Week02

Understanding the Supply Process:

Evaluating Process Capacity and Major Issues in Supply Chain

Assistant Professor
Dr. Soohoon Park
Chonnam National University
Department of Business Administration
Major Issues in Supply Chain
Link between OM and SCM

upstream downstream

2nd tier supplier 1st tier supplier

Orange Orange squeezing Juice-making Final

Retailer
Farm factory firm Consumer

Material flow

Cash flow

Information flow (what about demand information?)

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Link between OM and SCM

Internal External

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Supply Chain Operations Reference (SCOR) Model -
“Value Chain”

Purchasing from Internal Distribution to

Suppliers Value Chain Customers
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Environment & Design Factors

Environment Factors Efficient Supply Chains Responsive Supply Chains

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SCM – Key Issues (source: Simchi-Levi, 2009)

ISSUE CONSIDERATIONS
• Warehouse locations and capacities
Network Planning • Plant locations and production levels
• Transportation flows between facilities to minimize cost and time
• How should inventory be managed?
Inventory Control
• Why does inventory fluctuate and what strategies minimize this?
• Impact of volume discount and revenue sharing
Supply Contracts
• Pricing strategies to reduce order-shipment variability
• Selection of distribution strategies (e.g., direct ship vs. cross-docking)
Distribution Strategies • How many cross-dock points are needed?
• Cost/Benefits of different strategies
• How can integration with partners be achieved?
• What level of integration is best?
Integration and Strategic Partnering
• What information and processes can be shared?
• What partnerships should be implemented and in which situations?
• What are our core supply chain capabilities and which are not?
Outsourcing & Procurement Strategies • Does our product design mandate different outsourcing approaches?
• Risk management
• How are inventory holding and transportation costs affected by product design?
Product Design • How does product design enable mass customization?

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Supply Chain Process Measures
Customer
Relationship
▪ Percent of orders taken
accurately
▪ Time to complete the order
placement process
▪ Customer satisfaction with the
order placement process
Order Supplier
Fulfillment Relationship
▪ Percent of incomplete orders ▪ Percent of suppliers’ deliveries
shipped on time
▪ Percent of orders shipped on ▪ Suppliers’ lead times
time ▪ Percent defects in services
▪ Time to fulfill the order
and purchased materials
▪ Percent of botched services or
▪ Cost of services and
returned items
▪ Cost to produce the service or purchased materials
item
▪ Customer satisfaction with the
order fulfillment process
▪ Inventory levels of WIP and
FG
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Type of Inventory in the Supply Chain

Raw Work in Finished

materials process goods

Supplier Manufacturing plant Distribution center Retailer

Source Krajewski and Ritzman (2007)

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What is inventory and inventory management?

❑ In a broad sense, # of flow units within a process

❑ Examples

❑ How can you calculate average inventory level?

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What is inventory and inventory management?

❑ Consider the one hospital in Philadelphia

▪ (Average) Flow rate: 11 patients per day (i.e., 1 patient per hour)
▪ (Average) Flow time: 2.076 hours
▪ (Average) Inventory: 2.076 patients (can be obtained if you calculate inventory at every moment
in time throughout the day!)

❑ What is the relationship between the three? Any other way to easily calculate
inventory level?

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What is inventory and inventory management?

❑ Little’s law: Inventory = Flow Rate x Flow Time

▪ I = Inventory = how many flow units are in the process.
▪ R = Flow Rate = rate at which flow units enter or leave the process.
▪ T = Flow Time = total time a flow unit is in the process.

For example: I = Average number of callers on

R = On average 11 callers per minute. the phone with the call center
T = On average a caller spends. = R×T = 11×2.5
2.5 minutes with the call center. = 27.5 callers

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What is inventory and inventory management?

❑ Inventory
▪ Narrow view: Physical units within a process that are used for the production of goods or the
delivery of services—for example, gallons of milk at a dairy, syringes in a hospital, tons of coal at
a steel plant, etc.

❑ Inventory Management
▪ Definition: The planning and controlling of inventories to meet the demand while minimizing the
associated costs. To be more specific, the practice of deciding on the quantity, location, and type
of inventory in a process
▪ Objective: To have the right product in the right place at the right time so that the firm can
maximize its profit

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What is inventory and inventory management?

❑ Inventory management capabilities

▪ Forecasting – predicting future demand.
▪ Product and demand tracking
• Most firms find it challenging to maintain accurate inventory and demand data
• Case: Employee errors in managing inventory at Borders stores
– Result in “phantom product”

❑ Using RFID tags could be an effective solution to deal with data accuracyTon and Raman (2010)
▪ https://www.youtube.com/watch?v=i5dQxNA6TRM
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What is inventory and inventory management?

❑ Inventory management capabilities

▪ Analytical skills
• Motivation to study inventory modeling!
▪ Product transportation and handling assets
• Need to physically move inventory quickly, safely, and cost-effectively
• Investment includes large automated sorting equipment, robotic forklifts, trucks, etc.

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What is inventory and inventory management?

❑ Classification of inventory

Inditex 2015 annual report

raw material work in process finished good

https://www.youtube.com/watch?v=UUZetKIR55Y
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Reasons for holding inventory

❑ Flow time
▪ It takes time to create products and to move them from where they are made to where they are
needed
▪ Think about Little’s law!

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Reasons for holding inventory

❑ Seasonality
▪ Create inventory when it is combined with rigid capacity
▪ Production smoothing strategy: a strategy for scheduling production such that the rate of output
remains relatively stable over time even though demand varies predictably over the same period.

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Reasons for holding inventory

❑ Batching
▪ In many instances, it is economical to process several flow units collectively at a given moment in
time to take advantage of scale economies in operations (cycle inventory)
▪ More specifically, caused by setup time and other types of fixed cost to initiate the process (e.g.,
ordering cost)

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Reasons for holding inventory

❑ Buffers
▪ Inventory between process steps can serve as buffers
• Allows management to operate steps independently from each other
• Can absorb variations in flow rates by acting as a source of supply for a downstream process step, even
if the previous operation itself might not be able to create this supply at the given moment in time

https://www.researchgate.net/figure/Structure-of-production-line-with-buffers_fig2_323210012

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Reasons for holding inventory

❑ Stochastic demand
▪ Different from predictable variation in demand
▪ Especially significant problem in retailing environments or at the finished goods level of
manufacturers
▪ Inventory can be seen as a way to hedge against the underlying demand uncertainty (safety
inventory)

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Reasons for holding inventory

❑ Price
▪ Respond to the (expected) change in the value of their inventory

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How to measure inventory?

❑ Intuitive measures
▪ In terms of flow units (The “ I ” in I = R x T):
• Number of wetsuits, patients, tons of wheat, semiconductor chips, etc.
• Useful when the focus is on one particular flow unit.
▪ In terms of dollars:
• The $ value of inventory (intuitive measure of a firm’s total inventory)

❑ Still, not really possible to know whether a certain amount of inventory is small
amount or a large amount…
▪ Think about start-up vs. well-established firm
▪ What about the measurement with time?

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How to measure inventory?

❑ In terms of days-of-supply:
▪ The average number of days a unit spends in the system
• Put differently, the number of days inventory would last at the average flow rate if no replenishments
arrive
• Corresponds to the “T” (Flow time) = I/R from Little’s law (I = R x T)

❑ Example
▪ Let’s say $65,000 in inventory would be depleted in 65 days
▪ Flow rate must be $1000/day from the Little’s law (65,000=1000*65)
▪ Instead of a unit, 1$ can be used…
T = 65days

R = $1000/day

I = $65,000

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How to measure inventory?

❑ In terms of turns:
▪ The number of times the average amount of inventory exits the system.
▪ A financial and operational metric used to measure how efficiently a company manages its
inventory or stock of goods.
▪ How quickly a company is able to sell and replace its inventory within a specific period.
▪ Inventory Turns = 1 / T = R / I

❑ Benchmark for turn

▪ Refer to the inventory turns (or days-of-supply) of the firms in the same industry
▪ As a rule of thumb, items that are perishable turn faster than durable goods

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How to measure inventory?

❑ Using financial statement to estimate inventory turn

▪ Consider a financial statement of Kohl

Note: Some companies use the term “Cost of sales” to mean COGS

❑ COGS (Cost of Goods Sold) = Flow Rate

▪ Direct costs incurred by a company in the production of the goods or services that it sells during a
specific period (usually annual).
▪ The flow rate is not sales because inventory is measured in the cost to purchase goods, not in
the sales revenue that may be earned from the goods.

❑ Inventory
▪ Reflecting inventory value on the financial statements at the end of fiscal year.
▪ We can’t be sure about what its average inventory was throughout the year, but we can take this
snapshot of its inventory as an estimate for its average inventory
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How to measure inventory?

❑ Using financial statement to estimate inventory turn

▪ Consider a financial statement of Kohl

Note: Some companies use the term “Cost of sales” to mean COGS

❑ Using them, we can calculate days-of-supply (and inventory turn) using the Little’s
law
▪ Days-of-supply: inventory/flow rate = ($3,036 million)/(11,359 million/year) = 97 days. This
suggest that 97 days to translate a dollar investment into a dollar investment of revenues

▪ Annual inventory turns (= 365 / Days-of-supply): 365 days/ 97 days = 3.76

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Inventory Turns and Inventory Costs

❑ Using physical units as flow units is probably the most intuitive way to measure inventory.

❑ Working with physical units is not necessarily the best method for obtaining an aggregate
measure of inventory across different products. In such applications, inventory is often
measured in some monetary unit.

❑ Measuring inventory in a common monetary unit facilitates the aggregation of inventory

across different products.

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