• AccountingPeriodConcept–IncomeStatementoveraperiodoftime• ConservatismConcept-Chooserecordingmethodthatresultsinthelowestassetor

highestliabilityfigures• AccrualConcept–recordrevenueswhentheyareearned(e.g.whentheproductships)

andrecordexpenseswhentheyareincurred.• CostConcept-recordcosts,notmarketvalue• MaterialityConcept-disregardimmaterialtransactions• RealizationConcept-recognizerevenuewhengoodsaredelivered• ConsistencyConcept–usethesamemethodforrecordingtransactionsassociatedwith

specificassets/events• EntityConcept-accountingforanentity,notindividuals• GoingConcernConcept-assumecontinuingoperations• MatchingConcept-matchcostsassociatedwithrevenueinsameperiod• MoneyMeasurementConcept-moneyisthecommonmeasure

AccountingChoicesTheaccountantdoeshavechoiceshowtoreportdifferenttransactions;thesamesupplychainactioncanappeardifferentwaysinfinancialreports,andthesecanhavedifferentimpactonthefinancialreportsdependingonhowtheyarerecorded.Therearethreesetsofchoicestobeawareof:

• Productcosting.Theaccountantisfreetodeterminehowtoallocateoverheadandhowtocategorizeexpensestocreateasaninsightfulresultaspossible.

• Depreciationmethod.Therearemanywaystosettherateandperiodlengthfordepreciation.Forsometypesofassets,however,thereareestablishedaccountingpractices.


• Assetorexpense.Itisnotalwaysclearwhetheratransactionshouldbeclassifiedasacapitalinvestmentoranexpense.Oneexampleisaprototype.Theaccounthasleewayindecidinghowtoclassifythis.

LIFOvsFIFOTherearetwoverydifferentwaystoestimatethevalueofgoodsinaninventory:

• LIFOusesthemostrecentcostofinventorytoassigntosales,whichresultsinlowerstatedprofits(assumingmaterialcostsincreaseovertime).Asaresult,theremaininginventorycanbeundervalued.

• FIFOusestheoldestcostofinventory,whichresultsinpotentiallyhigherprofitsbutneartermtaxobligations.Asaresult,theremaininginventorycanbevaluedatcurrentreplacementcost.

CostingSystems

CostAccountingWhilecostaccountingisatypeofreporting,ithasadifferentpurposethanthefinancialreports.Thepurposeofcostaccountingispurelyinternaltothefirm–itisdesignedtomeasurecoststoenableperformanceanalysis,decision-makingandinternalreporting.So,whileinfinancialreporting,costsareclassifiedbasedontypeoftransactionforexternalreporting;incostaccounting,costsareclassifiedbasedonneedsofmanagementforinternaluse(decision-makingsupport).Thismeansthatcostaccountingdoesnothavetofollowgenerallyacceptedaccountingpractice.

OverheadandOtherTypesofCostsTherearemanytypesofcoststoconsiderinthecostaccountingprocess:

• Fixedcosts:thesecostsdonotvarywithvolume.o Ex.Monthlypaymentsforplant,property,equipment

• Variable&Semivariablecosts:coststhatvarywithvolumeo Ex.Costformaterialsusedtoproduceaproduct;morematerialsareneededto

makemoreunitsofproductiono Ex.Semivariable:costforsalariedemployeeswhogetcommissiononsales

• Directcosts:coststhatcanbeattributedtotheproductionofaspecificproducto Ex.Costforrawmaterialsorlaborhourstoproducetheproduct

• Indirectcosts(overhead):coststhatcannotbeattributedtotheproductionofaspecificproduct

o Ex.Legalfees,SG&A,insurance


Muchofthechallengeofthecostsystemistofindarepresentativewaytoallocatetheindirectcosts–theoverheadcosts.Thesecostsincludedepreciationofassets,supervision,qualitycontrol,andmanyothercosts.Toproperlyunderstandthecostofproducingcertainproducts/services,thecosttoservecertaincustomers,orthecosttorelyoncertainsuppliers,managersneedtoallocatetheseoverheadcostsinarepresentativeway.Thisisnoteasy,sincethereisoftennodirectrelationshipbetweenthecostandtheproduct!Differentcostsystemapplydifferentlogicforthisallocation,asyouwillseebelow.

TraditionalCostSystemsThemostcommonwaytoallocatecostsisusinga“traditional”costsystem.Withsuchacostsystem,“standardcosts”arecalculatedandusedtoallocatetheoverhead.Thestandardcostistheanticipatedoverheadcostforaprocessorproduct.Astandardrateisthencalculatedbasedonsomemeasure,e.g.throughputorlaborhours.Forinstance,iftotalstandardcostformanufacturingis$100,000andbudgetedthroughputis1,000,thestandardratetobeappliedis$100perunit.Whilethesesystemsoftenperformwellinmanyinstances,therearecertaininstanceswheretheyareproblematic.Thisincludesinstanceswhendepreciationandotheroverheadcostsaccountforalargershareandincomplexenvironmentswithmany(customized)productsand/orprocesses.

ActualCostSystemsActualcostsystemstrytouseactualcostsorquantitiestoprovideamoreaccuratepicturecomparedtostandardtraditionalsystems.Therearedifferentvariations:

• Actualcostusingactualquantitiesandstandardprices• Actualcostusingstandardquantitiesandactualprices• Actualcostusingactualquantitiesandactualprices

Itishoweverdifficulttouseactualpricessincethiswillnotbeavailableuntilaftertheperiodisover.

Activity-Based-Costing(ABC)Anincreasinglycommonwaytohandletheshortcomingoftheothercostingsystemsistouseanactivitybasedcostingapproach.Withthisapproach,relevantactivitiesaredefined,andalloverheadcostsarerelatedtotheseactivities.Basedonthenatureoftheactivity,acostdriverisidentifiedwhichisthenusedtocalculatetheoverheadcostfordifferentobjects(e.g.products,customer,suppliers).ThegeneralstepstofollowwhenusingABCarethefollowing:

1. Identifyallrelevant(repetitive)activities(aformalapproachwouldinvolvecreatingaprocessmodel).Notethatarelevantactivityisoftenoftheform“verb+object”,e.g.“scheduleproduction”.


2. Identifytheresourcesconsumedinperformingtheactivities.Basedoninterviews,reports,orotherinformation,identifytherelevantresourcesconsumedineachoftherelevantactivities.

3. Determinethecostsoftheactivities.Basedontheinsightsfromstep2,findthetotalcostforeachrelevantactivity.

4. Determinecost-driversoftheactivities.Thisisthe“unit”thatdrivesthecostoftheactivity:unitsproduced,batches,orders,shipments,etc.

5. Determinecost-driverratefortheactivities.Basedonthetotalcostoftherelevantactivity,useitstotalactivityleveltodeterminetherateforthecost-driver.Forinstance,if“numberoforders”isthecost-driver,findthetotalnumberofordersovertheaccountingperiod,thisistheactivitylevel.Tofindthedriverrate,dividetotalactivitycostwiththeactivitylevel.

6. Tracecoststo(secondary)costobjects.Onceyouhavealldriverrates,usetheinformationyouhaveabouteachobjecttomultiplethatobjectsactivitylevelwiththedriver-rate.

Activity-BasedCostingprovidesadifferentandpotentiallymoreaccuratecostforproducingproductsandprovidingservices.ABCcanbehelpfulfordecisionmakersassessingtheprofitabilityofvariousproducts,servicesorsegmentationsofthosebycustomerorgeography.

WorkingCapitalTheworkingcapitalisabasicmeasureofbothacompany'sefficiencyanditsshort-termfinancialhealth.Itisdefinedas:

Workingcapital=Currentassets–Currentliabilities

Positiveworkingcapitalenablesthefirmtocontinueitsoperationsandtosatisfybothmaturingshort-termdebtandupcomingoperationalexpenses.Basically,theycanpaytheircurrentbillswhendue.Negativeworkingcapitalmeansthattherearenotenoughcurrentassets(cash,accountsreceivable,inventory)tosatisfytheircurrentliabilities(accountspayable,maturingshort-termdebtandupcomingoperationalexpenses).Thismaybegood,ifthefirmcollectsitsbillsbeforepayingsuppliers.Butitmayalsobeabadthing:thecompanycannotconvertassetsintocashquickenoughtopayoffliabilities.Acompanycanhaveassets&profitsbutlackliquidityifassetscan’treadilybeconvertedtocash.KeepinmindthatafirmcanhaveanegativeCCCandpositiveworkingcapital.Sometimesworkingcapitalisanalyzedthroughthe“currentratio”.Ifthisratioissomewherebetween1and2itisconsideredahealthycompany.

Currentratio=currentassets/currentliabilities


Anothertestiscalledthe“acidtest”,andlooksonlyatthecurrentassetsthatcanbequicklyconvertedtocash.Iftheacidtestislessthanthecurrentratio,thecurrentassetsarehighlydependentoninventory.

Acidtest=(Cash+AccountsReceivables+shortterminvestments)/currentliabilitiesAthirdimportantmeasureistheworkingcapitalturnover.Thisdescribeshoweffectivelyacompanyisusingitsworkingcapitaltogeneraterevenues.Ingeneral,ahigherturnoverispreferable.

Workingcapitalturnover=sales/workingcapital

Cash-to-CashCycle(CCC)AlsoknownastheCashConversionCycle,theoperatingcycleorsimplythecashcycle.Thisisaliquiditymeasurethatcanhelpacompanyplanitstimingofworkingcapitalrequirements.Itmeasuresthenumberofdaysthatacompany'scashistiedupintheproductionandsalesprocessofitsoperations,andthebenefititgetsfrompaymenttermsfromitscreditors.Theshorterthecycle,themoreliquidthecompany’sworkingcapitalposition.Themeasureconsistsofthefollowingthreeparts:

• DaysOfInventoryOutstanding(DIO)–thisistheaverageinventoryinthesystem,expressedinnumberofdays

DIO=(AverageInventory/CostofSales*)x365

• DaysofSalesOutstanding(DSO)–thisistheaveragenumberofdaystocollectrevenuesfromasale,thatis,thecredittimegiventocustomers

DPO=(AverageAccountsPayable/CostofSales)x365

• DaysofPayablesOutstanding(DPO)–thisistheaveragenumberofdaysbeforepayingsuppliers

DSO=(AvgAccountsReceivable/TotalSales*)x365

TheCash-to-cashCycle,ortheCashConversionCycle,isthenfoundas:CCC=DIO+DSO-DPO


SupplyChainCashFlowsTherearethreeflowsinthesupplychain:thephysicalflow(goods),thefinancialflows(money),andtheinformationflows(data).Sincewemayusecontractorsformanyofourfirm’soperations,physicalflowsmaynotpassthroughourfirmatall.Financialflows,however,will.Consequently,thedesignofthefinancialflowsinthesupplychainwillhaveanimpactonthevaluewearecreatingandthereforehowvaluableoursupplychaindesignsare.

InvestmentsandfuturecashflowsTheprimarysourceforcapitalforafirmisfromitsstockholders,orequityinvestors.Theseinvestorspurchasestockinthefirmtoprovidethefirmwithcapital.Thefirmmaythencontractoutwithdebtors,banks,orbondholderstoraiseadditionalcapitalthatcanbeusedforinvestments.Thereisacontractualagreementwiththesedebtors.Forinstance,ifyouborrowmoneyfromabankyouwillhaveacontractwhereyoupaythembackoveracertainperiodoftime.Thisisnotthecasewithinvestors.Forthese,thefirmhopestomakeenoughmoneytopaythemback.How?Byinvestingthecapitalinoperationalassetstogeneratefuturecashflows.Thegoalistomanagetheassetsinthesupplychainwellenoughsothatrevenuesaregreaterthanexpenses.Investorscompareafirm’sresultwiththeotherinvestmentoptionstheyhavetocreateaportfolioofoptionsthatwillgivethemfuturereturns.Soinvestors’investmentinafirmisapartoftheirportfolio.Giventhefirm’sabilitytoprovidereturns,itwillbemoreorlessattractivetoinvestors.

InvestmentevaluationNormally–thosethathavethemoneyinanorganizationarealsothosethatdecidesonwhichinvestmentstomake.Followinggeneralcorporatefinanceguidelines,investmentsareevaluatedaccordingtothefollowingsteps:

1. Estimatetherelevantcashflows–thisincludesalsothecashoutflowofmakingtheinvestment

2. Calculateafigureofmeritfortheinvestment–thisistocomeupwiththe“value”oftheinvestment

3. Comparethefigureofmerittoanacceptancecriterion

Notethatthesameprocessmaybeusedtoevaluateprojects.

EBITandEBITDAToseparatedifferenttypesofoperatingincome,wewillusethefollowingconcepts:

• EBIT–EarningsBeforeInterestandTaxes.Thesearetheearnings,ortheprofit,beforeanyfinancialaspectsareadded.

• EBITDA–EarningsBeforeInterest,Taxes,DepreciationandAmortization.Thesearetheearnings,ortheprofit,beforefinancialaspectsaswellasdepreciationandamortization.Thatis,itisthegrossincomeminusCOGSandSG&A.


ProjectedcashflowsCashcominginareconsideredpositivecashflows;cashgoingoutisconsiderednegativecashflows.Tohandlethecashflowsintheevaluationmodels,theyareaggregatedin“bins”–normallyeachyearisabin.Commonpracticeassumescashflowsoccurattheendoftheprojectedperiod,orbin.Theappropriatetimehorizontoconsiderdepends–thedecisionmakerssimplyhavetocometoanagreement.However,onemustalsoconsidercashflowsattheendofthedecisionhorizon–assetsmaybedivestedand,whentheyare,incurasalvagevalue.

InflationTherearetwodifferentwaystothinkaboutinflationwhenevaluatingcashflows:

• Nominalcashflow:incorporateinflationinprice/cost.Theinflationratesmaydifferbetweendifferentcomponents.

• Realcashflows:donotincludeinflationinprice/cost.

Thechoicebetweennominalorrealcashflowsinfluencesthediscountrateusedwhencalculatingthefigureofmerit.

RelevantCashFlowsWeneedtomakesurethatthecashflowsweareprojectingarerelevanttotheparticularinvestmentorprojectweareevaluating.Sohowdowedeterminewhatisarelevantflow?

1. Cashflowprinciple:onlycashflowswheremoneymovesarerelevant.Thatis,acashfloweithergoesoutofthefirmorcomesintothefirm.Forinstance,depreciationisnotamovementofmoney,soitisnotarelevantcashflow.However,depreciationalsoaffectstaxes,whichisarelevantcashflow.

2. With-withoutprinciple:onlycashflowsthataredifferentwiththeinvestmentcomparedtowithouttheinvestmentarerelevanttothedecision.Notethatthisisdifferentfrom“beforeandafter”,sincewearelookingintothefutureattwodifferentworlds–weareonlyinterestedinthedifferencebetweenthoseworlds.Forinstance,ifrevenueswillnotdifferbetweenouralternatives,thentheyarenotrelevantcashflows.

Notethatthisalsomeansthatsunkcostsarenotrelevantcashflows.Opportunitycostofassetsshould,however,beincludedintheevaluation–itdiffersbetweenthealternativesandisthusarelevantcashflow.

FreeCashFlowsThefreecashflows(FCF)arethefundsavailableto(theequity)investorsafterthefirminvestscapitalandpaystaxes.Itprovidesaconvenientwaytocalculatecashflowstocompareinvestments,byrelyingonpostsinthefinancialreportsratherthanseparatelineitems.Forfreecashflowcalculationsweneedtoconsiderrevenues,COGS,operatingexpenses,andtaxesaswellascapitalexpendituresandworkingcapital.Notethatsomeofthesearefoundintheincomestatementwhereasothersarefoundinthebalancesheet.Startingwiththeincomestatement,relevantcashflowsincludetaxes.


Tomakesurewecapturetheeffectoftaxes,wemakeuseoftheNetOperatingProfitAfterTaxes(NOPAT).

NOPATt=(1-taxrate)*EBITt.

UsingNOPAT,whichtakesdepreciationintoaccount,wecanfindtherelevantcashflowsoftheincomestatementbyaddingthedepreciation“backagain”,thatis.Relevantcashflowsfromtheincomestatementattimet:

NOPATt+DAt

Fromthebalancesheet,wegetthecapitalexpenditureandthechangeinnetworkingcapitalrequirement.Relevantcashflowsfromthebalancesheetattimet:

CapExt,ΔNetWCt

CombingthedatafromtheincomestatementandthebalancesheetwegetFCFt=NOPATt+DAt-CapExt-ΔNetWCtFCFt=(1-taxrate)*EBITt+DAt-CapExt-ΔNetWCt

WorkingCapitalCashFlowsTheworkingcapitalcashflowisthenetchangeinworkingcapitalrequirementsfromthepreviousperiod.Forinstance,adecreaseinworkingcapitalrequirementsmeansthatmorecashisfreedup(notetheminussignintheFCFformula).Notethatworkingcapitalcashflowsoccurwhenthechangetakesplace.Forinstance,achangeininventorylevelaffectsworkingcapitalrequirementswhenwenextreplenishstock.

DiscountedCashFlowAnalysisWenowfocusonthetwosubsequentstepsininvestmentevaluation:howtocalculateafigureofmeritbasedontheprojectedrelevantcashflows,andcomparethisfiguretoanacceptancecriterion.Thebasicideaunderlyingthesecalculationsisthattoday’smoneyisworthmorethanmoneyinthefuture.Tocorrectforthiswhenwemakeinvestmentdecisions,weuseadiscountratetofindtoday’svalueoffuturecashflows.Whyistoday’scashmorevaluablethantomorrow’s?Thereareprimarilythreereasons:

• Opportunitycost–nothavingthemoneynowresultsinforegoneinvestmentreturns• Inflation–thisreducespurchasingpowerovertime• Risk/uncertainty–receiptofcashisnotguaranteedovertime

Owingtothis,weneedtocalculatethepresentvalueoffuturecashflowswhenevaluatingsupplychaindesigns.Aswesawinthislesson,thereareseveralwaystodothis.Commonforalldiscountedcashflowanalysis,isthatisquantifiesthevaluecreatedbyinvestments.


FigureofMeritThefigureofmeritisasinglenumberthatestimatestheeconomicvalueofaninvestment.Thisnumbercanbecomparedwithacriterionestablishedbythefirm.Thereisnouniversalcriterion.Therearealsoseveraldifferentfiguresofmerit,whichyouwillseemoreofbelow.

PaybackPeriodThepaybackperiodisthetimeuntilthecumulativecashflowisequaltoourinitialinvestment.Usingthisfigureofmerit,theacceptancecriterionistoinvestifthepaybackperiodisshorterthanthecut-offpoint.Thefirmdecidesthecut-offpoint.Thisisafairlysimplemeasure,whichiseasytocommunicate.Themaindrawbackisthatitdoesnotconsiderthetimingofcashflows.Forinstance,cashupfrontisnotvalueddifferentlythancashlater.Neitherdoesitconsidercashflowsafterthepayback-period,eventhoughthesemaybesignificant.

ReturnonAssets(ROA)Thereturnonassets(ROA)isdefinedby:

ROA=Netincome/AssetsTheacceptancecriterionusingthisfigureofmeritistomakeaninvestmentifROAisgreaterthansometargetreturn.“Assets”areforaninvestmentthetotalinvestmentincapital,whichwilldepreciateovertime.Thismeansthatlaterincomingcashflowsaregivenahigherweightinthecalculation,eventhoughearliercashflowsaregenerallymoredesirable.ROAisverymuchlinkedtothefinancialstatement.However,itisbasedonaccountingcalculationsandnotcashflows.Also,justlikethepaybackperiod,itdoesnotconsiderthetimingofcashflows.

PresentValueThepresentvalueofafuturecashflowsisgivenby:

PV=FV/(1+r)n

wherePVispresentvalue,FVisfuturevalue,risthediscountratefortheperiod,andnisthenumberofperiods.Notethatyoumusthavethesametimeperiodforyourrateandyournumberofperiods.Often,westicktoannualvalues.Thediscountrateisbasedoninvestors’expectedrateofreturn.Thisissometimesreferredtoasthehurdlerate–itsetsthehurdlebywhichwehavetorunouroperationstoexceedtheexpectationsofourinvestors.

NetPresentValueThenetpresentvalueisthesumofalldiscountedcashflowsfromallrelevantfutureperiodsofaninvestment:

NPV=c0+c1/(1+r)1+c2/(1+r)2+…+cT/(1+r)T


wherecirepresentsthenetcashflowinperiodi.Notethatwearenotdiscountingthecashflowofperiod0–thisisthepresentvaluealready!NPViseasilyimplementedinyourspreadsheetsoftware.Ifusingthebuilt-infunction,keepinmindthatperiod1isthefirstperiodinthefunction,period0cashflowsneedtobeaddedseparately.Thenetpresentvalueisafigureofmeritthatcanbeusedtoevaluateaninvestmentonitsownorcomparedifferentinvestmentswitheachother.TheacceptancecriterionforasingleinvestmentisthattheNPVisgreaterthanzero.

InternalRateofReturnWhiletheNPVhasalotofnicepropertiesforafigureofmerit,itisdependentonpickingtherightdiscountrate.Theinternalrateofreturn(IRR)addressesthisproblemby,insteadofconsideringtheNPVgivenacertaindiscountrate,considersthediscountrateatwhichtheNPV=0.Consequently,managementcancomparethetargetreturnwiththeIRR.ThecriterionofacceptanceisthustoinvestaslongasthetargetrateofreturnisbetweenzeroandtheIRR.TheIRRisfoundasthesolutionto

0=c0+c1/(1+IRR)1+c2/(1+IRR)2+…+cT/(1+IRR)TThereisnoclosedformsolutionforthis.Therearehoweverspreadsheetfunctionsavailabletocalculatethis.

TerminalValueWemaywanttoconsiderhowassetsthatlastbeyondourfinancialprojectionsshouldbehandled.Wehavetoucheduponthesalvagevaluebefore.Theremaybecashflowstoconsidereveniftheinvestmentisnotsalvaged–maintenance,certaininventorypolicies,etc.TheterminalvaluehandlesallthecashflowsthatareincurredafterperiodT,whichisthelastperiodofourprojections.AfterperiodT,cashflowsareassumedtobestable.Therearenormallytwoapproaches:

• Perpetuity:estimatedvalueofstablecashflowsthatcontinueindefinitely• Annuity:estimatedvalueofstablecashflowsfordefiniteperiodbeyondtheunique

projections

Youcanincorporategrowthintotheanalysisaslongasgrowthisstable.Aperpetuityisgeometricseriesthatconvergesto:

PV=C/rwhereCisthestablecashflowperperiod.Anannuityisthenetpresentvalueofstablecashflowsoveragivennumberofperiods.Theannuityisthusgivenby:

PV=C/r-C/(r*(1+r)^T)


InventoryHoldingCostIninventorymanagementweuseaholdingcost(orcarryingcost)forcalculatinghowmuchinventorytokeep.Thisisanannualcost,anditconsistsofseveralcomponents:

• Capitalo Opportunitycostofcapital

• Operatingo Warehouse(power,propertytaxes…)o Equipmento Labor(handling,stockkeeping,…)o Disposal,scrap(directorthirdpartycosts)

• Lostrevenueo Obsolescenceo Depreciation(realmarketvalue!)o Deteriorationo Shrinkageo Damageo Insurancetopreventlostrevenue

Oftentimes,werefertothelasttwocategoriesasnon-capitalholdingcosts.Buthowisthisincorporatedintodiscountedcashflowanalysis?Well,thesecashflowshavetobeevaluatedlikeanyothercashflows:

o Opportunitycostofcapitalisimplicitlyincludedinthediscountrate,andisnotarelevantcashflow.

o Thenon-capitalcosts(operatingcost,lostrevenue)arerelevant,projectedcashflows

Consequently,whenyoureduceinventory,yougettheworkingcapitalcashoncetoreinvestandyouavoidoperatingexpensesand/orlostrevenueovertime.


DefiningSupplyChainFinanceSupplychainfinancehasbeenusedasabroadterm.Itcandescribehowwelookatthesupplychainthroughafinanciallens.Ithelpsusidentifiesthefinancialimpactfromsupplychaintransactionsandhowsupplychaindecisionsimpactfinancialstatements.Butinrecentyears,thedefinitionofsupplychainfinancehasbeenformalizedasamethodtoprovideliquiditytobuyersandsellers.ThistypicallymeanspaymenttermsofNet30or2%10,Net30.Themovetoafocusonliquiditystemsfromtheglobalfinancialcrisisof2008,whentheissueofgettingcashtofundbusinessoperationswasexasperated.Ingeneral,buyersareincreasinglylookingforwaystoreducetheirnetoperatingworkingcapitalrequirements–thatis,thefundsnecessarytocontinueoperationofthebusiness.Manybuyerstryextendthepaymentcyclefrom30daysanywhereto150+days.Therefore,manysuppliershavetowaitalongtimetogetpaidandneedtocashtopaybillswhilewaitingfortheinvoicepayment.SupplyChainFinanceisthesetofsolutionsthatallowacompanytofinanceitsownworkingcapital,leveragingitsrolewithinthesupplychainanditsrelationshipswithotherplayersinthechain.SupplyChainFinancehasmanyvariationamongdifferentsolutionsandalsohasdifferentterminologyacrossusers.SCFprovidesfinancing

• “Financingistheactofprovidingfundsforbusinessactivities,makingpurchasesorinvesting.”

• Thirdpartiesofteninvolved:Banks,otherfinancialinstitutions.• Providingfunding/capitaloftentoconsumers(e.g.formortgages),andbusinesses

(capitalimprovements).• Supplychains‘finance’orfundtheirpayables(andsometimesinventory).

Theretwogeneraloptionsforfinancing(debtandequity).When applying these options to Supply Chain Finance (SCF). Most are using debt – or loans – to provide liquidity – cash – to the firm. Some entail selling the asset (e.g. a receivable from the buyer), usually at a deep discount. There are many variations and each have advantages and disadvantages

LiquidityLiquidityisthe“thedegreetowhichanassetorsecuritycanbequicklyboughtorsoldinthemarketwithoutaffectingtheasset’sprice.”Or…..theabilitytoquicklyconvertassetsintocashatvalue.Liquidityallowsthebusinesstooperate,topaybills,tobuymaterials,etc.LiquidityandtheCCCConsidertheCashConversionCycle,CCC(alsoknownasthecash-to-cashconversioncycle).TherearethreecomponentsintheCCC:thecycletimetopaysuppliers,thecycletimetogetpaidbycustomers,andthecycletimetoproduceandsellaproduct(fromorderentrytimetotimeofsale).Toprovidemoreliquiditythefirmcan:arrangeforfasterpaymentsfrom


customers;worktoreducetheproductionandsalescycletimes,and/orslowdownpaymentstosuppliers.CashConversionCycleAcronyms

SupplyChainFinance:Howdoesitwork? Case: Raw material purchase

• Situation: Buyer agrees to pay seller in X days • Seller can wait X days for payment or consider other options to get cash sooner

BasicFactoringIfthesellerdoesnotwanttowaitoneSellerOptioncalledFactoring:

• Sellthereceivabletoathirdparty(e.g.collectionsagency),calledtheFactor• Thereceivableisanobligationofthebuyertopaytheseller

DIO=DaysofInventoryOutstandingà howlongittakestoproduceandsellDSO=DaysofSalesOutstandingà howlongittakestocollectpaymentDPO=DaysofPayablesOutstandingà howlongthecompanytakestopaysuppliersCCC=CashConversionCyclehowlongtoconvertcashàinventoryàAPàcash


FactoringWithRecourse:TheFactorcangobacktosellertocollectifthebuyerfailstopay

• IftheBuyerfailstopaytheFactor,thentheFactorcancollectfromtheseller.• The%offinvoicewillbelowerbecausethesellerstillbearstheriskifthecustomerdoes

notpay.FactoringWithoutRecourse:TheFactorhasnooptiontogobacktothesellertocollect,canonlycollectfromthebuyer.

• IftheBuyerfailstopaytheFactor,thentheFactorisstuck.• Nooptiontogobacktothesellertocollect.• The%offinvoicewillbehigherbecausetheFactorbearstheriskifthecustomerdoes

notpay.

There are many options to finance receivables such as factoring. This is probably the most common but can come at a high cost, % of the invoice. Other options vary based on factors including: loan or sale of the receivable, timing of the payments, which party bears the risk of repayment, use of different types of collateral, who initiates the arrangement. Each option has different impact on net operating working capital.

OptionsforLiquidityintheSupplyChainOptionsforliquidityinthesupplychain DescriptionInvoiceDiscount

-Initiatedbytheseller-Nothirdpartyinvolved-Sellerofferslowerpriceforearlypayment-Buyerchoosestoexercisetheoptiontopayearlyatadiscount-ThepaymentamountZwillbelowerthantheinvoiceamount-Thetimingofthepaymentinexchangeforthediscountisdeterminedbytheseller,butitwillbeshorterthantheoriginalpaymentterm

Financingaloan(InvoiceDiscount+)

-Usethereceivableascollateralforthebasisofaloan(e.g.fromabank)-Initiatedbytheseller-Thirdpartyinvolved-Sellerusesinvoiceascollateralforloanwith3rdParty(e.g.Bank)-Thirdpartyissuesloantoseller,usessellercreditrisktosettherate

t=time,X=paymentdate,Y=amount


Forfeiting

-Usedforexports/imports-Initiatedbytheseller-Thirdpartyinvolved,usuallywithexpertiseinexport/import-Sellersellsthereceivabletothethirdpartyatadiscount-Thirdpartybuysreceivableatadiscount,collectsfromBuyer

ReverseFactoring

-InitiatedbytheBuyerwhoalsoinitiatesthefinancingoptions(loans)-ThirdpartyinvolvedthroughtheBuyer-Sellerhastheoptiontousethefinancingoptionsoffered-ThirdpartyofferstofinancereceivablebasedontheBuyer’screditrisk,meaninglowercostloan

Dynamic(Invoice)Discount -Initiatedbytheseller-Nothirdpartyinvolved-Sellerofferslowerpriceforearlypayment,timingofpaymentanddiscountratevaries-Buyernegotiatestimingandratesandchoosestoexercisetheoptiontopayearlyatadiscount-ThepaymentamountZwillbelowerthantheinvoiceamount

InventoryFinancing

-Initiatedbytheseller-Thirdpartyinvolved-Sellerarrangesline-of-creditorloaninordertopurchasematerials-ThirdpartyoffersloanwithSeller'sinventoryascollateral-UsefulwhensellermustpayitssuppliersbeforebeingabletosellFGI;alsousedtobuildinventorypriortopeakdemandseason

InvoiceAuction

-Initiatedbytheseller-Thirdpartiesinvited-Sellerarrangesanauctionprocesstosolicitbidsfortheinvoice(Buyerobligationtopay);sellercanuseexistingauctionplatform-Highestbidderwins-LikeFactoringwithoutRecourse,butusinganauctiontofindthirdparty


AdvancedOptionsUtilizeautomatedprocesses

• Lessuncertaintyintiming• Lowercostloanoperations

Solicitandusemoredetaileddataaboutsellerandbuyer• Moreinformedriskassessments• Canresultinlowerriskandthereforelowercostloans• Favorableratesforincreasedvisibilityandfasterprocessduetoautomatedinfosharing,

betterriskassessmentProactiveuseofinformationtechnologyforfasterandmoreinformeddecisionmakingOtherOptionstoFinancetheSupplyChainUseoperationalmeasurestoreducetheneedforworkingcapital:

• Consignmentinventory(customerspushthecapitalrequirementontothesupplier)• Directshipments(reducetheneedtotieupcapitalinwarehouses)• Variousformsofcollaboration–vendormanagedinventory(VMI),salesandoperations

planning(S&OP),collaborativeplanning,forecastingandreplenishment(CPFR),continuousreplenishment(CRP),etc….Eachofmayreducetheamountofinventorynecessarytomaintainservicelevels

BenefitsofSupplyChainFinanceTherearemanybenefitsofsupplychainfinanceinclude:

• PotentialtoreducetheNetOperatingWorkingCapitalRequirements(NOWC):lowerforbothsellerandbuyerviaquickercashtoseller,lowerinventories

• Potentiallowercostmaterials:viadiscounts;Loweroperatingcostswithuseoftechnologyforinformation

• Potentiallyfastercycletimes:Viafastercash,fasteroperations;ReducingCCC• Potentiallymorerobustsupplychain:Viacollaborativefinancialconnectionsand

ensuringsupplierhealth• Benefitstothirdparties:Morecustomersforloans,potentiallylowerrisk


AnalyzingFinancialPerformanceWemightaskourselves,whocaresaboutafirm’sfinancialperformance?Theobviousanswerisinvestors,executivesinthefirm,andemployeesofthefirm(ifitaffectstheirbonus).Beyondwhothismattersto,manysupplychainprofessionalaskfurtherquestionsincluding:Howdoyouanalyzefinancialperformance?Howdoyoumeasureit?Howdofinancialanalysisandmeasurementapproachesapplytosupplychainmanagement?Wewilldiscussthesequestioninthenextsection.ThemaingoalsofaCEOareto:provideshareholdervalue.Driversofshareholdervalueinclude:revenuegrowth,operatingmargin,andassetproductivity.Tomonitorthis,CEOsandotherexecutivesgenerallyneedascorecardtoassessthesedrivers.

Source:Lukac,E.G.,&Frazier,D.(2012).Linkingstrategytovalue.JournalofBusinessStrategy,33(4),49-57.


BalancedScorecard(seeFigurebelow)• “Ultimately,causalpathsfromallthemeasuresonaScorecardshouldbelinkedto

financialobjectives.”• “Wehavefoundthatcompaniesusethreefinancialthemestoachievetheirbusiness

strategies:o RevenueGrowthandMixo CostReduction/ProductivityImprovemento AssetUtilization/InvestmentStrategy”


DriversofShareholderValue

RatioAnalysisRatioAnalysisisthemathematicalcomparisonofafinancialstatementaccountsorcategories.Theserelationshipsbetweenthefinancialstatementaccountshelpinvestors,creditors,andinternalcompanymanagementunderstandhowwellabusinessisperformingandofareasneedingimprovement.Potentialcomparisonareasoneachstatementorsheet:IncomeStatementSalesCostofGoodsSoldGrossProfitSG&AExpensesDepreciation&AmortizationEBITInterestExpenseIncomeTaxesNetIncomesBalanceSheetCash&EquivalentsAccountsReceivableInventoriesTotalCurrentAssetsNetProperty/Plant/Equipment

𝑅𝑎𝑡𝑖𝑜 = 𝑁𝑢𝑚𝑒𝑟𝑎𝑡𝑜𝑟𝐷𝑒𝑛𝑜𝑚𝑖𝑛𝑎𝑡𝑜𝑟


TotalLongTermAssetsTotalAssetsAccountsPayableTotalCurrentLiabilitiesLongTermDebtTotalLiabilitiesCommonStockRetainedEarningsTotalStockholder’sEquityTotalLiabilities&Equity Overall measure of financial performance Is there a single metric that can reflect the firm’s financial performance for investors? Or executives?

• Return on Equity

• Return on Assets

Specific measures of financial performance Revenuegrowth

• Salesgrowth=(Salest/Salest-1)-1• CompoundAnnualGrowthRate(CAGR)=(Salest/Salest-n)1/n-1

Operatingmargin• Grossmargin=GrossIncome/Sales• Operatingmargin=OperatingIncome/Sales• Netmargin=NetIncome/Sales

Assetproductivity• Assetturnover=Sales/TotalAssets• Inventoryturnover=COGS/AverageInventory• Accountsreceivableturnover=CreditSales/AverageAccountsReceivable• Accountspayableturnover=COGS/AverageAccountsPayable• Daysofinventoryoutstanding=AverageInventory/(COGS/365)

𝑅𝑂𝐸 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒𝐸𝑞𝑢𝑖𝑡𝑦

𝑅𝑂𝐴 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒𝑇𝑜𝑡𝑎𝑙𝐴𝑠𝑠𝑒𝑡𝑠


RatioAnalysisAdviceThere are not any “correct” values for ratios. Ratio values need to be understood in context such as: compare with industry averages, compare with specific competitors; and/or observe trends over time. You will need to develop a framework of several ratios to monitor. In combination, these clues may tell an interesting story.

DuPontAnalysisDuPontanalysisisbasedonareturn-on-investmentformuladevelopedin1914byaDuPontexplosivessalesmannamedDonaldsonBrownandusedbythecompany.Mr.BrownlateruseditasCFOatGeneralMotors,butitwasalreadyknownastheDuPontformula.

TheformulacommonlyusedtodayfocusesonROEforDupontanalysisincorporatesfinancialleverage:

𝑅 = 𝑇×𝑃 𝑤ℎ𝑒𝑟𝑒𝑅= 𝑟𝑎𝑡𝑒𝑜𝑓𝑟𝑒𝑡𝑢𝑟𝑛𝑜𝑛𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑,

𝑇= 𝑟𝑎𝑡𝑒𝑜𝑓𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟𝑜𝑓𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑𝑐𝑎𝑝𝑖𝑡𝑎𝑙, 𝑎𝑛𝑑

𝑅𝑂𝐴 = 𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛×𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒

𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠

𝑇𝑜𝑡𝑎𝑙𝐴𝑠𝑠𝑒𝑡𝑠

𝑅𝑂𝐸 = 𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛×𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟×𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒


GMROI:GrossMarginReturnonInvestmentGMROI has a Narrower focus than DuPont and is useful in evaluating inventory decisions, and their impact on profitability.

ROICROIC=ReturnonInvestedCapital.ROICIsanoverallmeasureoffinancialperformance.Thisincludesreturnsonallcapitalforinvestorsseekingareturn,notonlyonequity.ROICisagoodmeasureforsupplychainperformance.Itisnotconfoundedbyfinancingstrategies.Itshowsthefundamentalearningpowerofthefirm,i.e.createdbyoperations.ROA=NetIncome/TotalAssetsROE=NetIncome/EquityBothmeasurescanbedistortedbyfinancialleverage,i.e.moredebtROIC=NOPAT/InvestedCapital

• NetOperatingProfitAfterTax(NOPAT)o NOPAT=EBIT(1-Taxrate)o Earningsaftertaxasifitwereallequityfinanced(i.e.,notconsideringinterest

expenseortaxbooks)• InvestedCapital

o IC=Interest-bearingDebt+Equityo Sumofallsourcesofcashonwhichareturnmustbeearned(i.e.,notincluding

accountspayable)o Youmaywanttosubtractexcesscasho PreferthebookvalueofInvestedCapital(i.e.thevalueinvested)ratherthanthe

marketvalue

𝐺𝑀𝑅𝑂𝐼 = 𝐺𝑟𝑜𝑠𝑠𝑀𝑎𝑟𝑔𝑖𝑛×𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

𝐺𝑟𝑜𝑠𝑠𝑀𝑎𝑟𝑔𝑖𝑛 = 𝐺𝑟𝑜𝑠𝑠𝑃𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦


RONARONA(ReturnonNetAssets)issimilartoROICandsimilartoROCE(ReturnonCapitalEmployed).Itisareturnonassetsthatareexpectedtoproduceprofit.

RONA = NOPAT / Net Assets

• Net Operating Profit After Tax (NOPAT) o NOPAT = EBIT (1 - Tax rate) o Same as ROIC

• Net Assets o NA = Fixed Assets + Non-cash Working Capital o NA = Total Assets - Current Liabilities - Cash

LearningObjectives• Understandthebasicsoffinancialreportingandaccounting• Understandtheimpactofdepreciationonthefinancialreports• Introduceyoutocostaccounting/costsystems• Becomefamiliarwiththeprinciplesofthedifferentcostsystems• Learnhowtoperformsimpleactivitybasedcosting(ABC)• BecomefamiliarwithworkingcapitalrequirementsandtheCashConversionCycle• Understandrelevantcashflowsandhowtoestimatethem• Understandandlearnhowtofindfreecashflowsfromthefinancialreports• Determinethefreecashflowsovertimeforaninvestment/project• Understandtheunderlyingreasonsfordiscountedcashflow(DCF)analysis• ReviewhowtocalculatetheNetPresentValue(NPV)andtheInternalRateofReturn

(IRR)ofaninvestment,andhowtousethesefigureofmeritsforevaluatinginvestments• HowtohandleinventoryreductionsinDCFanalysis • Understandchangeinpaymenttermstogetcashtofundoperations • Recognizesupplychainfinancedefinitionandthatithasvariations • BecomefamiliarwiththeCashConversionCycle • Reviewdifferenttypesoffinancereceivables • Recognizevariationsacrossfactoringinfinancingreceivables • Understanddifferentoptionstofinancesupplychain • Introductiontoeffectiveanalysistodriversofshareholdervalue • Recognizefinancialmetricsthatcanassesssupplychainperformanceandguidestrategy • Reviewwhichmetricsarebetteratassessingtotalsupplychainperformance


References• Hawkins,David,CorporateFinancialReportingandAnalysis:TextandCases3rded.,

Irwin,1986• Higgins,R.AnalysisforFinancialManagement.10thed.McGraw-HillIrwin,2011(or11th

ed.,2015),seeChapter1• Anthony,R.N.andBreitner,L.K.EssentialsofAccounting.10thed.PrenticeHill,2009,see

pages1-66[thisisaworkbookthatyoushouldworkthrough,itisnotenoughjusttoreadit!]

• Anthony,R.N.andBreitner,L.K.CoreConceptsofAccounting.10thed.PrenticeHill,2010,seepages1-43[thisbookprovidesasummaryoftheEssentialsbook,butthereadershouldgothroughtheEssentialsbookfirstforcompletecoverageofthematerial]

ForCostingSystems

• CostSystemAnalysis,HarvardBusinessSchoolPublishing,Product#9-195-181• MeasureCostsRight,MaketheRightDecisions,HarvardBusinessReview,Sept-Oct1


Organizational,Process,andPerformanceMetricDesign

SummaryWealsoreviewthreeareasof“soft”design:organizations,processes,andmetrics.Organizationaldesignforsupplychainshasevolvedastheprofessionhaschanged.Supplychainorganizationsstartedasseparatesilo-edfunctionsoractivitiesspreadoutacrossdifferentlargerdivisions,suchasfinance,manufacturing,andmarketing.Theareasstartedcombiningintomaterialsmanagement(coveringtheflowofinboundmaterials)andphysicaldistribution(coveringthemovementoffinalproductstocustomers).Logisticsgroupsemergedlatertobringthesetwofunctionstogetherinordertoworkouttrade-offsbetweenthesometimesconflictinggoalsofinboundandoutboundmanagement.Currently,therearevariousformsoforganizationsusedacrossdifferentcompanies.Themainperspectivesdifferintermsofviewingsupplychainsorlogisticsasasetoffunctions,asaprogram,orwithinamatrix.Thematrixformismostcommoninlargerglobalfirms.Inthesecases,logisticsisahorizontalfunctionthatinteractsdirectlywitheachverticalbusinessunitprovidingsharedservices.Thekeytrade-offinvolvedwithsupplychainorganizationaldesigniswhethertocentralizeordecentralizedifferentactivities.Centralizationimpliesthatalldecisionsaremadeataheadquarterswhiledecentralizationmovesthistotheregionsorindividualbusinessunits.Eachhasarolewiththegeneralruleofthumbshiftingmostprocurement,long-rangeplanning,andnewproductactivitiestocentralandkeepingdailyoperationsdecentralized.Processeswithinsupplychainsareessentiallytransformationsofinputsintooutputs.Procurementtransformsanorderintoproduct.TransportationconvertsmaterialataDCtoproductatthecustomerlocation.Eachoftheseprocessescanbemanagedindividuallyorlookedataswithinagreatersystem.Thedifferentprocesseswithinthesupplychainshouldbedesignedtocomplementeachother.Metricsfollowtheprocessstructure.Allmetricscanbeboileddowntoutilization,productivity,oreffectivenessmetrics.Utilizationmeasuresinputscomparedtosomenorm(capacity,standard,etc.).Productivityorefficiencycomparesinputstooutputs.Effectivenesscomparesoutputtosomenormvalue.Thedifferentmetricscanbeevaluatedforrobustness,integration,usefulness,andvalidity.Thereisnotsinglebestmetric,however,theywillallhavetrade-offsbetweenthesecriteria.Thisiswhysystemsofmetricsshouldbeusedinabalancedscorecardframework.

Centralizationvs.DecentralizationOrganizationaldesigncentersonwhethertocentralizeordecentralizeanactivity.Eachhasaplaceandtherearebasictrade-offsinvolved.


Centralized• Leverageseconomiesofscale• Harmonizespoliciesandpractices• Allowsforoptimal(global)solutions

Decentralized• Allowsdecisionmakingtobeclosertocustomer• Allowsdecisionstoreflectlocalculturesandcustoms• Allowsforoptimalsolutionswithinaregion• Allowsbusinessunitstoactautonomously

SupplyChainProcessesSupplychainprocessescanbethoughtoftransformationsofoneflowunittoanother.

Process FlowUnit Transformation

OrderFulfillment Orders Receiptoforder =>Deliveryofproduct

Production Products Receiptofmaterials =>Completionofproduct

OutboundLogistics Products Endofmanufacturing =>Deliverytocustomer

Procurement Supplies Fromissuingapurchaseorder =>Receiptofsupplies

CustomerService Customers Arrivalofcustomer Þ Departure

NewProductDevelopment

Projects Productdevelopmentstart Þ Launch

CashCycle Cash Expenditureoffunds Þ Collectionof

revenue

PerformanceMetricsMetricscanbedividedintoUtilization,Productivity,andEffectivenessmeasures.


PerformanceMetricCriteriaandTrade-offsMetricscanbeevaluatedaccordingtoseveralmetrics–buttheywillalwayshavetrade-offs.

• Robust:Themetricisinterpretedsimilarlybyallusers,iscomparableacrosstime,locationandorganizations,andisrepeatable.

• Valid:Themetricaccuratelycaptureseventsandactivitiesmeasuredandcontrolsforexogenousfactors.

• Integrative:Themetricincludesallrelevantaspectsoftheprocessandpromotescoordinationacrossfunctionsanddivisions(andevenenterprises).

• Useful:Themetricisreadilyunderstandablebydecisionmakersandprovidesaguidetoaction.

BalancedMetricsMetricsystemsshouldbedesignedtobalanceacrossthreekeyareas:Assetutilization(utilizationmetrics),Efficiency(productivitymetrics),andCustomerResponse(effectivenessmetrics).Differentindustrieswillemphasizedifferentaspectsofprocessperformance.


LearningObjectives• Understandhowsupplychainorganizationsaretypicallyandcanbeorganizedandwhy• Learnstrengthsandweaknessesofcentralizedversusdecentralizedorganizations• Gaininsightsintosupplychainprocesses• Abletodevelopanddesignperformancemetricsystemsforsupplychains