Supply Chain Integration

Learning Objectives
•What are the different stages of supply chain integration?
•What are the main causes of the bullwhip effect?
•What are the barriers to successful supply chain
integration?
•How do firms build successful partnerships in supply
chains?
•In what ways do industry initiatives like ECR, VMI & CPFR
help firms in achieving supply chain integration?
 The Supply Chain C1

C2

C3

C4

C5

C6
INBOUND INTERFACILITY DISTRIBUTION OUTBOUND
VENDORS PLANTS TRANSPORTATION CENTERS
CUSTOMERS
TRANSPORTATION TRANSPORTATION
 Enhancing Supply Chain Performance

SC Optimization
Inefficient Practices

SC Integration

.
Existing Position
SC Reconfiguration
Cost

0 100%
Service Level
 Achieving an Integrated Supply Chain

Subsequent Evolution Cost & Service Performance improved

Wastages Wastages

Efficiency Improved
Achieving an Integrated Supply Chain…

• The firm is structured on a functional basis and each of it operates at a local

performance level.
Stage1
• All departments manage their own buffer inventory!!!

• The internal operations are integrated at the organizational level, with seamless flow
of material and information.
• The firm works as one integrated unit.
Stage 2 • However, wastage still exists at the boundaries, where it interacts with the external
environment.
• More buffers at the two ends!!!

• The firm integrates itself with the suppliers and the customers, and acts as an
Stage 3 Integrated Chain.
Achieving an Integrated Supply Chain…

• Organizations have to make corresponding changes in the structure, processes

and performance measures.
• Most firms understand the need of the internal integration now, which is just
the tip of the iceberg…
• But most firms are still missing on external integration front… the benefits
might be invisible now.. But in long run are immense..
 Supply Chain Inventory for FMCG
Companies†

Data rarely
Internal Integration available, works
on estimates..
Higher Channel Inventory will ultimately result in:
• Higher Accounts Receivables
• Higher margins to be paid to the channel
† in days • Lost Sales
* Data Source: PROWESS(CMIE)
** based on limited study carried out by author in
year 2001
Planning and Control Structure for
Internal Integration

• If the firms are not internally organized, they will maintain a buffer at all
the local levels, thus resulting into inefficiencies at all levels.

• E.g., Aamir Khan’s Hum Hain Raahi Pyaar Ke!!!

• A split pump manufacturing example..

• This will result in increased inventories and reduced customer

satisfaction.
Planning and Control Structure for Internal Integration…

• Centralized Planning:

• It eliminates some of the problems arising from decisions based on local performance
measures. The decisions are made from the firm’s performance point of view.

• Impact of computing and communication technologies is high in this type of management.

• However, many firms are not still technically equipped…

• Also, many times, taking decisions at the local level are more quick and efficient.

• E.g., breakdown, change/shift of machinery/lot.

• It does not encourage innovations at the local level.

• Results in disempowerment of the local managers.

Planning and Control Structure for Internal Integration…

• Decentralized Planning

• An assured level of service is provided to internal customers.

• Builds customer-supplier linkages with service level contracts

• Responsibility Center Approach

• Service levels monitoring

• However, a Decentralized system might have higher slack and increased Lead
Times, as each unit will work on its own lead time individually.

• Thus might result into higher safety stocks at all levels, thus increasing the costs.
Planning and Control Structure for
Internal Integration…
• Hybrid approach

• Centralized planning for bottleneck resources, and

• Decentralized planning for rest of the resources

• Buffer stocks are maintained at critical junctures and customer serving points.

• However, in case of multiple products, it becomes difficult, or strict measures and policies
are to be made.

• As discussed, there is no ONE sure-shot solution.

• Firms will have to find the best way of using a hybrid approach where the best of both the
centralized and decentralized approaches can be combined.

• ERP can be a help to it!!!

Centralized Versus Decentralized Planning

• Hard constraints versus soft constraints

• Knowledge at local level
• Empowerment issues
• Higher lead-times and capacity slack in decentralized
systems
External Integration

• There should be a seamless flow of materials and information across the

boundaries of the organization.

• However, in practice, information flow gets distorted across the chain, as we

move up the chain.

• This increased volatility results in increased costs for all the members of the
chain.

• This distortion is mainly because each entity in the SC focusses on its own
short term performance measures.
Increase in Demand Volatility While Moving Up the Supply Chain

• Order to the upstream member in supply chain exhibit greater distortion

than actual variation observed in orders at the retail sale

• It has been found that in case of buyer-supplier situations, demand as

observed by the supplier has a much high variability compared to the
variability observed by the buyer at her end.

• The variance of orders increases as one moves upstream. This is called the
Bullwhip Effect.
 Demand Distortion: Unnecessary Inventory at Buyer–supplier
Interface

Material flow PVC pipe

producer
Information

Supplier Customer
Plant plant

FG inventory at RM inventory at
supplier plant customer’s plant
PVC producer
Demand as perceived by supplier
Consumption
pattern
at customer’s end
Demand Distortions Across the Buyer–Supplier Link
 Demand Distortion Due to BUYER Practices
• Forecasting of future trends in demand
• Updation of future demand based on receipt of recent demand
• Safety stock adjustments
• Supplier Lead Time Adjustments
• Impact of any promotion plan
• Order batching to take care of Economies of scale in Production and procurement
resulting in
• Large production runs
• Buying in large batches: FTLs
• To lessen the ordering costs, he might order just once a month; or vice-versa
Impact of Forecast Updating: Buyer–Supplier Link

• Buyer- supplier
• Lead-time for buyer = 2 weeks
• 1 Week for order transmission & 1 week for delivery
• Manufacturing Lead-time for supplier = 2 weeks
• Forecasting and SS policy used by buyer & supplier
• Forecast = current period demand
• Safety stock = 2 weeks of cover
Demand Distortion Across a Chain
Demand Distortion: Impact of SUPPLIER Practices
Incentives offered to buy in bulk
• Special Price promotions:
• Used for shifting the demands from peak periods to lean periods.
• To meet quarterly/annual sales
• Dispose off the excess inventory
• Results in Forward Buying
• Lot-size based quantity discounts, and not Volume based
• End-of-period discounts offered for Sales force incentives
• Supplier behaviour Uncertainty
• Shortage handling: Due to Rationing
• Price fluctuations
• Delivery reliability: Results in Higher SS
• Supplier inefficiency
• Long lead time, higher forecasting error
Demand Fluctuation at Different Stages of a Supply Chain
Bullwhip Effect
• The variance of orders increases as one moves upstream. When multiple stages are
involved in the SC, this impact is even greater.
• This is called the Bullwhip Effect.
• It is not un-common to find 3-6 months of inventory stuck in the distribution channel.
• In India, on an average 20-weeks of inventory is stuck in distribution for FMCG…
• There are 5 prominent causes for this Bullwhip Effect:
1. Multiple forecast updating
2. Order batching: All have their own Economies of Scale
3. Shortage gaming: Sort to Rationing – inflates orders
4. Price fluctuations: Discounts/price promotions/price fluctuations – Forward Buying
5. Long lead-times: Large SS
• P&G manages Walmart inventory through POS information
Counteracting Demand Distortions: Remedial Strategies
• Demand Information sharing across chain
• Aligning incentives across chain
• Contracts
• Revenue Sharing, Buy back contract, Sales Rebate contract,
• Fixed price for 3-6 months
• Benchmarked prices, as gold, oil on other countries’ exchanges
• Information sharing & Monitoring
• Shifting of decision rights
• Trust based relationship
• Improving Operational efficiencies
Challenges in Inter-firm Coordination

•Incentive compatible contracts

•Can not observe and monitor partner’s efforts?
•How do we motivate partner to invest in performance
improvement?
•May not be able to enforce contracts
Challenges in Supply Chain Integration

•Firms tend to focus on value appropriation and not on

value creation
•Power balance in chain
•Inherent conflict which can not be addressed by
incentive alignment
•Different stakeholders
•Different objectives
•Different worldview of future
•Dynamic nature of relationships
Cost Impact of Action/Initiative
HUL: Working Capital Management
Dynamic Nature of Supply Chain Relationships

•Changes in Environment
•Completive, technological
•Changes in skills and goals
•Fairness of treatment
•Assessment costs and benefits of
relationships
Genuine Differences in Aligning Incentives

•Manufacturer versus multi-brand retailer

•Supplier/customer competing in end market
•Listed firm’s focus on quarterly and annual results
•Supplier serving multiple industries
•Members do not share the same world view
Building Partnership and Trust in Supply Chains

•Design relationship
•Mutual dependence
•Central Hub ( Toyota, Benetton)
•Manage and nurture relationships
•Redesign relationship with change in environment
Building Supply Chain Relationships

•Assessing the value of relationships

•Identify operational roles and decision rights for each
party: if required reorganize activities
•Creating effective contracts
•Designing effective conflict resolution mechanisms
•Invest in relationships
Classification of Relationships
Supply Chain External Integration: Popular Initiatives

•VMI: Vendor Managed Inventory

•JIT II: Position one employee at the buyer’s place
•ECR: Efficient Customer Response
•Category Management
•Continuous Replenishment Program
•Efficient Promotions
•CFPR: Collaborative Planning, Forecasting and
Replenishment
Summary-I
• In well-managed chains, material, information and finance flows seamlessly
across department boundaries and organization boundaries.
• By working on supply chain integration it would be possible to shift the entire
efficiency frontier downward, which in turn would allow the firm to improve
performance on cost and service fronts simultaneously.
• Firms should work towards internal integration initially and at a later stage
should attempt to work towards external integration.
• To make supply chain integration possible, the organization will have to make
corresponding changes in organization structure processes and performance
measures.
• In a typical supply chain one observes a phenomenon called the bullwhip effect
as we move upstream in the chain from retailers to wholesalers and to
manufacturers. Each stage in the chain distorts demand and the variability in
demand keeps increasing as we move upstream in the chain the chain.
Summary-II
• Five different causes of the bullwhip effect : multiple demand forecast update
by various supply chain members, order batching at various stages in the
chain, price fluctuations within the chain, and shortage gaming by partners in
the chain, and long lead time involved in purchasing and manufacturing.
• Companies can avoid this bullwhip effect by information sharing , aligning
incentives and improving operational efficiency in the chain
• It is not unusual to find supply chains where two parties in the chain have
genuine differences and therefore external integration would be difficult to
attempt in such a situation.
• It has been found that successful relationship building involves the following
three elements: design relationship with cooperation and trust, manage and
nurture relationships and redesign relationships with changes in environment