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3
 Supply Chain
Management

Editor

Prof.Dr. Onur KAYA

Authors

CHAPTER 1 Prof.Dr. Onur KAYA

CHAPTER 2, 4
Dr. Mehmet ALEGÖZ

CHAPTER 3 Assoc.Prof. Özgür ÖZPEYNİRCİ

CHAPTER 5
Assoc.Prof. Zehra KAMIŞLI ÖZTÜRK

CHAPTER 6
Assoc.Prof. Tuğba SARAÇ

CHAPTER 7
Dr. Zeynep İdil ERZURUM ÇİÇEK

CHAPTER 8 Asst.Prof. Özgen KARAER

 T.C. ANADOLU UNIVERSITY PUBLICATION NO: 4018
OPEN EDUCATION FACULTY PUBLICATION NO: 2800

Copyright © 2020 by Anadolu University

All rights reserved.
This publication is designed and produced based on “Distance Teaching” techniques. No part of this
book may be reproduced or stored in a retrieval system, or transmitted in any form or by any means
of mechanical, electronic, photocopy, magnetic tape, or otherwise, without the written permission of
Anadolu University.

Instructional Designer
Research Assistant Bilal Saraç

Graphic and Cover Design

Prof.Dr. Halit Turgay Ünalan

Proof Readings
Assoc.Prof.Dr. Özgür Yıldırım
Assoc.Prof.Dr. Safiye İpek Kurugönen

Assessment Editor
Yaşar Özden İnceler

Graphic Designers
Ayşegül Dibek
Gülşah Karabulut

Typesetting and Composition

Gözde Soysever
Gül Kaya
Murat Tambova
Zülfiye Çevir
Diğdem Aydın
Kader Abpak Arul
Saner Murat Coşkun
Süreyya Çelik

SUPPLY CHAIN MANAGEMENT

E-ISBN
978-975-06-3798-8

All rights of this book belong to Anadolu University.

Eskişehir, Republic of Turkey, July 2020
3358-0-0-0-2009-V01
 Contents

Introduction to
Supply Chain
CHAPTER 1 Supply Chain CHAPTER 2
Network Design
Management

Introduction ................................................... 3 Introduction.................................................... 29

Basic Concepts in Supply Chain What is Supply Chain Network Design?...... 29
Management .................................................. 3 Costs................................................................ 31
Sourcing (Procurement) ....................... 5 Fixed Costs.............................................. 31
Production ............................................. 6 Variable Costs......................................... 31
Distribution ........................................... 6 Decisions......................................................... 32
Supply Chain Structure ......................... 7 Procurement Decisions
Supply Chain Management Strategies ........ 8 (Supplier Selection)............................... 32
Efficiency and Responsiveness in Facility Decisions................................... 33
Supply Chains ........................................ 9 Flow Decisions....................................... 34
Push and Pull Strategies in Supply Shipment Decisions................................ 35
Chains ..................................................... 11 Other Decisions...................................... 35
Decisions in Supply Chain Management ..... 12 Objectives........................................................ 36
Supply Chain Management and Logistics ........ 13 Constraints...................................................... 36
Future Trends in Supply Chain Supply Constraints................................. 37
Management .................................................. 16 Facility Constraints................................ 37
Flow Constraints.................................... 37
Demand Satisfaction Constraints......... 37
Capacity Constraints.............................. 38
Other Constraints.................................. 38
Factors Influencing the Network Design
Decisions......................................................... 39
Strategic Factors.................................... 39
Technological Factors............................ 39
Macroeconomic Factors........................ 39
Infrastructure Factors........................... 40
Competitive Factors.............................. 40
Logistics and Facility Costs................... 40
Solving Supply Chain Network Design
Problems.......................................................... 40
A Simple Supply Chain Network
Design Problem Example...................... 41
Solution Approaches for Network
Design Problem...................................... 44

iii
 Production
Logistics and
CHAPTER 3 CHAPTER 4 Planning in
Transportation
Supply Chains

Introduction ................................................... 59 Introduction ................................................... 79

Logistics .......................................................... 59 What is Production Planning? ..................... 79
What is Logistics? ................................. 59 Forecasting ..................................................... 80
Economic Importance .......................... 61 Evaluating Forecasts ............................ 81
Components of Logistics ...................... 63 Moving Average .................................... 83
Objectives of Logistics .......................... 64 Exponential Smoothing ........................ 84
Transportation ............................................... 66 Double Exponential Smoothing With
Demand for Transportation ................. 66 Holt’s Method ....................................... 86
Transport Measurement Units ............ 67 Push and Pull Production Control Systems:
Transportation Modes .................................. 68 MRP and JIT ................................................... 88
Modal Split ............................................ 69 Advantages of JIT and MRP ................. 88
Mode Selection ...................................... 69 The Explosion Calculus ......................... 88
Characteristics of Transportation Shortcomings of MRP ........................... 92
Modes ..................................................... 70 Workforce Planning ...................................... 92

Inventory
Procurement and
CHAPTER 5 Management in CHAPTER 6
Supplier Selection
Supply Chains

Introduction.................................................... 107 Introduction.................................................... 137

What is Inventory? ....................................... 107 Procurement Process..................................... 137
Types of Inventory................................. 108 Supplier Selection........................................... 139
The Role of İnventory Management.... 109 Tools and Techniques in The Supplier
Inventory Decisions............................... 111 Selection Process............................................ 142
Inventory Costs............................................... 112
Multi-criteria Decision Making............. 142
Purchase Costs ....................................... 112
TOPSIS Method...................................... 142
Ordering Costs........................................ 112
An Example to Solve the Supplier
Inventory Holding Costs ...................... 113
Stockout Costs........................................ 113 Selection Problem with TOPSIS
Inventory Models .......................................... 114 Method................................................... 143
Economic Order Quantity (EOQ)
Model ..................................................... 114
Economic Production Quantity
(EPQ) Model........................................... 117
Reorder Point (ROP) Model ................. 121
Multi-Echelon Inventory Management....... 123
Additional Approaches to Inventory
Management.................................................. 126
Just-In-Time (JIT) Inventory Systems....... 126
Distribution Requirement Planning
(DPR) ..................................................... 126
Vendor-Managed Inventory (VMI)...... 127

iv
 Information
Sustainability in
CHAPTER 7 Systems in Supply CHAPTER 8
Supply Chains
Chains

Introduction.................................................... 153 Introduction ................................................... 173

Information and Information Sustainability and Climate Change .............. 173
Management in Supply Chains...................... 153 Climate Change ..................................... 175
Supply Chain Information Systems............... 155 Measuring Sustainability in Supply
Information Systems Used in Supply Chains ............................................................. 180
Chains.............................................................. 157 Life Cycle Assessment ........................... 180
Electronic Data Interchange................. 157 Carbon Footprinting in Supply
Barcode................................................... 158 Chains ..................................................... 182
Radio Frequency Identification Operational Aspects of Sustainable
(RFID) .................................................... 159 Supply Chains ................................................. 186
Enterprise Resource Planning............... 160 Green Logistics ...................................... 186
Transportation Management Green Inventory Management ............ 187
Systems................................................... 162 Decarbonizing Supply Chains ............... 188
Inventory Management Systems ........ 163 Closed-Loop Supply Chains and
Internet of Things ................................. 163 Sustainability ................................................. 189

v
 Preface
Dear Reader,
A supply chain can be defined as a network
that obtains the inputs needed for production,
converts them to the final products or services,
and then delivers them to those in need
through a distribution system. It is generally
composed of many companies that operate in a
multi-stage setting. Supply chain management
aims to coordinate the activities of multiple
firms that operate to satisfy the demand of
customers in the best way possible by creating
a harmony between supply chain members
to increase customer satisfaction levels, to
decrease costs and to improve the profitability
of the whole chain. Supply chain management
also aims to optimize the production plans
and inventory levels in the chain to eliminate
unnecessary costs. In today’s competitive and
dynamic environment, businesses need to
create a strong and reliable supply chain in
order to satisfy the customer expectations,
improve the value they create, and in order to
survive and compete with their competitors.
The enterprises also want to keep up with the
changes in technology and want to create
innovative products or services that will be
highly demanded by the consumers. They also
aim to improve their business structures and
their operations by utilizing the technological
improvements.
The subjects of supply chain management
include various concepts such as supplier
selection and supplier relations, operations
management, distribution, logistics, marketing
and customer relations. Issues regarding the
design of supply chains, integration in the
supply chain, coordination among supply
chain members, sustainability of supply chain
operations are also considered in supply chain
management. These concepts are analyzed
and explained in detail in this book and several
examples are provided in order to make the
students understand the main supply chain
management subjects. The objective of
this book is to provide general information
about supply chain management subjects
and techniques in addition to presenting the
effects of the emergence of new technologies.
vi
This book is composed of eight chapters.
In the first chapter, we provide a general
introduction about the basic supply chain
management concepts. Basic decisions and
supply chain management strategies are
presented in this chapter while providing the
basic relations between supply chain members.
The second chapter is related to supply chain
network design in which high level strategic
decisions in the supply chain, such as locations
and capacities of the facilities, are analyzed.
Chapter three explains the transportation
and logistics issues in supply chains by
focusing on the flow of products in the supply
chain. Fourth chapter is about production
planning in supply chains and consider
different methods for demand forecasting,
materials and workforce planning. Chapter
five is related to inventory management and
presents different inventory models in supply
chains and their solution methods. Chapter
six focuses on the procurement and supplier
selection issues. Criteria that are important
in procurement and supplier selection are
explained and methods to select the best
suppliers are presented. Seventh chapter is
about information systems used in supply
chains. Classical information systems used
for supply chain management, as well as new
emerging technologies are explained in detail.
Finally, chapter eight is the last chapter and
explains sustainability in supply chains with
main sustainability concepts and ideas.
I want to sincerely thank everybody who
contributed to the publishing of this book,
especially the writers of the chapters for
spending their valuable time and effort. I hope
this comprehensive book satisfies the needs of
the readers in learning and understanding the
basic concepts in supply chain management.
Editor
Prof.Dr. Onur KAYA
 Introduction to Supply
Chapter 1 Chain Management
After completing this chapter, you will be able to;
Learning Outcomes

1 Understand the basic concepts in supply chain

management 2 Explain supply chain management strategies

3 Analyze the decisions in supply chain

management 4 Explain the relationship between supply chain
management and logistics

5 Understand the future trends in supply chain

management

Chapter Outline Key Terms

Introduction Supply Chain Management
Basic Concepts in Supply Chain Management Supply Chain Network Design
Supply Chain Management Strategies Supply Chain Coordination
Decisions in Supply Chain Management Logistics
Supply Chain Management and Logistics Efficiency
Future Trends in Supply Chain Management Responsiveness

2
Supply Chain Management
INTRODUCTION
A supply chain is generally composed of many
different organizations or departments that are
responsible for all the activities that are required to
satisfy the customer demand in production or service
systems. These activities include many different
functions such as procurement of materials from
suppliers, production, warehousing, distribution,
marketing, financing, after sales service etc. Some of
these activities are done within the same company
while others might be done by other companies in
the supply chain. Supply chain management (SCM)
deals with organizing and coordinating all these
activities in order to satisfy the customer demand
effectively and efficiently. Supply chain managers
aim to design systems and make decisions to obtain
the highest profit for the whole system.
In today’s world, the increasing competition
in global markets and advances in information
technologies have forced the companies to coordinate
their activities with the other companies that they
work with, such as their suppliers, distributors,
retailers etc. Focusing only on the internal
operations is not enough to compete in today’s
world. The companies that can not coordinate their
activities with the other supply chain members have
difficulties in competing with their competitors.
Relations of companies with each other in a supply
chain have started to become much more important
Suppliers Manufacturers
Manufacturing costs
Transportation costs
Material costs Transportation costs
Figure 1.1 A Typical Supply Chain
Source: Simchi-Levi, Kaminsky and Simchi-Levi (2008).
and attracted much more attention over the years.
Competition between the companies has extended
to become competition between supply chains. A
supply chain’s success depends on all the functions
and entities in a supply chain and all parties in the
supply chain need to work together and coordinate
their activities in order to ensure success.
BASIC CONCEPTS IN SUPPLY
CHAIN MANAGEMENT
In a typical supply chain, different companies such
as suppliers, manufacturers, distributors and retailers
work together in an integrated manner in order to
satisfy the customer demand as shown in Figure 1.1
Procurement of materials for production, processing
these materials into final products, transportation of
products between different locations, warehousing
and distributing the final products to customers
are some of the main processes that exist in supply
chains. Traditionally, these processes were analyzed
and operated independently, in isolation from
each other. However, each of these operations has
significant effects over the others. Thus, they need to
be analyzed and operated in an integrated manner in
order to be more competitive in the market. Supply
chain management deals with the integration and
coordination of these processes in order to increase
the efficiency and profitability of the supply chain.
Warehouses and Customers
distribution centers
Inventory costs
3

important
In a typical supply chain, different companies such
as suppliers, manufacturers, distributors and retailers
work together in an integrated manner in order to
satisfy the customer demand.
important
Supply chain management deals with the integration
and coordination of all processes in order to increase
the efficiency and profitability of the supply chain.
Supply chain management can be defined as
a set of approaches utilized to efficiently integrate
the supply chain members in order to maximize
total supply chain profitability. Supply chain
management aims to produce and distribute the
products to the right locations, at the right time,
in the right quantities, in order to maximize
systemwide profitability while satisfying customer
service levels (Simchi-Levi, Kaminsky and Simchi-
Levi, 2008). According to the Council of Supply
Chain Management Professionals (CSCMP),
supply chain management encompasses the
planning and management of all activities involved
in sourcing, procurement, conversion and logistics
management. It also includes coordination and
collaboration with channel partners, which may
be suppliers, intermediaries, third-party service
providers, or customers. In essence, supply chain
management integrates supply and demand
management within and across companies.
Supply chain management can be defined as a set
of approaches utilized to efficiently integrate the
supply chain members in order to maximize total
supply chain profitability.
important
Supply chain management aims to produce and
distribute the products to the right locations, at
the right time, in the right quantities, in order to
maximize systemwide profitability while satisfying
customer service levels.
4
Introduction to Supply Chain Management
Supply chain management deals with the
systematic and strategic coordination of the
business functions and tactics of all companies
in the supply chain in order to increase the long-
term performance of the whole system (Mentzer
et al., 2001). Accurate and efficient use of time,
space and financial resources is among the most
important issues in supply chain management.
According to APICS (2020), the performance of
supply chains is measured by the following five key
performance areas:
a. Reliability: Defined as the ability to
perform tasks as expected. On-time
delivery, providing the right quantity and
the right quality are some of the typical
metrics for reliability.
b. Responsiveness: Defined as the speed at
which tasks are performed. The time needed
to satisfy the customer needs or cycle-time
metrics are examples of typical metrics for
supply chain responsiveness.
c. Agility: Defined as the ability to respond to
external influences or changes in the market
to gain or maintain competitive advantage.
Flexibility and adaptability are some of the
typical metrics for agility.
d. Cost: Defined as the cost of operating the
supply chain processes, including labor
costs, material costs, management and
transportation costs among others. Cost of
goods sold can be used as a typical metric
for cost.
e. Asset Management Efficiency: Defined
as the ability to efficiently utilize assets.
Capacity utilization or inventory days of
supply are among the typical metrics for
asset management efficiency.
Even though supply chain management has
become popular since the 1990s, its roots go back
many years. For example, during World War II, the
importance of logistics were realized and logistics
operations were studied in detail, which were then
extended to business operations after the war.
Later on, inventory management and decreasing
costs were the main focus in supply chains.
Materials requirement planning (MRP) systems
and operations management tactics started to be
used. MRP systems were then improved leading
to more advanced MRP II and ERP systems
Supply Chain Management
that are used today. Globalization in the last 50
years forced many organizations to improve their
supply chains by integrating global sources into
their businesses. The supply chain management
term was first used in this era in 1982. Companies
needed to extend their operations beyond the
company walls and relations with other companies
became much more important. They started to
integrate different operations such as purchasing,
manufacturing, distribution, financials etc., with
the other companies to improve their businesses.
This led to SCM systems as we know today. Later
on, various other concepts such as Total Quality
Management (TQM), Lean Production and
Lean Supply Chains arose, aiming to improve the
efficiency of supply chains.
Today, the definition of SCM is extended
to include things like supply chain strategy, co-
innovation and supply chain design. Lately,
environmental and social considerations are
becoming much more important, and managers
are trying to increase sustainability in their supply
chains and decrease their carbon footprints. In
the traditional supply chains, products flow in
the forward direction from suppliers to customers
to satisfy the customer demand. However, today,
there is an increasing awareness in the society about
environmental concerns, carbon emissions, and
sustainability of supply chains. Activities such as
collection of used products, returns or take-backs
from customers, recycling or remanufacturing
of products, resale of used items have started to
get increasing attention over the last years. Thus,
supply chain management has started to focus on
the reverse flow of products from the customers
to the manufacturers or suppliers, in addition to
the forward flows. Closed-loop supply chain (CLSC)
management refers to the integration of forward
and reverse supply chain activities and improves
the sustainability of supply chains (Banasik et al.,
2017). Supply chain managers need to integrate
these reverse channel activities into their traditional
supply chains. Concepts like reverse logistics,
green supply chains, remanufacturing, CLSC
have taken increased attention. In addition, social
considerations such as worker rights, child workers,
working environments etc. are also being widely
considered in today’s supply chain decisions.
Closed-loop supply chain (CLSC) management
refers to the integration of forward and reverse
supply chain activities and it improves the
sustainability of supply chains.
Delivery of products and services to customers
is a complex process that includes many integrated
tools, functions and activities. Demand for the
product needs to be estimated, then, plans and
programs are developed in a certain period of time
to meet this demand. The materials may need to
be purchased from multiple suppliers. Each of
these suppliers prepares their products and sends
them to the production site. For example, General
Motors company has more than 2,500 suppliers.
These suppliers send products to the company’s
30 automobile and truck factories, in addition to
sending materials to 120 factories that produce
different parts of vehicles. These parts and materials
go through complex processes and the finished
products are sent to customers within the country
and abroad. These customers might also make
changes to the products and send them to their
own customers. Supply chain management deals
with all the activities during the flow of products
from the raw material state to the delivery to end-
users (Doğruer, 2005).
important
Supply chain management deals with all the activities
during the flow of products from the raw material
state to the delivery to end-users.
As stated above, sourcing, production and
distribution are the basic processes in a typical
supply chain and these processes are explained in
more detail below.
Sourcing (Procurement)
Sourcing refers to the processes to obtain or
buy goods or services required for production.
In order to satisfy the customer expectations,
companies need to procure the right products, at
the right time, at the right location, at the right
price, at the right quality and in the right quantity.
5

These terms are referred to as the “six rights of
sourcing”. Mutual trust and cooperation between
the suppliers and the buyers has an important role
in the success of supply chains. Thus, companies
need to act carefully and consider the integration
of their own processes with their suppliers when
choosing their suppliers. Supplier selection is an
important concept in the sourcing of the required
materials and affects the success of supply chains
significantly. There might be different suppliers
with different characteristics that can supply the
same materials to the company. Which of these
suppliers should be used is an important decision
for many supply chains. Companies use different
criteria with different importance levels when
selecting their suppliers. Price, reliability, quality,
timeliness in delivery, past performances, technical
competency, research and innovation capabilities,
guarantee and return policies, production capacity
and flexibility are some of the major factors that
affect supplier selection. Each of these factors
might have different importance for different
supply chains. For example, if a supply chain aims
to decrease its costs, suppliers that provide the
lowest price could be selected. However, if a supply
chain aims to produce high quality products or
if customer satisfaction is more important, then
suppliers that are more reliable, flexible or that
provide higher quality products need to be selected.
Companies need to create a balance between these
factors depending on their target customers and
customer expectations.
Sourcing refers to the processes to obtain or buy
goods or services required for production.
important
Companies need to procure the right products, at the
right time, at the right location, at the right price, at
the right quality and in the right quantity, which are
referred to as the “six rights of sourcing”.
Production
Production includes the core operations in
supply chains that are needed to transform the
6
Introduction to Supply Chain Management
raw materials to finished goods. Facility planning,
demand forecasting, production planning,
manufacturing method selection, inventory
management, production scheduling are some of
the problems that need to be analyzed during the
production phase. There are various decisions that
are made related to these problems. Where to make
the production; when and how much raw material
inventory to order; when, how much and which
products to produce; what type of machines and
manufacturing methods to use; what should be the
production schedule; how many and what type of
workers, materials, machines are needed; how to
forecast the demand; what should be the quality
control, maintenance, inventory and warehousing
strategies, are some of the main questions that need
to be answered during the production phase.
The trade-off between competence (meeting the
demand) and efficiency constitutes one of the main
problems faced by the managers. If production
facilities have more than enough capacity, they
can be flexible and meet the demand by quickly
responding to sudden fluctuations in product
demand. However, the excess capacity that is not
used for certain durations causes additional costs.
On the other hand, if there is no excess capacity at
the facilities, the costs might be lowered, but the
fluctuating demand cannot be met quickly in case
of increased demand at certain times.
Distribution
Distribution refers to the movement of
products between the facilities in the supply chain
and the delivery of finished goods to the customers.
There are different options in supply chains to
deliver the products to customers. For example,
in some supply chains, products are delivered to
customers by direct shipping from manufacturers,
while in some others customers buy the products
from retailers in different locations. In addition,
several warehouses at different locations can be
used for an efficient distribution system depending
on the supply chain characteristics. How should
the distribution network be designed; how many
warehouses, retailers to be used and where should
they be located; which mode of transportation
(air, truck, rail, ship, pipeline or electronic
transportation) to use; which products should be
delivered to which customers from which facilities;
Supply Chain Management

which vehicle routes to follow during deliveries, are
some of the decisions that need to be made related
to distribution operations.
Distribution refers to the movement of products
between the facilities in the supply chain and the
delivery of finished goods to the customers.
Supply Chain Structure
The structure of the supply chain is defined
by the number of facilities in the chain and their
relations with each other, which create the length,
width and dimensions of the chain. There might
be different companies in a supply chain that
perform different activities. Suppliers, producers,
distributors, retailers and customers are the main
components of a typical supply chain, in addition
to various service providers that provide services
to these components, as shown in Figure 1.2. In
its simplest form, a supply chain is composed of
the suppliers and customers of the main company.
Extended supply chains include three other types
of participants: (i) the supplier’s supplier or the
ultimate supplier at the beginning of an extended
supply chain, (ii) the customer’s customer or
ultimate customer at the end of an extended supply
chain, (iii) service providers to other companies in
the supply chain, which supply services in logistics,
finance, marketing, information technology, etc.

Supply Chain Structure

Simple Supply Chain

Supply Company Customer

Extended Supply Chain

Ultimate Ultimate
Supplier Company Customer
Supplier Customer

Service
Provider
Service Providersin
areas such as;
• Logistics
• Finance
• Market Research
• Product Desing
• Information Technology

Example of an Extended Supply Chain

Product Market
Designer Research

Raw
Manufacturer Distributor Retailer Retail
Material
Customer
Producer

Logisitics Finance Business

Provider Provider Customer

Figure 1.2 Different Supply Chain Structures

Source: Hugos (2003).

7

important
Suppliers, producers, distributors, retailers and
customers are the main components of a typical
supply chain, in addition to various service providers
that provide services to these components.
Learning Outcomes
1 To understand the basic concepts in supply chain management
Self Review 1 Relate
Relate the activities of different
Explain the basic processes in a
supply chain members with
typical supply chain.
each other.
SUPPLY CHAIN MANAGEMENT
STRATEGIES
Globalization of businesses have forced the
companies to change their strategies in order to
effectively coordinate their operations. A key factor
in this change is establishing closer relations with
suppliers and customers. Companies and their
suppliers compete as a supply chain with other
supply chains to deliver better quality products
in a faster manner. Customers expect high quality
customized products, cheaper prices, faster and
reliable deliveries, and companies need to satisfy
these expectations in order to continue their
existence. These expectations require closer relations
and coordination with suppliers and other related
companies. In addition, increasing uncertainty in
customer demand and rapid changes in technology
and economy require more flexibility in supply
chains. Every supply chain needs to develop its own
strategy depending on its customers’ expectations
in order to become successful and improve its
performance.
8
Introduction to Supply Chain Management
Different factors such as customer expectations,
demand variety, logistics costs and capabilities,
economic factors, business culture, competition
in the market, financial regulations, etc. affect the
supply chain structure. In some cases, for example
when the products are delivered directly from the
manufacturers to customers, the supply chain can be
short and simple, while in others various suppliers,
warehouses, distributors, retailers might exist, leading
to a much longer and complex supply chain structure.
Tell/Share
Tell the stages that a product
that you use goes through in
its supply chain before being
bought by the customers.
important
Every supply chain needs to develop its own strategy
depending on its customers’ expectations in order to
become successful and improve its performance.
Supply chains first need to identify their
target customers, analyze and understand the
characteristics and the needs of the customer
segments that they intend to serve. The supply
chain strategy should be designed to satisfy these
target customer expectations. All the supply chain
management decisions need to support this issue
and the attributes of the supply chain should be
based on these expectations. For example, if a
supply chain is targeting low-end customers, then
they should decrease the price even if the quality of
the product also needs to be decreased. However,
if the target customers are high-end customers,
then highest quality products should be served at
a higher price.
Supply Chain Management
The consistency between supply chain strategies
and target customer expectations is defined as
the strategic fit (Chopra & Meindl, 2007).
Companies need to focus on understanding their
target customer expectations and their supply
chain capabilities in order to design the appropriate
strategy and to achieve strategic fit. To achieve
strategic fit, a company must ensure that its supply
chain capabilities support its ability to satisfy the
targeted customer segments (Chaharsooghi and
Heydari, 2011).
Strategic fit is the consistency between supply chain
strategies and target customer expectations.
Every company needs to define its core
competency that differentiates itself from others,
and every supply chain has to develop different
competencies and strategies in order to gain
advantage in competition. The competitive strategy
of a supply chain defines the target customer needs
and aims to satisfy them through its products and
services. The competitive strategy is developed
to satisfy more of the customer’s expectations
than the competitors. Target customers and their
specific needs, such as the product type, orders,
information, special services, and so on need to be
considered in developing the competitive strategy.
Then, based on the competitive strategy, a product
development strategy needs to be established
in order to determine the portfolio of products
that the company will develop. Then, marketing
and sales strategy determines how the market
will be segmented, products will be positioned,
priced and promoted. Finally, the supply chain
strategy specifies how materials will be procured,
transported, manufactured and distributed. For
the success of the supply chain, all these strategies
should be consistent with each other and support
each other. For example, the performance of the
supply chain will be closely related to the supply
chain strategy in responding to the established
competitive strategy.
important
Every company needs to define its core competency
that differentiates itself from others, and every supply
chain has to develop different competencies and
strategies in order to gain advantage in competition.
Efficiency and Responsiveness in
Supply Chains
In addition to customer expectations, supply
chain capabilities are also important in the
determination of the supply chain strategy.
Minimizing costs and increasing responsiveness
are two of the main objectives of supply chains.
Supply chain efficiency is defined as the cost
of making and delivering the products to the
customers. Companies aim to minimize their costs
and want to be efficient. However, the definition of
efficiency does not say anything about improving
customer service or effectiveness of the supply
chain. A supply chain might be very efficient in
minimizing costs but if it does not satisfy customer
expectations, it will not be an effective supply
chain. Effectiveness of a supply chain is about how
well the supply chain is meeting the expectations
and demands of the customers.
Supply chain efficiency is defined as the cost
of making and delivering the products to the
customers.
Apart from minimizing costs, supply chains
also aim to increase their responsiveness. Chopra
and Meindl (2007, p. 30) define supply chain
responsiveness as its ability to:
• respond to wide ranges of quantities
demanded
• meet short lead times
• handle a large variety of products
• build highly innovative products
• meet a high service level
• handle supply uncertainty
9
 Introduction to Supply Chain Management

important example, if target customers expect low prices, costs

become more important and an efficient supply
chain strategy might be more suitable. On the other
A supply chain’s responsiveness is measured by
hand, if target customers expect highly innovative
its ability to respond to wide ranges of quantities
products, higher service levels or larger varieties of
demanded, meet short lead times, handle a large
products in a short time, then a responsive supply
variety of products, build highly innovative
chain strategy might be more appropriate.
products, meet a high service level and handle supply
uncertainty.
important

Increasing responsiveness means having more A right strategy for a supply chain depends on its
of these abilities, however, it might require a higher customer expectations, product characteristics and
cost. For example, to meet short lead times, faster supply chain capabilities.
production and distribution methods need to
be used, which might be more expensive. Thus,
Figure 1.3 denotes the zone of strategic fit
increasing responsiveness might lead to decreased
with respect to uncertainty of demand. If demand
efficiency. Supply chains need to develop their
uncertainty is low, decisions that will minimize
strategies to position themselves at a certain
the costs can be made much easily and an efficient
point between extremely efficient and extremely
supply chain would be a better fit for this system.
responsive standings. There is no single position
However, as the demand becomes more uncertain,
that is right for every supply chain, thus every
more flexibility will be required and the supply
supply chain has to find the best position for them
chain needs to be more responsive to handle
in order to achieve strategic fit. Every supply chain
the changes in demand. However, increasing
needs to determine the right strategy for itself
responsiveness leads to higher costs and decreased
depending on its customer expectations, product
efficiency.
characteristics and supply chain capabilities. For

Responsive
supply chain

of it
Responsiveness o ne ic F
spectrum Z teg
ra
St

Efficient
supply chain
Certain Implied Uncertain
demand uncertainty demand
spectrum

Figure 1.3 Zone of Strategic Fit

Source: Chopra and Meindl (2007).

10
Supply Chain Management
Push and Pull Strategies in Supply
Chains
Processes in a supply chain can be divided
into two groups depending on whether they are
executed in anticipation of a customer order (push)
or in response to a customer order (pull). A push
strategy is a speculative one and production is
initiated in anticipation of customer orders based
on forecasts. On the other hand, a pull strategy is a
reactive one and execution is initiated in response
to actual customer orders. Make-to-order systems
in which customer orders are received first and
manufacturing is done later according to these
orders, is an example of a pull strategy. Under this
strategy, a certain time is required for production
processes. Thus, the products can only be delivered
to customers after a certain time period, called
as the lead time. On the other hand, under the
push strategy, products are produced based on
forecasts, before the actual demand arrives and
these products are placed in the warehouses or on
the shelves of retail stores and wait for the actual
customers to arrive. In this system, products
are manufactured and delivered to retail stores
first, and then the customers arrive to the system
and buy the products. Both strategies have their
advantages and disadvantages. In a pull strategy,
there is a waiting time for the customers before
obtaining their products. However, they can
specify the product characteristics as they want and
customized products can be produced and served to
the customers. In addition, inventory and wastage
costs are minimized under this strategy because
Learning Outcomes
2 To explain supply chain management strategies
Self Review 2 Relate
How should the supply chain
Build a relationship between
managers define their supply
efficiency and responsiveness.
chain strategy?
companies do not need to carry any finished goods
inventory and they do not have any risk of unsold
products since production is only done after the
actual demand is observed. On the other hand,
under the push strategy, customers can obtain
the product immediately since they are already
produced before and ready for sale at the stores.
However, it is also possible that customers may not
find exactly what they want and they need to select
among the alternatives that exist. Since production
is done based on forecasts, due to the uncertainty
in demand, some of the products might be left
unsold if the actual demand is lower than expected,
and some of the products might be out of stock if
there is higher demand than forecasted, leading to
high inventory and wastage costs and losses for the
supply chain.
important
A push strategy is a speculative one and execution is
initiated in anticipation of customer orders. On the
other hand, a pull strategy is a reactive one and execution
is initiated in response to actual customer orders.
internet
Read more:
https://blogs.oracle.com/scm/5-strategies-for-better-
supply-chain-management-in-the-current-economy
Tell/Share
Share what you think about
the supply chain strategy of a
company that you know.
11

DECISIONS IN SUPPLY CHAIN
MANAGEMENT
In order to improve the efficiency and
profitability in supply chains, various decisions
related to different operations are made. These
decisions require a systems approach that considers
all the relations and interactions of different
operations with each other. Decisions related to
the number and locations of facilities, structure of
the supply chain, distribution of materials in the
supply chain, operations at each facility, inventory,
transportation, etc. are only a few of the decisions
that need to be made in supply chains.
Supply chain management decisions can be
classified as strategic, tactical and operational level
decisions depending on their significance and the
time span that they cover. Strategic level decisions
are long-term decisions that will be effective for
many years and are mostly made by the top level
managers. Types of products to produce, number
and locations of facilities, distribution and
information systems to be used are some examples
of strategic level decisions. These decisions are
generally about the structure of the supply chain and
are difficult to change after they are implemented.
Thus, strategic decisions need to be made carefully
considering future uncertainties. Tactical level
decisions are medium-term decisions (generally
between 6 months and 2 years) and are generally
made by medium level managers. Inventory
policies, distribution tactics, marketing tactics
and promotions, human resources decisions are
some examples of tactical decisions. When making
these decisions, supply chains need to consider
demand and supply uncertainty, competition and
changes in the system over time among others..
Operational level decisions are generally daily
or weekly decisions made by low level managers.
These decisions are made to operate daily
activities. Assigning workers to jobs and machines,
production scheduling, deciding order due dates,
giving replenishment orders to suppliers are some
examples of operational decisions.
Strategic level decisions are long-term decisions that
are generally about the structure of the supply chain
and made by top level managers.
12
Introduction to Supply Chain Management
Operational level decisions are short-term decisions
made to operate daily activities.
The decisions in supply chain management
are mainly related to Production, Inventory,
Location, Transportation or Information. These
five components are also called the major supply
chain drivers, as seen in Figure 1.4. The decisions
about these drivers are all related to each other.
Production related decisions take into account
different factors such as the manufacturing capacity,
workload balance, quality control and equipment
maintenance. Which product, how many and
when should be produced, what should be the
production plan are some of the production related
decisions. These decisions are also in relation with
Inventory decisions, which focus on the stocking
quantities at each stage of the supply chain, either
as finished goods, raw materials or work-in-process
inventory. Some of the Location related decisions
can be stated as: Where should the manufacturing
facilities, warehouses and retailers be located?
What should their capacities be? Should new
facilities be built or should existing ones be used?
These decisions also affect the distribution and
transportation system of the supply chain. How
should materials be moved from one supply chain
location to another, which mode of transportation
to use, which products should be distributed from
which warehouse to which customer, are some
of the Transportation related decisions. Finally,
Information related decisions analyze the type and
amount of data to collect, process and share in the
supply chain. Timely and accurate information
helps the supply chain managers to make better
decisions about all aspects of the supply chain.
important
The five major supply chain drivers are Production,
Inventory, Location, Transportation and Information.
Supply Chain Management

THE MAJOR SUPPLY CHAIN DRIVERS

1. 2.
All the decisions in the supply PRODUCTION INVENTORY
chain should be consistent with What, how, and when to How much to make and
produce how much to store
the supply chain strategy and the
capabilities of the supply chain.
For example, if the strategy of the 5.
supply chain is to serve a market INFORMATION
The basis for making
where mass production is intense
these decisions
and price is the main factor, it
would be better to have a type of
supply chain to ensure low cost
compliance. On the other hand, 4. 3.
TRANSPORTATION LOCATION
if the strategy of the supply chain How and when to move Where best to do what
is focused on a certain part of the product actiwity
market where customer service is
important, developing a supply RESPONSIVENESS versus EFFICIENCY
chain based on quick response The right combination of responsiveness and efficiency in each of
would make more sense. these drivers allows a supply chain to “increase throughput while
simultaneous reducing inventory and operating expense.”
Figure 1.4 Major Supply Chain Drivers
Source: Hugos (2003).

Learning Outcomes

3 To analyze the decisions in supply chain management

Self Review 3 Relate Tell/Share

What are the major supply

Associate strategic, tactical Tell a strategic level decision
chain drivers and what types
and operational level decisions that a company has made in
of decisions need to be made
with each other. real life in the last few years.
about these drivers?

SUPPLY CHAIN MANAGEMENT There are different definitions of logistics.

AND LOGISTICS CSCMP defines logistics as the part of supply
chain management that plans, implements, and
Logistics is a part of supply chains that is mainly
controls the efficient, effective forward and reverse
related to the distribution and transportation of
flow and storage of goods, services and related
products or services between facilities. On the other
information between the point of origin and the
hand, supply chain management is a much larger
point of consumption in order to meet customers’
concept that includes all the operations between
requirements. Harrison and Van Hoek (2008)
the sourcing of raw materials and the delivery of
define logistics as the task of coordinating material
the products or services to the end-users. Supply
flow and information flow across the supply chain.
chain management deals with all the sourcing,
manufacturing, information and marketing decisions
in addition to logistics or distribution decisions.

13

Logistics management is the part of supply
chain management that plans, implements, and
controls the efficient, effective forward and reverse
flow and storage of goods, services and related
information between the point of origin and the
point of consumption in order to meet customers’
requirements.
Logistics processes are aimed to provide the
right materials at the right place at the right
time. In order to achieve this objective, different
distribution network designs and transportation
options can be utilized. In some supply chains
products are delivered to the customers directly
from the manufacturers, while in others various
warehouses and retailers are used to distribute the
products to the customers. In addition, different
modes of transportation, such as trucks, railroads,
ships, airways or pipelines can be utilized for
the transshipment of the products. Some of the
different distribution strategies can be stated as
follows:
• Direct Shipping: Materials are directly
shipped from the manufacturing facility to
the customers without any intermediaries.
• Hub and Spoke Model: Materials are
sent to hubs that serve as central nodes for
nearby places, and the demand of spokes is
satisfied by the shipments made from the
related hubs.
• Pooled Distribution: Materials are sent
to the warehouses at predetermined
geographical regions and these warehouses
are used to satisfy demand at those regions.
• Cross-Docking: Materials, coming from
different facilities but going to different
customers, are seperated and re-combined
14
Introduction to Supply Chain Management
depending on customer requirements at
intermediate locations with minimum
handling, aiming a seamless connection
between incoming and outgoing materials.
• Milk Runs: Materials to be collected from
(or delivered to) multiple facilities are
collected (or delivered) via a certain route to
minimize total routing and transportation
costs.
important
The mission of logistics is to provide the right
materials at the right place and at the right time, while
optimizing a given performance measure subject to a
given set of constraints.
Logistics operations can be classified as
inbound, outbound and manufacturing logistics,
as shown in Figure 1.5. Logistics operations from
the suppliers to the company about acquiring the
required materials for production are called inbound
logistics, and the logistics operations that are about
delivering the finished goods from the company to
the customers are called outbound logistics. The
logistics operations that are performed inside the
company for manufacturing processes are called
in-plant or manufacturing logistics.
Logistics operations from the suppliers to the
company about acquiring the required materials
for production are called inbound logistics, and the
logistics operations that are about delivering the
finished goods from the company to the customers
are called outbound logistics.
Supply Chain Management

Inbound Logistics Outbound Logistics

Raw Pack
Materials Finished Retailer
Supplier
Goods Distribution Center
Warehouse 1
(DC) 1

Raw Pack Finished

Materials Goods
Supplier
Warehouse 2
Plant and Distribution Retailer
Center (DC) Distribution Center
(DC) 2
Raw Pack Finished
Materials Goods

Supplier
Warehouse n Retailer
Distribution Center
(DC) n
Figure 1.5 Inbound, Manufacturing and Outbound Logistics
Source: Felicio and Sharma (2018).

Logistics management activities include the incoming and outgoing transport management, fleet
management, stocking, material distribution, order completion, logistics network design, inventory
management, supply-demand planning and third party logistics service provider activities. Depending
on the network design and transportation decisions, customer service levels, costs and profitability in
the supply chain will be affected. The cost of the logistics operations, which is mainly composed of the
transportation, warehousing, inventory, order processing and administrative costs, will also be affected
by the logistics decisions. The main objective of logistics is to satisfy customer expectations at minimum
cost. Based on the supply chain strategy, companies need to decide on how to satisfy customer demand,
determine their optimal logistics network design, number and locations of facilities, inventory levels,
and transportation modes and routes in order to minimize their total costs while satisfying customer
expectations.

Learning Outcomes

4 To explain the relationship between supply chain management and logistics

Self Review 4 Relate Tell/Share

What are the differences Associate inbound logistics Share the logistics activities that
between logistics and supply and outbound logistics with are required for the delivery of a
chain management? each other. product that you use.

15

FUTURE TRENDS IN SUPPLY
CHAIN MANAGEMENT
Globalization in today’s world forces the
companies to be international and to do business
with many different enterprises in dynamic and
constantly changing global environments. The
rapid change in information technologies and the
rise of the Internet also changed the classical way
of doing business and many different companies
started to change their supply chain structures and
sales channels. Today, many companies make online
sales instead of using classical brick-and-mortar
stores. As the speed and capabilities of computer
systems increase, data can be processed more
rapidly and better decisions can be made in supply
chain management. Also, customer requests can be
answered instantly, real-time transactions can be
made and flexibility can be provided in planning
and controls. Interactive and real-time computer
systems can help supply chain managers make
better decisions about their stock levels, storage
locations and other related logistics activities. Also,
supplier and customer relations can be handled
in a much better and faster manner, information
between different parties can be exchanged much
more effectively and coordination between supply
chain members can be achieved much easily.
Advances in IoT (Internet-of-Things)
technologies, artificial intelligence and machine
learning techniques are changing the supply chain
businesses and operations. Supply chain firms have
plenty of data at their fingertips, not only about
their own processes, both also about their suppliers
and customers, their expectations and behaviours.
Utilizing big data in the correct way allows these
firms to better understand their customers and
their supply chain system. They gather vital
business intelligence from these data and can use
these data to make much more improved decisions.
Changing market structures and customer
expectations also affect the supply chains. Today,
customers expect more specialized products and supply
chains need to be flexible to produce different varieties
of products depending on customer needs in order
to be able to compete in the global market. More
innovative products are being developed and life cycles
of products are becoming shorter. As a result, supply
chain managers need to create new products in shorter
times and design their supply chains accordingly.
16
Introduction to Supply Chain Management
important
Supply chains need to be flexible to produce different
varieties of customized products depending on
customer needs in order to be able to compete in the
global market.
Globalization also changed the supply chain
businesses through changing trade regulations and
removal of customs barriers and tariffs. Another
orientation that changed the supply chain dynamics
is trade agreements. Depending on the level of
cooperation between the countries participating in
the agreement, countries are responsible for the free
movement of products, services and people. These
changes facilitate the movement of products across the
world much easily. Companies can sell their products
to different customers across the world, but they need
to develop much advanced supply chain and logistics
operations in order to manage these operations and to
deliver their products to these customers.
In today’s world, there is also a growing
consideration for environmental and social issues
in addition to the financial objectives. Sustainable
supply chain management is becoming an important
concept because of these considerations. Economic,
environmental and social considerations are three
main pillars of sustainability and maintaining
the balance between them is the key issue to
achieve sustainability. Supply chain managers
started to modify their operations to improve the
sustainability of their supply chains. They are trying
to find new ways to manage their operations with
decreased emissions. In addition, transporters are
bound by the legislation enforcing driver working
hours, and unbalanced working times are seen to
create problems among the workers and against the
company (Gagnon et al., 2010). Thus, supply chain
companies need to focus on their environmental
and social objectives as well as the financial ones.
important
Economic, environmental and social considerations
are three main pillars of sustainability and maintaining
the balance between them is the key issue to achieve
sustainability.
Supply Chain Management
Reusing, recycling, remanufacturing and other
forms of recovery are promoted by the Waste
Electrical and Electronic Equipment (WEEE)
directive applied by the European Environment
Agency in order to reduce the quantity of electrical
and electronic waste to be disposed. Electronic
companies are forced to collect at least a certain
portion of their products back from the customers
at the end of their useful lives. Companies need
to develop new logistics activities called reverse
logistics, to collect the products from the end
users. The WEEE Directive sets the criteria for
the collection, treatment and recovery of waste
electrical and electronic equipment. In addition,
different emission regulations are arising in different
countries and supply chains are becoming bound
by these emission rules and emission regulations.
Carbon tax, carbon cap or carbon trade policies are
the most widely adopted regulations throughout
the world and supply chains need to be aware of
their carbon emissions and change their operations
according to these policies.
Reverse logistics refers to the activities related to the
collection of products from the end users.
Companies engage in recycling and
remanufacturing processes either because of
legislation in their countries or because of
economical reasons (Kaya, 2010). For example,
in Europe, recycling and reuse of materials are
Further Reading
5 Digital Trends that are shaping the
future of Supply Chain Management
August 6, 2019
by David Rogers
Supply Chain and Logistics has undergone
a major transformation in the past decade.
Customer expectations are high and the
demand for quick, even same-day, delivery at
the lowest possible cost is fast becoming the
driven by legislation, and companies are legally
responsible for collecting their end-of-life products.
However, several companies in the US and other
countries collect back their products and use
them in remanufacturing or recycling operations
to reap economic benefits from these processes,
even though they are not legally bound to do so.
Remanufacturing is the process of collecting used
items, extracting the useful parts and reusing these
parts in the production of new products. Studies
have shown that the unit cost of remanufacturing
can be about 40–60% of the unit manufacturing
cost of an original product in some industries.
Supply chains can save from direct material costs,
disposal and energy costs through remanufacturing
(Kaya, 2010). Giuntini and Gaudette (2003)
estimated that 120 trillion BTUs/year of energy are
saved from remanufacturing globally, accounting
for about 16 million barrels of crude oil and about
$500 million in energy costs, in addition to 14
million tons of material savings per year worldwide.
Remanufacturing is the process of collecting used
items, extracting the useful parts and reusing these
parts in the production of new products.
important
Supply chains can save from direct material costs,
disposal and energy costs through remanufacturing.
norm. Combine this with newer regions opening
up for trade, greater access to semi-urban and
rural areas, and stringent regulations from local
agencies and national governments, and you can
see that the supply chain industry is in the midst
of disruption—and technology is going to play a
major role in shaping this disruption.
A Gartner survey, named “Improve the
Supply Chain With Advanced Analytics and
17

AI “, spoke to supply chain leaders and found
that 96% of respondents use predictive analytics,
85% use prescriptive analytics, and 64% use
artificial intelligence. Five trends that are
going to influence how future supply chains
are designed and operated are estimated to be:
Artificial intelligence, IoT, Blockchain, Advanced
analytics, and Custom applications.
1. Artificial intelligence and machine
learning
AI and natural language capabilities are
currently at the forefront of emerging solutions
for supply chain partners. Three areas where they
could be game-changers are:
• In-demand forecasting
• Production planning
• Predictive maintenance
Machine learning takes historical shipment
data and converts it into a forecast. These
forecasts can gauge seasonal fluctuations in
demand, and provide predictions at a product,
store, or facility level, for any time frame
ranging from daily to monthly and even beyond.
Warehousing and transportation will particularly
benefit from AI and machine learning, as their
capacity to improve order deliveries and service
increases with automation. For instance, using
AI, a company can determine optimal routes
for fulfilling orders promptly. Knowing future
demands allows businesses to plan production
and predictive maintenance to a far more reliable
degree than was possible before. Lead times
can be drastically shortened so that customers
receive their deliveries quickly. Using predictive
analytics, businesses can know in advance when
and if a component in the system needs repairs
and create alternate production schedules to
compensate for it.
2. Internet of Things
The more devices can talk to each other, the
more communication can flow between them,
and the more efficiently the entire network can
operate. The use of advanced robotics combined
with big data gives companies a comprehensive
and accurate view of the real-time status of their
supply chain networks, partners, and shipments.
Since IoT connectivity brings in data, it allows
processes across the entire supply chain to be
highly optimised. Many companies already
use sensors to keep track of their containers
18
Introduction to Supply Chain Management
or shipments, which gives them the ability to
quickly respond to issues on the ground, and
forecast and even prevent problems from arising
in the future. From optimising asset utilisation
to improving overall supply chain performance,
IoT can greatly increase the reliability of supply
networks.
• IoT allows continuous monitoring of
critical equipment so that the state of every
asset in the supply chain is known
• It improves inventory practices, allowing
managers to check inventory levels at any
time and prevent stockouts
• It allows transparent marketing to the extent
that brands can even let their customers know
where their products are sourced from and
how they are acting ethically and responsibly
3. Blockchain
A supply chain can only be considered robust
when all the parties in the network are known
and trusted. However, the reality may be very
different. There might be too many players to
keep track of, varying levels of accepted standards
involved, and it might be simply impossible to
maintain a central repository of the thousands—
if not millions—of records generated with every
transaction.
The adoption of blockchain technology in
supply chains can counter these challenges. All
the entities in the blockchain network can know
where any transaction originated from. This
could entail anything from recording the source
of raw materials to payments made to vendors
to copyrights of assets. Since it’s not possible to
erase a transaction within a blockchain, the only
way a change can be made to it is by adding a
new record, thus increasing the transparency of
every transaction and ensuring the security of
the entire operation.
4. Advanced analytics
Advanced analytics gives companies the
ability to work with processes in real time, or
near real time. This has direct relevance in areas
like dynamic pricing and replenishment. What
in-depth analytics allows business leaders to do
is extrapolate data from existing conditions and
imagine future scenarios, thus allowing them to
design more profitable processes and create
highly efficient supply chains.
Supply Chain Management

Due to the stringent quality standards fast
becoming the norm in the functioning of supply
chain networks, the ability to track products,
optimise transportation, and even analyse returns
on products and routes are important reasons for
integrating advanced analytics into supply chain
management platforms. The biggest advantage
of using analytics is that it forms a cohesive
link between planning and execution, making
supply chains both agile and highly responsive.
It allows managers to set standardised processes
and benchmarks, utilise assets to their optimum
levels, and eliminate waste. What this translates
into for supply chain leaders is that locked capital
is freed up, cash flow increases, and margins are
improved.
5. Custom applications
A one-size-fits-all software might meet the
basic needs of any business. But organisations
need unique solutions to cater to the specific
requirements of their business and their internal
departments. Custom applications can be
personalised to suit the unique requirements
of individual parties in the supply chain. They
enable both senior-level decision makers and on-
the-ground executives to gain greater power with:
• Real-time visibility: Anyone can find out
where shipments are, at any point in time
• Flexibility on the move: It allows managers to
take data and insights with them, wherever
they go, cutting down the delay involved in
heading back to one’s desk to place an order
or call people to provide updates
• Dynamic tracking: Any potential hurdles can
be identified in advance, and a mitigation
plan set in place immediately
• Increased opportunities for collaboration:
Applications break down the limitations
posed by geographical barriers, and enable a
smooth flow of communication, wiping out
the previously existing disconnect between
different operators, and improves the cross-
functioning of teams within an organization
• Hands-free operation on the warehouse
floor: Employees can ditch pen and paper
because they introduce manual errors, make
processes more time-consuming and don’t
connect the dots between data originating
from different entities
The trade world is becoming increasingly open,
and also increasingly complex. Customers have easy
access to many options when it comes to deciding
what to buy, where to buy it, and at what price,
which is increasing competition. This calls for
companies and their supply chains to be faster, and
more flexible, efficient, and secure. By leveraging
these technologies, supply chain leaders can ensure
that their businesses don’t just survive, but actually
thrive in this highly chaotic environment, while also
meeting and exceeding customer expectations.
Source: Rogers, D. (2019, August 6). 5 Digital
Trends that are shaping the Future of Supply Chain
Management. Retrieved from: https://www.zoho.
com/creator/blog/5-digital-trends-that-are-shaping-
the-future-of-supply-chain-management.html

Learning Outcomes

5 To understand the future trends in supply chain management

Self Review 5 Relate Tell/Share

Tell some of the environmental

What are the major trends that
will influence future supply
chains?
Build a relationship between
effects of end-of-use products
globalization and supply chain
that are disposed to the
management.
environment.

19
 Introduction to Supply Chain Management

To understand the basic concepts

LO 1 in supply chain management

In a typical supply chain, different companies such as suppliers, manufacturers, distributors and retailers
work together in an integrated manner in order to satisfy the customer demand. Supply chain management
can be defined as a set of approaches utilized to efficiently integrate the supply chain members in order
to maximize total supply chain profitability. There exist many different operations that need to be done
throughout the supply chain from sourcing of raw materials to distribution of finished goods to customers.
Summary

Supply chain management deals with the integration and coordination of these processes in order to
increase the efficiency and profitability of the supply chain. Supply chain management encompasses the
planning and management of all activities involved in sourcing, procurement, conversion and logistics
management. It also includes coordination and collaboration with channel partners, which may be
suppliers, intermediaries, third-party service providers, or customers.
The structure of the supply chain is defined by the number of facilities in the chain and their relations
with each other. Suppliers, producers, distributors, retailers and customers are the main components of a
typical supply chain, in addition to various service providers that provide services to these components.
Sourcing, production and distribution are the basic processes in a typical supply chain. Sourcing refers
to the processes to obtain or buy goods or services required for production. Production includes the core
operations in supply chains that are needed to transform the raw materials to finished goods. Finally,
distribution refers to the movement of products between the facilities in the supply chain and the delivery
of finished goods to the customers.

To explain supply chain

LO 2 management strategies

Companies and their suppliers compete as a supply chain with other supply chains to deliver better
quality products in a faster manner. Customers expect high quality customized products, cheaper prices,
faster and reliable deliveries, and companies need to satisfy these expectations in order to continue
their existence. Supply chains first need to identify their target customers, analyze and understand the
characteristics and the needs of the customer segments that they intend to serve. The supply chain strategy
should be designed to satisfy these target customer expectations. The consistency between supply chain
strategies and target customer expectations is defined as the strategic fit.
Every company needs to define its core competency that differentiates itself from others, and every supply
chain has to develop different competencies and strategies in order to gain advantage in competition.
The competitive strategy of a supply chain defines the target customer needs and aims to satisfy them
through its products and services. The competitive strategy is developed to satisfy more of the customer’s
expectations than the competitors. Then, based on the competitive strategy, a product development
strategy needs to be established in order to determine the portfolio of products that the company will
develop. Then, marketing and sales strategy determines how the market will be segmented, products will
be positioned, priced and promoted. Finally, the supply chain strategy specifies how materials will be
procured, transported, manufactured and distributed.
Minimizing costs and increasing responsiveness are two of the main objectives of supply chains. Supply
chain efficiency is defined as the cost of making and delivering the products to the customers. Besides
minimizing costs, supply chains also aim to increase their responsiveness. A supply chain’s responsiveness
is measured by its ability to respond to wide ranges of quantities demanded, meet short lead times, handle
a large variety of products, build highly innovative products, meet a high service level and handle supply
uncertainty.

20
Supply Chain Management

To analyze the decisions in supply

LO 3 chain management

Supply chain management decisions can be classified as strategic, tactical and operational level decisions
depending on their significance and the time span that they cover. Strategic level decisions are long-term
decisions that will be effective for many years and are mostly made by the top level managers. These
decisions are generally about the structure of the supply chain and are difficult to change after they are
implemented. Tactical level decisions are medium-term decisions (generally between 6 months and 2

Summary
years) and are generally made by medium level managers. Operational level decisions are generally daily
or weekly decisions made by low level managers. These decisions are made to operate daily activities.
Production, Inventory, Location, Transportation and Information are the major supply chain drivers.
Production related decisions take into account different factors such as the manufacturing capacity,
workload balance, quality control and equipment maintenance. Which product, how many and when
should be produced, what should be the production plan are some of the production related decisions.
Inventory decisions focus on the stocking quantities at each stage of the supply chain. Some of the
Location related decisions can be stated as: Where should the manufacturing facilities, warehouses and
retailers be located? What should be their capacities? Should new facilities be built or should existing ones
be used? Transportation decisions analyze how materials should be moved from one supply chain location
to another, which mode of transportation to use, which products should be distributed from which
warehouse to which customer. Finally, Information related decisions analyze the type and amount of data
to collect, process and share in the supply chain. Timely and accurate information helps the supply chain
managers to make better decisions about all aspects of the supply chain.

To explain the relationship

LO 4 between supply chain
management and logistics

Logistics is part of supply chains that is mainly related to the distribution and transportation of products
or services between facilities. Logistics is a part of supply chain management that plans, implements,
and controls the efficient, effective forward and reverse flow and storage of goods, services and related
information between the point of origin and the point of consumption in order to meet customers’
requirements. On the other hand, supply chain management is a much larger concept that includes all the
operations between the sourcing of raw materials and the delivery of the products or services to the end-
users. Supply chain management deals with all the sourcing, manufacturing, information and marketing
decisions in addition to logistics or distribution decisions.
Logistics management activities include the incoming and outgoing transport management, fleet
management, stocking, material distribution, order completion, logistics network design, inventory
management, supply-demand planning and third party logistics service provider activities. Logistics
processes are aimed to provide the right materials at the right place at the right time. In order to achieve
this objective, different distribution network designs and transportation options can be utilized. Logistics
operations can be classified as inbound, outbound and manufacturing logistics. Logistics operations from
the suppliers to the company about acquiring the required materials for production are called inbound
logistics, and the logistics operations that are about delivering the finished goods from the company to the
customers are called outbound logistics. The logistics operations that are performed inside the company
for manufacturing processes are called in-plant or manufacturing logistics.

21
 Introduction to Supply Chain Management

To understand the future trends

LO 5 in supply chain management

Globalization in today’s world forces the companies to be international and to do business with many
different enterprises in dynamic and constantly changing global environments. Also changing trade
regulations and removal of customs barriers and tariffs facilitate the movement of products across the
world much easily. The rapid change in information technologies and the rise of the Internet also changed
the classical way of doing business and many different companies started to change their supply chain
Summary

structures and sales channels. As the speed and capabilities of computer systems increase, data can be
processed more rapidly, customer requests can be answered instantly, real-time transactions can be made
and flexibility can be provided in planning and controls. Also, supplier and customer relations can be
handled in a much better and faster manner, information between different parties can be exchanged
much more effectively and coordination between supply chain members can be achieved much easily.
Advances in IoT technologies, artificial intelligence and machine learning techniques are also changing
the supply chain businesses and operations. Supply chain firms have plenty of data at their fingertips and
utilizing big data in the correct way allows these firms to better understand their customers and their
supply chain system.
In today’s world, there is also a growing consideration for environmental and social issues in addition
to the financial objectives. Sustainable supply chain management is becoming an important concept
because of these considerations. Economic, environmental and social considerations are three main pillars
of sustainability and maintaining the balance between them is the key issue to achieve sustainability.
Supply chain managers started to modify their operations to improve the sustainability of their supply
chains. Studies have shown that the unit cost of remanufacturing can be about 40–60% of the unit
manufacturing cost of an original product in some industries. Supply chains can save from direct material
costs, disposal and energy costs through remanufacturing.

22
Supply Chain Management

1 Which of the following statements about 6 Which of the following is not a major supply
supply chain management (SCM) is false? chain driver?
A. SCM deals with the integration and A. Production B. Finance
coordination of the processes in supply chains C. Inventory D. Location

Test Yourself
B. SCM is a set of approaches utilized to efficiently E. Information
integrate supply chain members
C. SCM encompasses the planning and
management of all activities in supply chains 7 I. Logistics is mainly related to the
D. SCM integrates supply and demand manufacturing of products.
management only within the company II. Logistics deals with material and
E. SCM includes coordination and collaboration information flow across the supply chain.
with channel partners III. Logistics aims to provide the right materials
at the right place at the right time.
IV. Logistics is only a part of supply chain
2 Which of the following are the basic processes management.
in a typical supply chain? Which of the above statements related to logistics
A. Sourcing, Production, Distribution are correct?
B. Sourcing, Production, Finance A. II and III B. II and IV
C. Sourcing, Marketing, Distribution C. I, II and III D. I, III and IV
D. Production, Marketing, Finance E. II, III and IV
E. Marketing, Distribution, Finance
8 Which of the following is about acquiring
3 Which of the following specifies how materials the required materials for production from the
will be procured, transported, manufactured and suppliers?
distributed?
A. Inbound logistics
A. Competitive strategy B. Outbound logistics
B. Supply chain strategy C. Manufacturing logistics
C. Product development strategy D. In-plant logistics
D. Marketing strategy E. Distribution logistics
E. Core competency
9 Which of the following is not a digital trend
4 Which of the following does not increase that might change the future of supply chains?
supply chain responsiveness?
A. Artificial Intelligence
A. Responding to wide ranges of quantities B. Machine Learning
demanded C. Logistics
B. Meeting short lead times D. Big Data Analytics
C. Minimizing costs E. Internet-of-Things
D. Handling a large variety of products
E. Meeting a high service level
10 Which of the following refers to the process
of collecting used items, extracting the useful parts
5 Which of the following is an operational level and reusing these parts in the production of new
decision in a supply chain? products?
A. Location of a warehouse to be built A. Recycling B. Remanufacturing
B. Inventory policy of the company C. Reuse D. Repairing
C. Assignment of workers to machines today E. Redistributing
D. Type of products to produce
E. Human resources strategy of the company

23
 Introduction to Supply Chain Management

If your answer is wrong, please review If your answer is wrong, please review the
1. D 6. B
the “Basic Concepts in Supply Chain “Decisions in Supply Chain Management”
Management” section. section.
Answer Key for “Test Yourself”

If your answer is wrong, please review If your answer is wrong, please review the
2. A 7. E
the “Basic Concepts in Supply Chain “Supply Chain Management and Logistics”
Management” section. section.

If your answer is wrong, please review the If your answer is wrong, please review the
3. B 8. A
“Supply Chain Management Strategies” “Supply Chain Management and Logistics”
section. section.

If your answer is wrong, please review the If your answer is wrong, please review
4. C 9. C
“Supply Chain Management Strategies” the “Future Trends in Supply Chain
section. Management” section.

If your answer is wrong, please review the If your answer is wrong, please review
5. C “Decisions in Supply Chain Management”
10. B
the “Future Trends in Supply Chain
section. Management” section.

Explain the basic processes in a typical supply chain.

Suggested Answers for “Self Review”

Sourcing, production and distribution are the basic processes in a typical supply
chain. Sourcing refers to the processes to obtain or buy goods or services required
for production. In order to satisfy the customer expectations, companies need
to procure the right products, at the right time, at the right location, at the
self review 1 right price, at the right quality and in the right quantity, which are referred to
as the “six rights of sourcing”. Production includes the core operations in supply
chains that are needed to transform the raw materials to finished goods. Finally,
distribution refers to the movement of products between the facilities in the
supply chain and the delivery of finished goods to the customers.

How should the supply chain managers define their

supply chain strategy?

Supply chain managers first need to identify their target customers, analyze and
understand the characteristics and the needs of the customer segments that they
intend to serve. The supply chain strategy should be designed to satisfy these
target customer expectations. In addition to customer expectations, supply chain
capabilities are also important in the determination of the supply chain strategy.
Supply chain managers first need to define their core competency that differentiates
themselves from others in order to gain advantage in competition. They first
decide on their competitive strategy that defines the target customer needs, and
self review 2 aims to satisfy them through its products and services. The competitive strategy
is developed to satisfy more of the customer’s expectations than the competitors.
Then, based on the competitive strategy, a product development strategy needs to
be established in order to determine the portfolio of products that the company
will develop. Then, marketing and sales strategy determines how the market will be
segmented, products will be positioned, priced and promoted. Finally, the supply
chain strategy specifies how materials will be procured, transported, manufactured
and distributed. For the success of the supply chain, all these strategies should be
consistent with each other and support each other.
24
Supply Chain Management

What are the major supply chain drivers and what types

Suggested Answers for “Self Review”

of decisions need to be made about these drivers?

Production, Inventory, Location, Transportation and Information are the

major supply chain drivers. “Which product, how many and when should be
produced”, “what should be the production plan” are some of the production
related decisions. Inventory decisions focus on the stocking quantities at
each stage of the supply chain. “Where should the manufacturing facilities,
warehouses and retailers be located”, “what should be their capacities”,
self review 3 “should new facilities be built or should existing ones be used”, are some of
the Location related decisions. Distribution decisions aim to answer questions
such as “how should stocks be moved from one supply chain location to
another”, “which mode of transportation to use”, “which products should be
distributed from which warehouse to which customer”. Finally, Information
related decisions analyze the type and amount of data to collect, process and
share in the supply chain.

What are the differences between logistics and supply

chain management?

Logistics and supply chain are commonly mistaken for each other. Supply
chain management is a much larger concept that includes all the operations
between the sourcing of raw materials and the delivery of the products or
services to the end-users. However, logistics is part of supply chains that is
mainly related to the distribution and transportation of products or services
between facilities. CSCMP defines logistics as the part of supply chain
self review 4 management that plans, implements, and controls the efficient, effective
forward and reverse flow and storage of goods, services and related information
between the point of origin and the point of consumption in order to meet
customers’ requirements. On the other hand, supply chain management deals
with all the sourcing, manufacturing, information and marketing decisions in
addition to logistics or distribution decisions.

What are the major trends that will influence future supply
chains?

There are various changes and developments in today’s world that will affect
future supply chains. Changing market structures and customer expectations
as well as globalization and changing trade regulations are affecting the supply
chains significantly. In addition, improvements in information technologies
and the rise of the Internet, artificial intelligence, machine learning, Internet-
of-Things (IoT), Blockchain technologies, big data and advanced analytics,
self review 5 and custom applications are some of the major trends that will influence
future supply chains. Finally, growing concerns for environmental and
social issues in addition to the financial objectives are changing the supply
chain operations and sustainable supply chain management is becoming an
important concept. In the future, supply chain managers need to modify their
operations to improve the sustainability of their supply chains.

25
 Introduction to Supply Chain Management

References
Banasik, A., Kanellopoulos, A., Claassen, G. D. H., Giuntini, R. and Gaudette, K. (2003).
Bloemhof-Ruwaard, J. M. and van der Vorst, J. Remanufacturing: The next great opportunity
G. (2017). Closing loops in agricultural supply for boosting US productivity. Business Horizons,
chains using multi-objective optimization: A case 41–48.
study of an industrial mushroom supply chain.
Harrison, A. and van Hoek, R. (2008). Logistics
International Journal of Production Economics,
Management and Strategy: Competing Through
183, 409-420.
the Supply Chain (3rd Edition). Prentice Hall,
Chaharsooghi, S. K. and Heydari, J. (2011). Pearson Education Ltd., England.
“Strategic Fit in Supply Chain Management: A
Hugos, M. (2003). Essentials of Supply Chain
Coordination Perspective”. Li, P. (Ed.), Supply
Management. John Wiley and Sons, Inc., NJ.
Chain Management in (331-350), Rijeka, Croatia,
Intech Ltd. Kaya, O. (2010). Incentive and production decisions
for remanufacturing operations. European Journal
Chopra, S. and Meindl, P. (2007). Supply Chain
of Operational Research, 201, 442–453.
Management: Strategy, Planning, and Operation
(3rd Edition). Prentice Hall, New Jersey, USA. Mentzer, J. T., DeWitt, W. J., Keebler, J. S., Min,
S., Nix, N. W., Smith,C. D and Zacharia, Z. G.
Doğruer, İ. M. (2005). Üretim Organizasyonu ve
(2001). Defining Supply Chain Management,
Yönetimi. Alfa Basım Yay. Dağ. İnş. Tur. San. ve
Journal of Business Logistics, 22(2), 1-25.
Dış Tic. Ltd. Şti., İstanbul.
Simchi-Levi, D., Kaminsky, P. and Simchi-Levi, E.
Felicio, G.M.P and Sharma, D. (2018). Driving
(2008). Designing and Managing the Supply Chain:
Savings via Inbound Logistics Network Design.
Concepts, Strategies and Case Studies (3rd Edition).
Gagnon, E., P., Desaulniers, G., Drexl, M. and McGraw-Hill Professional, OH, USA.
Rousseau L-M. (2010). European Driver Rules
in Vehicle Routing With Time Windows.
Transportation Science, 44(4), 455-473.

Online References
APICS (2020), Association for Supply Chain Management, “Understand the Structure of SCOR”. Retrieved
from: http://www.apics.org/apics-for-business/benchmarking/scormark-process/scor-metrics.
Rogers, D. (2019, August 6). 5 Digital Trends that are shaping the Future of Supply Chain Management. [web
log comment]. Retrieved from: https://www.zoho.com/creator/blog/5-digital-trends-that-are-shaping-the-
future-of-supply-chain-management.html
Slade, S. (2017, July 12). 6 Strategies for Better Supply Chain Management in the Current Economy. [web
log comment]. Retrieved from: https://blogs.oracle.com/scm/5-strategies-for-better-supply-chain-
management-in-the-current-economy

26
 Supply Chain
Chapter 2 Network Design
After completing this chapter, you will able to;

1 2
Learning Outcomes

Explain the “supply chain network” and Explain the costs considered in supply chain
“supply chain network design” terms network design problems

3 Explain the decisions considered in supply

chain network design problems 4 Define the objectives considered in supply
chain network design problems

5 Define the constraints faced in supply chain

network design problems 6 Explain the factors influencing the supply chain
network design decisions

7 Solve simple supply chain network design

problems

Chapter Outline
Introduction
What is Supply Chain Network Design? Key Terms
Costs Supply Chain Network
Decisions Supply Chain Network Design
Objectives Fixed Cost
Constraints Variable Cost
Factors Influencing the Network Design Flow
Decisions Facility Location
Solving Supply Chain Network Design
Problems

28
 2
Supply Chain Management

INTRODUCTION
As the competition among companies increases due to various factors such as technological developments
and globalization, companies seek new management models to effectively manage their processes. In this context,
supply chain management was introduced in the early 1980s. This approach is briefly based on the fact that a
company must manage all the processes with a system approach instead of managing the processes separately.
Over time, many companies realized the significance of supply chain management (Govindan et al., 2017).
Supply chain management covers various problems and decisions at different levels. In this chapter,
we focus on one of the most important and widely studied problems in supply chain management, the
supply chain network design problem, which is also called strategic supply chain planning in the literature
since the design decisions are strategic decisions. We first focus on the common concepts and definitions.
Then, we discuss the costs, decisions, objectives and constraints observed in network design problem and
present the factors influencing the network design decisions. Finally, we focus on a simple supply chain
network design problem and show how we can solve simple problems by hand. We conclude the chapter
by discussing the solution approaches used for solving large size instances of network design problems.

WHAT IS SUPPLY CHAIN NETWORK DESIGN?

A traditional (forward) supply chain network includes suppliers, manufacturers, distribution centers,
retailers and customers. In this structure, components/raw materials are manufactured by the suppliers and
shipped to manufacturers. In manufacturing plants, products (finished goods) are manufactured by using
the raw materials/components procured from suppliers. Then, these products are shipped to distribution
centers in different regions and shipped from distribution centers to retailers. Finally, the products in
retailers are purchased by the customers. Although the mentioned supply chain is a typical supply chain
which may be observed in many companies, some different supply chain structures can also be observed
in real life. For example, in some companies, products are shipped directly from manufacturing plants to
customers, i.e. there is no distribution center or retailer. In
some other companies, both channels may be used, i.e. some
of the products are shipped directly from manufacturer to A traditional (forward) supply chain is a
customers while some others follow the traditional channel. network of suppliers, manufacturing plants,
An example of a forward supply chain network is given in distribution centers and customers created to
Figure 2.1. In this network, the products are manufactured
satisfy the demands of customers.
in manufacturing plants and shipped from manufacturing
plants to customers via the distribution centers.
Suppliers Manufacturing Distribution Customers
Plants Centers

Figure 2.1 A Forward Supply Chain Network

29
2
Supply Chain Network Design

Recently, in addition to forward supply chains, closed-loop supply chains have also become popular in
both academia and industry due to increasing concerns about sustainability and economic value that can
be obtained by product recovery. In a closed-loop supply chain, forward flows work as in the traditional
(forward) supply chains and satisfy the demands of customers. However, there are also some reverse supply
chain processes in addition to forward supply chain processes.
These processes include collection of used-products, quality
control, repair, remanufacture and disposal of non reusable A closed-loop supply chain is a network of
products or components. Hence, a closed-loop supply chain forward and reverse supply chain facilities
network may also include facilities such as collection center, organized to satisfy the demands of customers
remanufacturing center and disposal center in addition to and present the used products back to the
forward supply chain facilities. Figure 2.2 shows a typical economy.
closed-loop supply chain network.
Suppliers Manufacturing Distribution
Plants Centers

Collection
Centers

Remanufacturing
Centers

Figure 2.2 A Closed-loop Supply Chain Network

After defining the supply chain network, we can now focus on the supply chain network design problem.
Supply chain network design problem includes the decisions regarding the number, location and capacity
of each facility (for example manufacturing plants or distribution centers), the assignment of each market
region to one or more supply locations, and supplier selection for sub-assemblies, components and materials
(Meixell and Gargeya, 2005). The decisions in network design problem are long-lasting decisions. For instance,
once you determine the location of your manufacturing plant, you should expect your manufacturing plant
to be in that location at least in the next 5-10 years, you cannot easily change the locations of your facilities
due to high fixed costs. Hence, most of the supply chain network design decisions can be considered as
strategic level decisions. Santoso et al. (2005) state that the strategic configuration of the supply chain is a
key factor influencing efficient tactical operations, and thus
important
has a long-lasting impact on the company. All these factors
make the supply chain network design problem one of the
most important and mostly studied problems in the supply Decisions in supply chain network design problem
chain management literature. are generally long-lasting strategic decisions.

30
 2
Supply Chain Management

Learning Outcomes

1 To explain the “supply chain network” and “supply chain network design” terms

Self Review 1 Relate Tell/Share

Share a case in which

Explain the product flow
in a forward supply chain
network.
Associate forward and
you send a used product
closed-loop supply chains
(paper, glass etc.) to a
with each other.
remanufacturer.

COSTS second months, the same renting cost ($300 in our

While designing the supply chain network, the
decision maker must consider various different
costs. Generally, these costs have a relationship with
each other, i.e. decreasing one may yield an increase
in another. For this reason, it may be difficult for
the decision maker to find the optimal supply
chain network. Note that here and in the rest of
the chapter, optimal solution refers to a feasible
solution where the objective function takes its best
value (minimum value in minimization problems
and maximum value in maximization problems).
We can divide the costs into two categories as fixed
costs and variable costs. In the next subsections, we
will discuss these costs in detail.
Optimal solution is a feasible solution in which
the objective function takes its maximum value
in maximization problems and minimum value
in minimization problems.
Fixed Costs
Fixed costs are costs which are independent
from the amount processed. For example, suppose
that a company rents a warehouse at a cost of $300
per month. In the first month, the company keeps
100 units of products in that warehouse but in the
second month, 90 units of these products are sold
and only 10 units of products are kept in the same
warehouse. Although amount of products kept in
the warehouse are very different in the first and
example) is paid in both months. In other words,
renting cost does not depend on the amount kept in
the warehouse. Hence, this cost can be considered
as a fixed cost.
Fixed costs are costs that do not depend on
the amount processed.
Following costs are among the fixed costs that
are considered while designing the supply chain
network.
• Fixed costs of facilities: Renting costs and
property taxes of manufacturing plants,
distribution centers, warehouses etc.
• Fixed costs of vehicles: Salaries of drivers,
renting costs of vehicles, taxes of vehicles etc.
Variable Costs
Variable costs are costs depending on the
amount processed. For example, suppose that a
company makes manufacturing at a unit cost of
$1. In the first month, assume that the company
manufactured 2000 units, since unit manufacturing
cost is $1, in this month total manufacturing cost
will be $2000. On the other hand, assume that in
the second month, the manufacturer manufactured
1500 units, in this month total manufacturing cost
becomes $1500. As this simple example shows,
manufacturing cost depends on the amount of
products manufactured. Hence, it is a variable cost.

31
2
Supply Chain Network Design

The following examples can be given to variable costs

that are considered while designing the supply chain
Variable costs are costs that depend on the
network.
amount processed.
• Variable costs of operations: Variable costs of
manufacturing, packaging, distributing, holding,
quality control, remanufacturing etc.
• Variable cost of shipment: Fuel cost, cost of bridges, highways etc.
• Procurement cost: Costs of raw materials/components procured from suppliers.

Learning Outcomes

2 To explain the costs considered in supply chain network design problems

Self Review 2 Relate Tell/Share

How can we decide whet- Associate facility costs and Share examples of fixed and
her a cost is a fixed cost or shipment costs with each variable costs you face in
variable cost? other. your life.

DECISIONS
The decision maker focuses on various decisions while designing the supply chain network. These
decisions can be listed as follows:
• Procurement Decisions (Supplier Selection)
• Facility Decisions
important
• Flow Decisions
• Shipment Decisions
• Other Decisions Since the decisions in supply chain network
Note that these decisions cannot be made separately since design problem affect each other, they must
they generally affect each other. For example, procurement be made in an integrated manner.
decisions affect the facility decisions, facility decisions affect
the flow decisions and so on. Hence, the decision maker must simultaneously consider and make these
decisions and due to this simultaneous consideration, in some cases it may be very difficult for the decision
maker to find a trade-off. In the next subsections, we will discuss these decisions in detail.

Procurement Decisions (Supplier Selection)

Since raw materials/components play an important role
in the manufacturing process, selecting the appropriate
supplier(s) and creating a long-term relationship are crucial
for the success of the entire supply chain. While selecting the
suppliers, various qualitative and quantitative criteria such
as cost, quality, lead time and environmental performance
should be considered and these criteria generally contradict
with each other. Hence, selecting the appropriate suppliers
becomes a difficult problem for the decision maker.
important
While selecting the appropriate suppliers
to work with, various qualitative and
quantitative criteria such as cost, quality
and environmental performance must be
considered.

32
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Supply Chain Management

When we review the existing literature, we observe that there are numerous papers which address the
supplier selection problem by using different approaches. Among these approaches, use of multi-criteria
decision making methods is one of the most preferred approaches. In this approach, researchers generally
address the supplier selection problem by using one or a few of the multi-criteria decision-making methods
such as AHP, ANP, TOPSIS, VIKOR etc. Sometimes fuzzy variations of these methods are also used. These
methods allow the decision maker to consider both qualitative and quantitative criteria simultaneously
and make the supplier selection based on all criteria. In addition to selecting the appropriate suppliers,
some studies also deal with order allocation among suppliers; they determine which suppliers should be
selected and how many components/raw materials should be procured from each supplier. Procurement
decisions of a company are illustrated in Figure 2.3.

Suppliers M. Plants

S1 C1

C2 C1

C1 C2
S2

C2

S3 C1

C2

S4 C1

C1

C2
S5

Figure 2.3 Procurement Decisions of A Company

As seen in Figure 2.3, in our example, the company works with Supplier 1, Supplier 2, Supplier
3 and Supplier 5 whereas Supplier 4 is not selected. All suppliers serve more than one manufacturing
plant for different components. The structure in Figure 2.3 seems simple since in our example there
are only five suppliers and five manufacturing plants and the manufacturing plants procure only two
different components. However, in real life there are companies that need to procure hundreds of different
components from dozens of suppliers. In such cases, supplier selection and order allocation problem
becomes very difficult to solve and advanced solution approaches may need to be used. Please refer to
Chapter 6 for detailed discussions and explanations on procurement and supplier selection.

Facility Decisions
Facility decisions include the determination of the number, locations and capacities of the facilities
(manufacturing plants, distribution centers, warehouses etc.). In the existing supply chain network
design literature, most studies assume that there are candidate locations for these facilities. In such a
case, the decision maker deals with the selection of appropriate locations for facilities among a set of

33
2
candidate locations. For example, assume that
candidate locations for the manufacturing plant are
determined as Ankara, Eskişehir, Konya, Bilecik
and Bursa. Then, the decision maker’s problem
becomes the selection of a city for the location of
the manufacturing plant among these five cities.
Facility decisions are decisions related to
number, locations and capacities of facilities
in a supply chain.
Existing literature reports that there is a
relationship between the number of facilities and
transportation costs as in Figure 2.4. As seen in
that figure, increasing the number of facilities up to
a value brings a decrease in transportation cost but
after that value, a further increase in the number
of the facilities brings an increase in transportation
cost. Hence, it is important to determine the
optimal number of facilities.
Transportation
Costs
Number of facilities
Figure 2.4 Relationship Between Transportation Costs
and Number of Facilities
Source: Chopra et al. (2013).
It should also be noted that in some cases
locations of some facilities may be fixed. For
example, the manufacturing plant of a company
may be considered as fixed in a city and it cannot
be changed due to operational reasons. In such
cases, the decision maker must definitely consider
this issue while designing the supply chain network
because if it is not considered, the obtained supply
chain network may not be feasible in real-life.
34
Supply Chain Network Design
important
In some cases, locations of some facilities
in the supply chain may be fixed and the
decision maker must consider this issue while
designing the supply chain network.
Finally, when it comes to facility capacity
decisions, we observe that most of the studies in the
literature assume that the capacities of facilities are
fixed and known. In other words, the decision maker
makes no capacity decision. However, there are also
some studies which consider capacity decisions or
capacity expansion decisions. This consideration
makes the proposed models more real-life oriented
since in real-life companies may have capacity
options such as having capacity flexibility while
building the facility, physical expansion availability,
purchase of new or efficient machines, overtime
working or contracting the operation to third-party
companies. Ignorance of these options may lead to
wrong or inefficient decisions.
Flow Decisions
As the name indicates, these decisions focus on
the determination of the flows between different
facilities in the supply chain. If there is only
one manufacturing plant, distribution center or
retailer, then it is certain that all the products will
be processed in that facility. However, what if the
company has two manufacturing plants, three
distribution centers and eight retailers? In such a
case, how many products should be manufactured
in manufacturing plant 1 and manufacturing plant
2? How many products should be shipped from
each one of the manufacturing plants to each
one of the distribution centers, for example from
manufacturing plant 2 to distribution center 3?
Similarly, how many products should be shipped
from each one of the distribution centers to each
one of the retailers, for example from distribution
center 1 to retailer 7? Finally, which retailer should
serve which customer or customers, for example
which retailer will satisfy the demand of customer
2? Flow decisions basically focus on these questions
and determine the flows in the entire supply chain.
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Supply Chain Management

Shipment Decisions
Shipment decisions mainly cover two decisions; transportation mode decisions and vehicle decisions.
First, we discuss the transportation mode decisions. Road transportation, rail transportation, marine
transportation and air transportation are among the main transportation modes the companies use.
Each of these modes have some advantages and disadvantages in terms of cost, time, security, shipment
capacity etc. The decision maker should select the appropriate mode by considering all these advantages
and disadvantages. There are also some companies which use intermodal transportation in which various
transportation modes are combined in order to find a trade-off between conflicting criteria.
In addition to mode selection, shipment decisions also cover the vehicle decisions. In some transportation
modes it becomes not possible for the company to select the vehicles but especially in road transportation,
selection of the appropriate vehicles is important since the vehicles in road transportation significantly
differ from each other in terms of various criteria such as cost, capacity, speed etc. and generally there
is a conflict between these criteria, i.e. it may not be possible to find a vehicle with low cost but high
speed and capacity. Hence, the decision maker must find a trade-off between these criteria while selecting
the appropriate vehicle. The reader may refer to Chapter 3 for detailed discussions and explanations on
transportation and logistics.

Other Decisions
In addition to above-mentioned decisions, in some
cases the decision maker may face some other decisions
such as quality decision, sustainability level decision and Shipment decisions are decisions related to
outsourcing decision. Putting these decisions into account selection of transportation mode and one or
may make the problem more difficult but at the same time a set of vehicles that make the shipments.
more real-life oriented.

Learning Outcomes

3 To explain the decisions considered in supply chain network design problems

Self Review 3 Relate Tell/Share

Why should the decision

maker make different
Associate facility decisions
decisions in an integrated Tell two decisions that af-
and shipment decisions
manner (not separately) fect each other.
with each other.
while designing the supply
chain network?

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Supply Chain Network Design

OBJECTIVES
Supply chain networks strongly depend on the objective or objectives considered in the design process.
In real life and in the literature, different objectives are considered in different applications. The objectives
can be categorized as economic, environmental and social. A few examples to each one of them can be
given as follows:
Economic Objectives: Minimization of total supply chain cost, maximization of total profit,
maximization of after-tax profit etc.
Environmental Objectives: Minimization of carbon emissions, maximization of collected product
quantity, maximization of environmentally friendly raw material rate etc.
Social Objectives: Minimization of work accidents, maximization of job opportunities etc.
Although most of the studies in the supply chain
network design literature propose single objective models, important
especially in recent decades, concerns about sustainability,
governmental regulations, public awareness and economic Multi-objective models provide the
value that can be obtained by collecting used products lead opportunity of simultaneous consideration
to simultaneous consideration of economic, environmental of two or more conflicting objectives while
and social objectives by using a multi-objective framework. designing the supply chain network.

Learning Outcomes

4 To define the objectives considered in supply chain network design problems

Self Review 4 Relate Tell/Share

Why should the companies

consider environmental
Relate objectives and Share two objectives that
and social objectives
strategy of a company. contradict with each other.
together with the economic
objectives?

CONSTRAINTS
While designing the supply chain network, the decision maker must consider various constraints.
These constraints can be listed as follows.
• Supply constraints
• Facility constraints
• Flow constraints
• Demand satisfaction constraints
• Capacity constraints
• Other constraints
In the next subsections, we discuss these constraints in a more detailed manner.

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Supply Chain Management
Supply Constraints
As explained earlier, raw materials and
components are procured from the suppliers
to be used in manufacturing processes by the
manufacturer. In real life, suppliers have some
constraints due to either cost considerations or
operational reasons, and while designing the
supply chain network, the decision maker must
consider these constraints. Some examples of these
constraints can be given as follows:
• Minimum purchasing quantity of a raw
material can be 2500 units.
• A component is sold in 200-unit packages;
hence the manufacturer must purchase
either 200 units or multiples of 200 units.
• Minimum purchasing quantity for
a component is 150 units but if the
manufacturer purchases 500 units or more,
a 5% all unit quantity discount can be
applied.
• The manufacturer can purchase at most
2250 units of a raw material. Due to
operational reasons, the supplier cannot
provide more.
• If the manufacturer works with a supplier
for a certain component, he cannot work
with any other supplier for the same
component due to the company policy of
that supplier.
Supply constraints are constraints related
to procurement of components or raw
materials.
Facility Constraints
While determining the number and locations
of the facilities (manufacturing plants, distribution
centers, warehouses etc.) in the supply chain, the
decision maker may face various constraints. Some
examples of these constraints can be given as follows:
• Location of the manufacturing plant is
fixed and it cannot be changed.
• It is not possible to open two distribution
centers in the same city.
• If a manufacturing plant is opened at a
certain location, a distribution center must
also be opened at a close location.
2
• Number of the distribution centers cannot
exceed 12.
• At least 3 and at most 7 warehouses must be
opened in a region.
Flow Constraints
These constraints basically control the flow
of products from suppliers to customers. Some
examples of these constraints can be given as follows:
• Shipment between two manufacturing
plants or between two distribution centers
is not allowed.
• Products manufactured in a certain
manufacturing plant cannot be shipped to
some distribution centers.
• Products manufactured in a certain
manufacturing plant can only be shipped
to certain retailers.
• Amount of products shipped from all the
manufacturing plants to a distribution
center must be equal to the amount of
products shipped from that distribution
center to the customers.
Note that these constraints change from a case
to another. Hence, it may not be necessary to
consider all of them in a specific case.
important
Different flow constraints can be observed in
different supply chains.
Demand Satisfaction Constraints
These constraints ensure the satisfaction of the
demands of either all or a fraction of the customers
in the supply chain. They vary significantly from a
company to another based on the structure of the
company and objective of the supply chain. Some
examples of these constraints can be given as follows:
• Demands of all customers must be met
(common constraint in the network design
literature).
• Demands of at least 90% of customers
must be satisfied.
• Demands of at least 75% of customers
must be satisfied within 14 days and
demands of all customers must be satisfied
within 21 days.
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Supply Chain Network Design

Here, it should also be noted that, in real life, demand important

is not a certain parameter. For example, a washing machine
company cannot exactly know the next year demand for
Demand uncertainty in supply chains can be
their washing machines. However, they can make a forecast
handled by using approaches such as fuzzy
based on the historical data by using forecasting techniques
programming and stochastic programming.
and the forecasted demand can be used as the demand
parameter. Please refer to Chapter 4 for detailed discussions
about forecasting and production planning. As an alternative and maybe more real-life oriented approach,
the uncertain structure of the demand can be considered while designing the supply chain network
and approaches that put the uncertainty into account can be used. Fuzzy programming and stochastic
programming are two examples to the approaches that consider the uncertainty in the problem.

Capacity Constraints
In real life applications, capacities of the facilities and vehicles are generally limited. Hence, while designing
the supply chain network, the decision maker must consider the capacity constraints. If they are not considered,
obtained supply chain network may be infeasible in daily operations. Some examples of capacity constraints
can be given as follows:
• Monthly production quantity in a manufacturing plant cannot exceed 2500 units.
• At most 1000 units of product can be stored in a warehouse.
• At most 27-ton products can be shipped by company owned trucks.
• 200 units of product can be packaged and 150 units of product can be repaired in a distribution
center.
important

Other Constraints
Ignoring a capacity constraint while
In addition to above-mentioned common constraints,
designing the supply chain network may
in some cases the decision maker may also need to consider
yield infeasibilities in daily operations of the
some specific constraints that are related to governmental
company.
regulations, product characteristics or company policies.
Some examples of these constraints can be summarized as
follows:
• Warehousing and shipping temperature of the product must not exceed 12° C.
• The raw materials must be shipped from supplier to manufacturing plant within 8 hours.
• The vehicle must enter İstanbul between 21:00 and 23:30.
• The products must be shipped from manufacturing plants to distribution centers via company-
owned vehicles.
• The products must be shipped from retailers to customers via third-party common carriers.
• Total emission in manufacturing process cannot exceed 25,000-ton CO2 per year.
• At least 50% of the end-of-life products must be collected and remanufactured or disposed by the
company.

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Supply Chain Management
Learning Outcomes
5 To define the constraints faced in supply chain network design problems
Self Review 5
What can the consequence
of ignoring a constraint Relate the flow constraints
while designing the supply and capacity constraints.
chain network be?
FACTORS INFLUENCING THE
NETWORK DESIGN DECISIONS
Chopra et al. (2013) state that various factors
influence the network design decisions. Some of
these factors can be listed as follows:
• Strategic
• Technological
• Macroeconomic
• Infrastructure
• Competitive
• Logistics and facility costs
In the following subsections, we will discuss
them in detail.
Strategic Factors
Companies may have different strategies to
compete with other companies and a company’s
strategy significantly affects the supply chain
network design decisions. For example, if a
company’s strategy is providing the products to
customers at the lowest possible price, then that
company must create a supply chain network which
minimizes the total supply chain cost. On the
other hand, if a company’s strategy is providing the
fastest service to their customers, then the supply
chain network can be designed by considering the
closeness to customers.
important
A firm’s strategy has a substantial effect on the
supply chain network of that firm.
2
Relate Tell/Share
Tell a constraint that you
consider in your life.
Technological Factors
Characteristics of the production and shipment
technologies affect the supply chain network design
decisions. For example, in some cases such as
computer components manufacturing, creating a
manufacturing plant requires very high fixed costs
and shipment of these products may not be costly.
For this reason, in those cases, opening only one
manufacturing plant and shipping the products
from that manufacturing plant to distribution
centers in different regions may be better compared
to opening more than one manufacturing plant
in terms of total supply chain cost. On the other
hand, for some other cases such as water bottling
companies, fixed cost of opening a manufacturing
plant may be less and due to high volume of
shipments, opening more manufacturing plants
may be better in terms of the total supply chain cost.
Macroeconomic Factors
As a result of globalization, nowadays, companies
continue their operations in different countries.
For example, a product may be manufactured in
the manufacturing plant in China and shipped to
distribution centers in the USA and Canada. Then,
they are shipped to customers in England and
Germany. In such a global supply chain, factors such
as taxes, tariffs and exchange rates significantly affect
the cost of the company. Hence, while designing the
supply chain network, they should be considered.
important
Macroeconomic factors involve taxes, tariffs
and exchange rates.
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Supply Chain Network Design

Infrastructure Factors
If a manufacturing plant is opened in somewhere that is far from the city center, it may be difficult and
costly for the company to find workers that will work in that manufacturing plant. On the other hand, it
may be easier and less costly to find workers for a manufacturing plant that is located near the city center.
In addition, proximity to airport, seaport and rail service are also among the infrastructure factors that
should be considered while designing the supply chain network.

Competitive Factors
While designing the supply chain network, a company should also consider the competitor’s strategy.
For example, where do the competitors open manufacturing plants, how many distribution centers do
they have, what are their main goals while designing their supply chain networks, should the company be
close to their competitors or far from them? These kinds of questions play an important role for the success
of a supply chain and hence they must be considered while designing the supply chain network.

Logistics and Facility Costs

Facility and logistics costs significantly differ from a region to another. In some regions, facility costs
such as renting costs are very high and opening a facility in that region may bring a significant cost to the
company while there are also some regions in which facility costs are very low. Similarly, in some regions,
shipment costs are very high while there are also some regions in which this cost is very low. Moreover,
increasing the number of facilities may increase the facility costs but decrease the logistics costs. On the
other hand, opening less facilities may decrease the facility costs but increase the logistics costs. While
determining the location and number of facilities, the company must consider these issues and find a
trade-off between these costs.

Learning Outcomes

6 To explain the factors influencing the supply chain network design decisions

Self Review 6 Relate Tell/Share

Which strategies can be What is the relationship Consider a problem you

considered while designing between strategic and face in your life and tell
the supply chain network? competitive factors? which factors you consider.

SOLVING SUPPLY CHAIN NETWORK DESIGN PROBLEMS

In the previous sections, we discuss the costs and decisions, objectives and constraints that must be
considered while designing the supply chain network. At this point, the following questions may arise:
how can we design a supply chain network, how can we compare two network designs with each other or
how can we find the optimal supply chain network design for a problem? In this section, we try to answer
these questions by focusing on a simple supply chain network design problem first. In that problem, we
show how we can evaluate the cost of a design option. Next, we discuss the characteristics of the supply
chain network design problems that can be seen in real-life and discuss the approaches that can be used to
solve those problems.

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Supply Chain Management

A Simple Supply Chain Network Design Problem Example

A company manufactures motherboards for their customers. After the raw materials are procured from
suppliers, motherboards are manufactured in the manufacturing plant and sent to the distribution center
to be kept there until there is a demand. Finally, according to customers’ demands, motherboards are sent
to customers from the distribution center.
Currently, the company has two alternative suppliers to work with, two alternative locations to open
their manufacturing plants and two alternative locations to open their distribution centers. Currently, the
company sells their motherboards to two major customers (computer manufacturers) who have fixed and
known locations. Distance between candidate suppliers and candidate manufacturing plants are presented
in Table 2.1.

Table 2.1 Distance between candidate suppliers and candidate manufacturing plants (km)
Manufacturing Plant 1 Manufacturing Plant 2
Supplier 1 200 300
Supplier 2 900 100

Moreover, distance between candidate manufacturing plants and candidate distribution centers are
presented in Table 2.2.

Table 2.2 Distance between candidate manufacturing plants and candidate distribution centers (km)

Distribution Center 1 Distribution Center 2

Manufacturing Plant 1 450 500
Manufacturing Plant 2 100 700

Finally, distance between candidate distribution centers and customers and monthly demands of
customers are presented in Table 2.3.

Table 2.3 Distance between candidate distribution centers and customers (km) and monthly demands of customers (unit)

Customer 1 Customer 2
Distribution Center 1 500 600
Distribution Center 2 700 400
Monthly Demand 3000 5000

It is also known that one unit of motherboard requires one unit of raw material. Due to company policy,
the company must work with only one supplier. However, if needed, more than one manufacturing plant
or distribution center can be opened. Shipment cost is determined as $0.2 per unit per km. Capacities
of the manufacturing plants and distribution centers are assumed to be enough for satisfying the current
demands of customers. Monthly renting and operating costs (opening costs) of manufacturing plants and
distribution centers are expected to be as presented in Table 2.4.

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Supply Chain Network Design

Table 2.4 Monthly renting and operating costs of manufacturing plants and distribution centers ($)
Manufacturing
Manufacturing Plant 2 Distribution Center 1 Distribution Center 2
Plant 1
Monthly Cost 300,000 450,000 100,000 200,000

Based on the given information, we have various options for the design of the supply chain network.
For example, as the supplier, we can select supplier 1 to work with, open the first manufacturing plant and
second distribution center. As another option, we can select supplier 2 to work with, open manufacturing
plant 1 and distribution center 2. One can derive dozens of options in addition to these two. In order to
compare one option with another, we must calculate the monthly total supply chain costs corresponding
to those options. In our example, total supply chain cost includes the total shipment costs of products and
monthly renting and operating costs of facilities. As an example, we calculate the total supply chain costs
corresponding to three options as follows:
As the first option, suppose that we select the first supplier to work with and open the first manufacturing
plant and first distribution center. In this option, we have a supply chain network as in Figure 2.5.

8000 units
Supplier 1 Man. Plant 1 Dist. Center 2 Customer 2

8000 units 5000 units

Supplier 2 Man. Plant 2 Dist. Center 1 Customer 1

3000 units

Figure 2.5 Supply Chain Network in Option 1

In this option, we can calculate the total supply chain cost as follows: Opening cost (monthly renting
and operating cost) of manufacturing plant 1 is given as $300,000 and opening cost of distribution center
1 is given as $100,000. Hence, we have 300,000 + 100,000 = $400,000 total facility cost in this option.
Total demands of customers are 3000 + 5000 = 8000 units. Since in the problem it is stated that one unit
of product requires one unit of raw material, 8000 units of raw material need to be shipped from supplier
1 to manufacturing plant 1. Distance between supplier 1 and manufacturing plant 1 is given as 200 km
in Table 2.1 and unit shipment cost is given as $0.2 per unit per km. For this reason, our shipment cost
between supplier and manufacturing plant will be 8000 units x 200 km x 0.2 = $320,000. Similarly, we
can calculate the shipment cost between manufacturing plant and distribution center. Distance between
manufacturing plant 1 and distribution center 1 is given as 450 km and we ship 8000 units from the
manufacturing plant to the distribution center. Hence, we have 8000 units x 450 km x 0.2 = $720,000.
Finally, we must calculate the shipment cost from the distribution center to customers. Demand of
customer 1 is 3000 units and distance between distribution center 1 and customer 1 is 500 km. Hence, we
have 3000 units x 500 km x 0.2 = 300,000 and similarly since the distance between distribution center 1
and customer 2 is 600 km and since the demand of customer 2 is 5000 units, we have 5000 units x 600 km
x 0.2 = $6000,000. Now if we sum these shipment costs, we can obtain the total shipment cost as 320,000
+ 720,000 + 300,000 + 600,000 = $1,940,000. So, in this case total shipment cost is $1,940,000 and total
facility cost is found as $400,000. If we sum these two values, we can obtain the total supply chain cost for
this case as 1,940,000 + 400,000 = $2,340,000
As the second option, now suppose that we select the second manufacturing plant instead of the first
manufacturing plant while we still select supplier 1 and open distribution center 1 as in Option 1. In this
case, our supply chain network will be as presented in Figure 2.6.

42
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Supply Chain Management

Supplier 1 Man. Plant 1 Dist. Center 2 Customer 2

8000 units 5000 units

8000 units
Supplier 2 Man. Plant 2 Dist. Center 1 Customer 1
3000 units

Figure 2.6 Supply Chain Network in Option 2

In this option, since the opening cost of the second manufacturing plant is given as $450,000 and
opening cost of distribution center 1 is given as $100,000, we have $550,000 facility cost, which is $150,000
higher than the facility cost obtained in the first option. So, in this option we observe that the facility cost
increases. Now, let us focus on the shipment cost and see whether it also increases or decreases. Shipment cost
between supplier 1 and manufacturing plant 2 can be calculated as 8000 units x 300 km x 0.2 = $480,000
and moreover shipment cost between manufacturing plant 2 and distribution center 1 can be calculated as
8000 units x 100 km x 0.2 = $160,000. Finally, since we select the same distribution center (distribution
center 1), shipment cost between distribution center 1 and customers will not change and will be $900.000
as in Option 1. In this context, total supply chain cost for this option can be calculated as 550,000 +
480,000 + 160,000 +900,000 = $2,090,000. Total supply chain cost in first option was $2,340,000. In this
option, by selecting manufacturing plant 2 instead of manufacturing plant 1, we decrease this total cost by
$250,000, even in this case our facility cost is higher compared to option 1. Moreover, observe from Table
2.1. that manufacturing plant 1 is closer than manufacturing plant 2 to supplier 1. Hence, shipment cost
from supplier 1 to manufacturing plant 1 is lower than shipment cost from supplier 1 to manufacturing plant
2 but despite this fact and despite the higher opening cost of manufacturing plant 2, selecting manufacturing
plant 2 is still beneficial when we consider the total supply chain cost. This observation shows that while
designing the supply chain network, the entire system must be considered to find the best solution.
As another option (Option 3) let us select supplier 1, open manufacturing plant 1 and open both
distribution center 1 and distribution center 2 with the assumption that the customers will be served from
the closest distribution center. Since the customer 1 is closer to distribution center 1 and customer 2 is
closer to distribution center 2, in this case, we will have a supply chain network as presented in Figure 2.7.

8000 units 5000 units 5000 units

Supplier 1 Man. Plant 1 Dist. Center 2 Customer 2

3000 units

Supplier 2 Man. Plant 2 Dist. Center 1 Customer 1

3000 units

Figure 2.7 Supply Chain Network in Option 3

In this case, opening costs of manufacturing plant and distribution centers will be 300,000 + 100,000
+ 200,000 = $600,000. Shipment cost from supplier 1 to manufacturing plant 1 will be 8000 units x 200
km x 0.2 = $320,000. As mentioned earlier, since the customers will be served from the closest distribution
center, customer 1 will be served from distribution center 1 and customer 2 will be served from distribution
center 2 (See Table 2.3). Hence, we should send 3000 units of product from manufacturing plant 1 to
distribution center 1 to satisfy the demand of customer 1 from distribution center 1 and we should send
5000 units of product to distribution center 2 to satisfy the demand of customer 2 from distributiın
center 2. In this context, shipment cost from manufacturing plant 1 to distribution center 1 will be 3000

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Supply Chain Network Design

units x 450 km x 0.2 = $270,000 and shipment cost from manufacturing plant 1 to distribution center
2 will be 5000 units x 500 km x 0.2 = 500,000. Finally, we must calculate the shipment costs between
distribution centers and customers. Shipment cost of 3000 units of product from distribution center 1
to customer 1 will be and shipment cost of 5000 units of product from distribution center 2 to customer
2 will be Now, we can obtain the total supply chain cost by summing all these costs as Observe that
this cost is higher than the costs obtained in the previous two options. However, as we discuss in the
“Objectives” section, cost is not the only objective of the company to consider while designing the supply
chain network. Opening two distribution centers may increase the service level and customer satisfaction
since in such a case the company will be closer to its customers and satisfy their demands faster. Hence,
there are instances in real life in which companies open more facilities to increase the service level even
it generally brings higher costs.
In addition to the analyzed three options we have discussed above, there are many other options and
in order to find the optimal supply chain network, that is the network with minimum total supply chain
cost, one should evaluate all the options and compare the costs with each other. Since these kinds of small
questions include 20-30 options in total, optimal solution may be found by hand, but in real life supply
chains consist of dozens of facilities which are selected among hundreds of candidate facilities and it is
generally very difficult or sometimes impossible to evaluate all the options by hand. As an example, a
sample real-life supply chain network is illustrated in Figure 2.8.

Figure 2.8 Illustration of A Supply Chain Network

In Figure 2.8, the red rectangle represents the manufacturing plant and green rectangles represent the
distribution centers. Black lines represent the flows from the manufacturing plant to distribution centers
and blue lines represent the flows from distribution centers to customers. Eight distribution centers in this
real-life example are selected from 80 candidate locations and the customers are assigned to distribution
centers in such a way that the total supply chain cost is minimized.
In such problems, evaluating all the alternatives to find the minimum cost solution may not be possible.
Hence, different solution approaches may be needed. In the next subsection, we discuss which approaches
can be used for the solution of supply chain network design problems.

Solution Approaches for Network Design Problem

There are many different solution approaches to deal with the supply chain network design problems.
We can categorize them in two groups as exact solution approaches and heuristic solution approaches. We
will discuss them in detail as follows:

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Supply Chain Management
Exact Solution Approaches
These approaches ensure obtaining the best
solution for the considered network design
problem. For example, if the objective function is
minimization of total supply chain cost, an exact
solution approach ensures obtaining the supply
chain structure which provides the minimum
possible total supply chain cost. In that solution, a
further decrease in the total supply chain cost is not
possible without ignoring or violating a constraint.
Hence, by using exact solution approaches, the
decision maker may be sure about the fact that the
optimal solution is obtained.
Exact solution approaches are approaches
that provide the optimal solution for a
problem.
Mathematical programming is one of the
exact solution approaches that are commonly
used in existing supply chain network design
literature. In mathematical programming, the
decision maker generally begins with creating a
mathematical model to find the solution of the
considered problem. A mathematical model can
be defined as the representation of a system by
using mathematical statements. In order to create
the model, first the sets, parameters and decision
variables are defined. Then, the objective function
of the model and corresponding constraints are
defined, which can be considered as the last step of
the modelling phase.
A mathematical model is the representation
of a system by means of mathematical
statements.
After creating the model, the model can be solved
by using appropriate approaches for that model.
Since the network design problems are generally
large size problems, solving the problem by hand
is generally difficult or sometimes impossible.
Actually, the same concern is also valid for various
other real-life problems. Hence, nowadays,
commercial optimization softwares are widely used
2
by the practitioners and researchers who deal with
an optimization problem. As an example, GAMS is
one of the well-known and widely used commercial
optimization softwares. Each optimization software
has some advantages and disadvantages such as
price, ease of use, performance etc. Thus, while
selecting the appropriate software, the decision
maker should consider these criteria.
Heuristic Solution Approaches
As we discussed in the previous subsection,
network design problems are generally solved by
using commercial optimization softwares since
they are generally difficult or sometimes impossible
to solve by hand. However, if the problem size is
very large, even those commercial optimization
softwares cannot find the optimal solution. In other
words, in some problem instances, it may not be
possible for the decision maker to find the optimal
solution by using exact solution approaches. In
those cases, the decision maker may consider using
a heuristic solution approach to find a solution.
Heuristic approaches are efficient algorithms
developed with the expectation of finding a “good”
solution. These approaches never guarantee to find
the optimal solution. For example, suppose that the
objective function of the problem is minimization
of the total supply chain cost and suppose that you
use a heuristic approach and find the minimum
total supply chain cost as $1,000,000. In this case,
you cannot be sure that this cost is the optimal
cost. There may be, for example, a supply chain
network which provides a total supply chain cost
of $900,000, which is not found by the heuristic
approach you used. Unfortunately, we cannot
know whether there is a better solution than the
solution obtained by using a heuristic approach.
Heuristic approaches are approaches that
do not ensure finding the optimal solution
but expected to provide a reasonably good
solution in an acceptable time.
Since they do not guarantee the optimal
solution, heuristic solution approaches are generally
used in the cases in which the decision maker could
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Supply Chain Network Design

not obtain a solution by using exact solution approaches and they are used with the expectation of finding
at least a good solution. Finally, it should be noted that there are numerous researchers who focus on
developing high quality heuristic approaches providing high quality solutions for different problems.
These approaches generally include multi-step complex algorithms and they find near optimal or optimal
solutions in a reasonable time.

Learning Outcomes

7 To solve simple supply chain network design problems

Self Review 7 Relate Tell/Share

Why do we need to Associate the exact solution Share a problem you face in
use heuristic solution approaches and heuristic your life and solve by using
approaches? solution approaches. a heuristic approach.

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Further Reading

Our Supply Chain Is Not Optimal!

Establish is a supply chain consulting firm focusing on supply chain strategy, transportation consulting
services, warehouse design & improvements and supply chain audits & analytics. A manufacturer of
cookware, bakeware, dinnerware and household tools made a series of changes in their supply chain
network as a result of both organic growth and growth through acquisitions. The changes included the
number and location of manufacturing operations, the number and location of distribution centers
and the re-configuration of the company’s customer base (mass merchants, department stores, specialty
retailers and online businesses).

The management of the company concluded that to achieve the optimal supply chain network from
the perspective of cost and service performance, the entire network needed to be redesigned. To do so,
a special project team was then commissioned to manage the network redesign internally and Establish
was engaged to create the new redesigned network.

The Solution

Establish developed a project methodology based on the project objective and scope and the firm’s
experience (30+ years) and judgment. The methodology was multi-stepped. Establish also selected a
best-in-class network modeling tool to use for the work required.

The first step in the methodology was for the manufacturer’s project team and the Establish team to
meet to structure the project work, refine the project scope, develop planning factors and identify key
contacts at the major locations and the sources for the data that would need to be gathered.

Second, site visits were scheduled to observe a number of the manufacturer’s operations so that Establish
would develop an understanding of current network to include the product groups in the network,
their storage and shipping characteristics and requirements, customer’s service requirements, current
issues, etc. From these visits several quick fix opportunities were also identified and implemented
immediately. Implementation of these opportunities actually yielded benefits that offset the project
costs.

Third, the data was gathered and analyzed, and developed as necessary to reflect the operation of the
current supply chain. Progress meetings were scheduled to validate the data against the actual supply
chain costs.

Fourth, a validation model run was prepared to confirm the accuracy of the model. Then, a 5-year
forecast was applied to the validation model to create a model Baseline.

Fifth, a number of alternative scenarios were modeled to identify the optimal supply chain network.
The alternative supply chain network scenarios were compared to the baseline. The overall best supply
chain network, from the prospective of cost and service performance, was identified and then it was
evaluated for practicality. Minor location adjustments were made, a few product groups were shifted
and the completed result was the redesigned optimal supply chain network.

Source: https://www.establishinc.com/network-design-for-household-goods

47
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Supply Chain Network Design

To explain the “supply chain network” and

LO 1 “supply chain network design” terms

Although the structure of a supply chain significantly differs from a company to another, a traditional
forward supply chain network includes suppliers, manufacturing plants, distribution centers and customers.
In this network, raw materials are procured by the manufacturers from the suppliers and products (finished
goods) are manufactured in manufacturing plants by using these raw materials. Then, those finished goods
are shipped to distribution centers in different regions and shipped from distribution centers to retailers
based on the demands of retailers. Finally, the products in retailers are purchased by the customers.
Summary

In recent years, due to concerns about sustainability and possible economic value that can be obtained, closed-
loop supply chains have become an important concept in both real-life and academia. Closed-loop supply chains
include both forward and reverse flows. Forward flows work just as a forward supply chain and aim to satisfy
the demands of customers, whereas reverse flows deal with activities such as collection of used products from
customers, initial quality control, remanufacturing, repairing, recycling of reusable products and disposal of
non reusable products. In order to do these activities, a closed-loop supply chain also includes facilities such as
collection center, repair center, remanufacturing center, recycling center and disassembly center.
Supply chain network design problem is one of the most important problems in the area of supply chain
management and it is also called as strategic supply chain planning since the design decisions are generally
strategic level decisions. Network design problem broadly includes the determination of the number,
location and capacity of facilities such as manufacturing plant, distribution center etc., the assignment of
each market region to these facilities and supplier selection for the components or raw materials that are
used in the manufacturing process.

To explain the costs considered in supply

LO 2 chain network design problems

While designing the supply chain network, the decision maker must consider various different costs that
generally affect each other. The costs can be divided into two groups as fixed costs and variable costs. Fixed costs
are independent from the amount processed. Renting costs and property taxes of facilities such as manufacturing
plants, distribution centers and warehouses, salaries of drivers, renting costs of vehicles and taxes of vehicles can be
mentioned as examples of fixed costs that must be considered while designing the supply chain network. On the
other hand, variable costs depend on the amount processed. Variable costs of operations such as manufacturing,
packaging, distributing, holding and quality control, variable costs of shipments such as fuel cost, cost of bridges
and highways and procurement costs of components that are procured from suppliers can be examples of variable
costs that must be considered while designing the supply chain network.

To explain the decisions considered in

LO 3 supply chain network design problems

The decision maker focuses on various decisions while designing the supply chain network. These
decisions can be categorized as procurement decisions (supplier selection), facility decisions, flow
decisions, shipment decisions and other decisions. Facility decisions include the determination of the
number, locations and capacities of the facilities such as manufacturing plants, distribution centers,
and warehouses. Flow decisions include the determination of the flows between different facilities in
the supply chain. Shipment decisions mainly cover two decisions; transportation mode decisions and
vehicle decisions. In addition to above-mentioned decisions, in some cases the decision maker may face
some other decisions such as quality decisions, sustainability level decisions and outsourcing decisions.
Note that these decisions cannot be made separately since they generally affect each other. For example,
procurement decisions affect the facility decisions and vice versa.

48
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Supply Chain Management

To define the objectives considered in

LO 4 supply chain network design problems

Supply chain networks strongly depend on the objective or objectives considered in the design process.
In real life and in the literature, different objectives are used in different applications. We can categorize
the objectives in three groups as economic objectives, environmental objectives and social objectives.
Minimization of total supply chain cost, maximization of total profit and maximization of after-tax profit
can be considered as examples of economic objectives. Minimization of carbon emissions, maximization
of collected product quantity and maximization of environmentally friendly raw material rate can be

Summary
examples of environmental objectives. Finally, minimization of work accidents and maximization of job
opportunities can be considered as examples of social objectives. In the existing network design literature,
in addition to the studies that propose single objective models such as cost minimization, there are also
some studies which consider a multi-objective problem setting. These studies generally deal with environ-
mental and/or social objectives together with the economic objective.

To define the constraints faced in

LO 5 supply chain network design problems

While designing the supply chain network, the decision maker must consider various constraints. These
constraints can be listed as supply constraints, facility constraints, flow constraints, demand satisfaction
constraints, capacity constraints and other constraints. Supply constraints are observed while procuring
the raw materials or components from suppliers. Lot size constraints of suppliers such as “at least 250
units of product must be purchased” and “only 100 units or multiples of 100 units can be purchased” can
be examples of these constraints. Facility constraints are faced by the decision maker while determining
the number and locations of facilities (manufacturing plants, distribution centers, warehouses etc.).
Constraints such as “Location of manufacturing plant is fixed and cannot be changed”, “At least 3 and at
most 7 warehouses must be opened”, “two warehouses cannot be opened in the same city” can be given
as examples of these constraints. Flow constraints basically control the flow of products from suppliers to
customers. Constraints such as “shipment between two manufacturing plants is not allowed, “products
manufactured in manufacturing plant 1 cannot be shipped to distribution center 2” are examples of
these constraints.
Moreover, demand satisfaction constraints ensure the satisfaction of the demands of either all or a
fraction of the customers in the supply chain. Constraints such as “Demands of all customers must
be met” and “demands of at least 95% of customers must be satisfied within 14 days.” can be given as
examples of demand satisfaction constraints. Since in real life applications, capacities of the facilities
and vehicles are generally limited, the decision maker also faces capacity constraints while designing
the supply chain network. Constraints such as “at most 27-ton product can be shipped by Truck 2”
and “200 units of products can be packaged and 150 units of products can be repaired in the third
distribution center.” can be given as examples of capacity constraints. Finally, in addition to above-
mentioned common constraints, in some cases the decision maker may also need to consider some
specific constraints that are related to governmental regulations, product characteristics or company
policies. Constraints such as “total emission in manufacturing process cannot exceed 25,000-ton
CO2 per year” and “at least 50% of the end-of-life products must be collected and remanufactured or
disposed by the company” can be examples of these constraints.

49
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Supply Chain Network Design

To explain the factors influencing the

LO 6 supply chain network design decisions

There are many factors influencing the network design decisions such as strategic, technological,
macroeconomic, infrastructure, competitive, and logistics and facility costs. For example, a firm’s strategy
has a substantial effect on the supply chain network of that firm.
Summary

To solve simple supply chain network

LO 7 design problems

Simple supply chain network design problems can be solved by hand by evaluating the total supply chain
cost corresponding to each option and comparing the costs of all options. However, as the problem
size increases, the number of options also significantly increases and it becomes very difficult and time
consuming or sometimes impossible to solve the problem on hand. Hence, some solution approaches are
needed to be used. It is possible to categorize these approaches in two groups as exact solution approaches
and heuristic solution approaches.
Exact solution approaches are approaches which guarantee obtaining the best solution about the
considered problem. For example, if the objective is maximization of profit, these approaches ensure that
the obtained objective value cannot be further increased without violation of a constraint, in other words
it is the optimal solution. Mathematical programming is one of the exact solution approaches that are
commonly used in existing supply chain network design literature. In this approach, the decision maker
creates a mathematical model to obtain the optimal decisions and objective value for that problem. On
the other hand, heuristic solution approaches are efficient algorithms developed with the expectation
of finding a “good” solution. These approaches never ensure that we obtain the optimal solution and
never give any idea about how far we are from the optimal solution. However, they are expected to give
reasonably good solutions in an acceptable time.

50
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Supply Chain Management

1 Which of the following facilities/actors is not 5 Which of the following objectives can be
seen in a forward supply chain? considered as a social objective?
A. Manufacturing plant A. Minimization of total supply chain cost
B. Distribution center B. Minimization of work accidents in a year

Test Yourself
C. Collection center C. Minimization of carbon emissions in a year
D. Supplier D. Maximization of after-tax profit
E. Retailer E. Maximization of total supply chain cost

2 Which of the following operations can only 6 Which of the following constraints can be an
be seen in a closed-loop supply chain? example to supply constraints?
A. Manufacturing A. At least 3 and at most 7 warehouses must be
B. Recycling opened in that region
C. Distribution B. Products manufactured in manufacturing
D. Procurement plant 2 can only be shipped to retailer 4
E. Packaging C. Demands of all customers must be met
D. Minimum purchasing quantity of raw material
3 Which of the following costs is one of the 2 can be 2500 units.
fixed costs that can be observed in a supply chain? E. Monthly production quantity in second
manufacturing plant cannot exceed 2500 units
A. Fuel costs of company owned vehicles
B. Procurement costs of components 7 Which of the following constraints can be an
C. Cost of manufacturing finished goods example to capacity constraints?
D. Cost of packaging finished goods
A. Monthly production quantity in second
E. Monthly renting costs of warehouses
manufacturing plant cannot exceed 2500 units
B. Warehousing and shipping temperature of the
4 Which of the following decisions can be product must not exceed 12° C
considered as a procurement decision? C. The vehicle must enter İstanbul between 21:00-
A. Component 3 will be supplied from supplier 2. 23:30
B. Road transportation will be used. D. The products must be shipped from retailers to
customers via third-party common carriers
C. Two warehouses will be opened.
E. It is not possible to open two distribution
D. A manufacturing plant will be opened in İstanbul.
centers in the same city
E. Height of the warehouse will be 3 m.

51
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Supply Chain Network Design

8 Which of the following can be an example to 10 A problem, which has the objective function
macroeconomic factors that should be considered
of minimizing total supply chain cost, is solved
while designing the supply chain network?
by using an exact solution approach and optimal
A. Firm’s strategy cost is found as $2,500,000. If the same problem
Test Yourself

B. Competitor’s strategy (with the same parameters) is solved by a heuristic

C. Proximity to airport, seaport and rail service solution approach, which of the following objective
function values can be obtained?
D. Taxes and tariffs
E. Characteristics of the production technologies A. $2,100,000
B. $2,200,000
C. $2,300,000
9 Distance between the manufacturing plant D. $2,400,000
and distribution center of a company is 200 km E. $2,600,000
and 100 units of products are shipped between
these facilities in a day. What is the daily total
shipment cost between these facilities if the unit
shipment cost is $0.2 per unit per km?
A. 2000
B. 4000
C. 6000
D. 8000
E. 10000

52
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Supply Chain Management

If your answer is wrong, please review the

1. C 6. D If your answer is wrong, please review the
“What is Supply Chain Network Design?”
“Constraints” section.
section.

Answer Key for “Test Yourself”

If your answer is wrong, please review the
2. B 7. A If your answer is wrong, please review the
“What is Supply Chain Network Design?”
“Constraints” section.
section.

If your answer is wrong, please review the

3. E If your answer is wrong, please review the 8. D
“Factors Influencing the Network Design
“Costs” section.
Decisions” section.

If your answer is wrong, please review the

4. A If your answer is wrong, please review the 9. B
“Solving Supply Chain Network Design
“Decisions” section.
Problems” section.

If your answer is wrong, please review the

5. B If your answer is wrong, please review the 10. E
“Solving Supply Chain Network Design
“Objectives” section.
Problems” section.

Explain the product flow in a forward supply chain

Suggested Answers for “Self Review”

network.

In a traditional forward supply chain, raw materials and components that

need to be used in the manufacturing process are procured from suppliers
by manufacturing plants. In the manufacturing plant, by using those raw
materials and components, main products (finished goods) are manufactured
and they are shipped to distribution centers or warehouses. In these warehouses
self review 1 or distribution centers, the products are kept and based on the demands of
retailers, they are sent to retailers in different regions. Finally, the customers
purchase the products from the retailers which can be considered as the last
step of forward supply chains. Note that above mentioned product flow is
just a general framework and product flows in a supply chain may vary from
a case to another

How can we decide whether a cost is a fixed cost or

variable cost?

Fixed costs are independent from the amount processed and they are generally
charged for a certain period. For example, when you rent a warehouse, you pay
the same monthly renting cost without considering how many products you
store at that warehouse. You can store just one product, 100 units of product
or 250 units of product, the amount of stored products does not affect the
self review 2
renting cost, you pay the same monthly renting cost in all these cases. On
the other hand, variable costs are dependent on the amount processed. For
example, the fuel cost can be considered as a variable cost since it depends on
the distance travelled. If you travel 100 km, you pay, for instance, $10 but if
you travel 200 km, you pay $20. So, it changes based on the distance traveled.

53
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Supply Chain Network Design

Why should the decision maker make different decisions

in an integrated manner (not separately) while designing
the supply chain network?
Suggested Answers for “Self Review”

In order to make two decisions separately, these two decisions must be

independent from each other, in other words they must not affect each other.
However, in a supply chain network design problem, almost all decisions affect
each other. For example, let us focus on the procurement decision (supplier
selection) and facility location decision. While selecting the appropriate
suppliers to work with, the decision maker must consider the locations of
self review 3 manufacturing plants and optimal procurement decision may be different for
different locations of manufacturing plant. Similarly, a decision maker must
consider the suppliers to work with while making the location decisions and
optimal location decisions may also be different for different procurement
decisions. Hence, if we firstly make the procurement decisions and secondly
location decisions or vice versa, this approach does not guarantee us the global
optimal solution for the entire supply chain. For this reason, all decisions
must be made in an integrated manner.

Why should the companies consider environmental and

social objectives together with the economic objectives?

Environmental concerns, public awareness, governmental legislations and

economic value that can be obtained by being more environmentally friendly
or more socially responsible can be considered as most important factors
that make the companies consider the environmental and social objectives
together with the economic objectives. Today, in many countries there is an
self review 4 emission regulation such as carbon cap, carbon cap-and-trade or carbon tax
which forces the producers to control their emission level. In those countries
it is a necessity rather than an option to consider these objectives. Moreover,
due to the high public awareness, some people prefer the products of the
companies which give importance to environment and take responsibility on
social issues. The companies know this fact and anticipate the economic value
that can be obtained by considering the environmental and social objectives.

What can be the consequence of ignoring a constraint

while designing the supply chain network?

Ignoring a constraint while designing the supply chain network may bring
infeasibilities in companies’ daily activities or may bring solutions that are
not applicable in real life. For example, suppose that a supplier has a lot size
constraint such as “component 3 can be procured as 300 units or multiples of
300 units.” If the decision maker ignores this constraint, optimal procurement
self review 5 quantity can be obtained as, for instance, 280 units. However, in real life
it is not possible to purchase 280 units due to supplier’s lot size constraint.
Hence, the solution is not applicable in real life. Similarly, suppose that a
warehouse has a capacity constraint as 300 units. If the decision maker ignores
this constraint and finds the amount to store in that warehouse as 350 units,
this brings infeasibility in daily activities.

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Supply Chain Management

Which strategies can be considered while designing the

supply chain network?

Suggested Answers for “Self Review”

One of the most commonly considered strategies while designing the supply
chain network is low cost strategy. In this strategy, the aim of the companies is
minimization of total supply chain cost, which in the end allow the companies
to provide the products to customers at lowest possible price. Especially if
there is a strong cost competition between a company and its rivals, this
self review 6 strategy may be very beneficial. Another commonly used strategy is closeness
to customers. Being close to customers not only increases the service level but
also may help the company keep the communication with customers at the
highest possible level. Apart from these two strategies, hybrid strategies which
find a trade-off between cost and service level can also be used.

Why do we need to use heuristic solution approaches?

Since the small instances of a problem include only a few options, they can
be solved by hand by evaluating the objective function value in each option
and comparing them with each other. As the problem size increases, the
number of options significantly increases and it becomes not possible to
solve that problem by hand. In those cases, exact solution approaches such
as mathematical programming are used. Generally, a mathematical model is
self review 7 created first and then it is solved by using commercial optimization softwares.
However, after a certain size, it becomes not possible to obtain the solution
by using exact solution approaches. In those cases, in order to find a solution,
heuristic approaches are used. Heuristic approaches do not guarantee that the
optimal solution is obtained and do not give a clue about how far we are from
the optimal solution, but they are expected to give reasonably good solutions
in an acceptable time.

55
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Supply Chain Network Design

References
Chopra, S., Meindl, P. and Kalra, D. V. (2013). Supply chain management: strategy, planning, and operation (Vol.
232). Boston, MA: Pearson.
Govindan, K., Fattahi, M. and Keyvanshokooh, E. (2017). Supply chain network design under uncertainty:
A comprehensive review and future research directions. European Journal of Operational Research, 263(1),
108-141.
Meixell, M. J. and Gargeya, V. B. (2005). Global supply chain design: A literature review and critique.
Transportation Research Part E: Logistics and Transportation Review, 41(6), 531-550.
Santoso, T., Ahmed, S., Goetschalckx, M. and Shapiro, A. (2005). A stochastic programming approach for
supply chain network design under uncertainty. European Journal of Operational Research, 167(1), 96-115.

Internet References
Establish Network Design Case: https://www.establishinc.com/network-design-for-household-goods (Access:
February 27, 2020)

56
 Logistics and
Chapter 3 Transportation
After completing this chapter, you will able to;
Learning Outcomes

1 Define logistics, its components and objectives

2 Understand the importance of transportation

3 Explain transportation modes and their

characteristics

Key Terms
Chapter Outline Logistics
Introduction Objectives of Logistic
Logistics Total Cost Concept
Transportation Transportation
Transportation Modes Landed Cost
Transportation Modes

58
Supply Chain Management
INTRODUCTION
Logistics is the set of activities related to
organization, movement and storage of materials,
people and related information. These activities
span not only the locations between the origins of
materials at their suppliers and the final destinations
at final users, but also the after sale services.
LOGISTICS
Moving soldiers to battle fields and ensuring the
adequate supply of food, ammunition and housing
at the battle field were crucial military requirements
that initiated the logistics. It is believed that the
word “Logistics” has roots from ancient Greek with
a meaning of “science of computation” and experts
on computing military requirements were named
“Logistikos” by ancient Greeks (Farahani et al.,
2011, p. 3). Also it is important to note that the
Greek word “lógos” means order and French word
“loger” means allocate (Ghiani et al., 2013, p.1).
We refer Leighton (2017) for a discussion from a
historical perspective. In our contemporary world,
logistics is a key element of both private and public
sectors.
What is Logistics?
Several definitions of logistics are available.
Chartered Institute of Logistics and Transport in
the United Kingdom (CILT-UK) defines logistics
as five rights. According to CILT-UK, “logistics is
the process of ensuring that goods or a service is:
• In the right place
• At the right time
• In the right quantity
• At the right quality
• At the right price” (CILT-UK, 2020)
important
Logistics requires simultaneous satisfaction
of five rights; right place, right time, right
quantity, right quality and right price.
The European Committee for Standardization
defines logistics as “the planning, execution and
control of the movement and placement of people
and/or goods and of the supporting activities
related to such movement and placement, within
a system organized to achieve specific objectives.”
(Gleissner and Femerling, 2013).
Council of Supply Chain Management
Professionals (CSCMP) defines logistics as the “part
of supply chain management that plans, implements,
and controls the efficient, effective forward and
reverse flow and storage of goods, services and related
information between the point of origin and the
point of consumption in order to meet customers’
requirements” (CSCMP, 2020). The definition of
CSCMP requires a detailed discussion:
• First, logistics is defined as a “part of
supply chain management” (SCM). As
described in Chapter 1, SCM is a broader
term and it focuses on the coordination of
several business functions both within an
organization and between organizations.
Logistics, on the other hand, considers
interactions among different business
functions within an organization.
• Logistics “plans, implements and controls”.
Planning and implementing are both
important. However, real life is full of
surprises and implementation may deviate
from the plan. From an operational point
of view, control is necessary for monitoring
whether the implementation is in line with
the plan or not. In case of any deviation,
control provides feedback, and the plan may
be revised. From a strategic level, control is
necessary to monitor the activities and their
results are following the company strategy.
• Logistics should be both efficient and
effective. Efficiency is doing the job right
and effectiveness is doing the right job
(Drucker, 1963). A logistics operation
converts company inputs into outputs. An
efficient operation uses minimum amount
of inputs to produce the required amount
of outputs, whereas an effective operation
generates outputs that are relevant with
customer requirements. Hence, to be both
efficient and effective, logistics should be
doing the right job right.
59
 Logistics and Transportation

in transportation or an unexpected increase

Efficiency is doing the job right. Effectiveness
is doing the right job.
• From a traditional point of view, logistics
deals with the flow and storage of goods
from suppliers to customers. Returned
goods originate at the point of consumption
and have to flow in the reverse direction
through the suppliers, this is called Reverse
Logistics. Companies may be involved
in reverse logistics due to several reasons
including returned goods management,
environmental considerations, social
responsibility or to gain competitive
advantage.
Reverse logistics deals with the flow
and storage of goods from the point of
consumption in the reverse direction.
• Flow operation deals with movement or
transportation of goods in forward or
reverse directions. During storage, the
goods are either being processed or waiting
for another movement. Flow and storage
generate place and time utility. Place
utility is generated by moving products
where customers need them. Time utility
is generated by having products when
customers need them. For example, a street
seller offering umbrellas on a rainy day
generates both place and time utility.
important
Logistics generates place and time utility by
enabling the right product at the right place.
in sales at retail stores. Information is also
important for the customers. According
to FedEx CEO Frederick W. Smith,
“the information about the package is as
important as the package itself.”
• The last words of the definition summarize
the purpose of logistics; “to meet customers’
requirements”. The logistics system should
not be designed based on the current
capabilities of suppliers, manufacturers
or retailers. It should be designed to meet
the requirements of customers. Moreover,
customers’ requirements are not necessarily
the same for all customer groups, some
customers may require higher customer
levels whereas some may seek for low cost
solutions. The logistics system should
be flexible enough to meet different
requirements.
important
The purpose of logistics is to meet customers’
requirements.
Although logistics is generally considered in
a for-profit setting, humanitarian logistics is a
branch of logistics that operates in a not-for-profit
environment and aims to help people who have
been affected, or likely to be affected by a (natural
or man-made) disaster. Humanitarian logistics is
defined as “the process of planning, implementing
and controlling the efficient, cost-effective flow and
storage of goods and materials, as well as related
information, from the point of origin to the point
of consumption for the purpose of alleviating
the suffering of vulnerable people” (Thomas and
Kopczak, 2005, p. 2).
important

Humanitarian logistics deals with logistics

• Information related to the flow and storage
aspects of disaster management.
of goods and services are also important
both for the companies and for the
customers. Companies may update their
production, distribution or procurement
plans based on information such as delays

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Supply Chain Management

Logistics affects multiple organizations and it is possible to consider a network composed of these
organizations. Figure 3.1 presents a simple logistics network. The company under consideration is named
as the focal company and placed at the center of the network. The customers of the focal company are
the warehouses and called as first tier customers. Retailers are the customers of the warehouses and they
are the second tier customers of the focal company. Similarly, the focal company has first and second tier
suppliers. The customers of retailers are the consumers of the goods. In Figure 3.1, rectangles correspond
to locations where the goods are stored or processed. Arrows correspond to the movements of goods
between consecutive locations.

Second Tier FirstTier FirstTier Second Tier

Suppliers Suppliers Suppliers Suppliers

Retailer
Suppliers
C
Suppliers Warehouse Retailer
u
Suppliers
Retailer
s
Focal Company
t

o
Suppliers Retailer

Warehouse
m
Suppliers

Retailer e
Suppliers
r
Retailer
s
Warehouse

Retailer

Inbound Logistics Outbound Logistics

Figure 3.1 A Simple Logistics Network

Economic Importance
Logistics is one of the major sources of economic growth and development. Logistics activities accounted
for €850 billion ($1.2 trillion) in European Union (EU-27) in 2009 and $1.2 trillion in United States in
2010 (Grant, 2012, p. 6). Table 3.1 shows the share of the logistics in Gross Domestic Product (GDP) of
selected countries and European Union (EU-27). For Turkey, this share is estimated to be around 11%-
13% (UTİKAD, 2020). Although the shares vary among countries, logistics plays an important role in a
country’s economy.

61
 Logistics and Transportation

Table 3.1 Share of Logistics Costs in Gross Domestic Product

Country & Group of Countries Logistics as a Percent of GDP
EU-27 7.2
United States 8.5
Brazil 12.0
Turkey 11.0-13.0
South Africa 12.8
India 13.0
People’s Republic of China 18.0
Sources: Murphy and Knemeyer (2018), Grant (2012), UTİKAD (2020).

The share of logistics in GDP is around 8% in the US and EU-27, however the share was around
15% in the 1980s. This significant decrease is due to several reasons including improvements in logistics
systems, advances in information technology and infrastructure investments. Figure 3.2 shows the share
of logistics in GDP between 2000 and 2014 for the US.
important
The figure splits the logistics cost into three components;
inventory carrying, transportation and administrative.
The share of logistics decreases from 10% levels to 8% Total logistics cost of Turkey is estimated to
levels in this 15-year period. Note that the transportation be around 11% - 13% of the GDP.
costs have the highest shares in each year.

% of GDP Inventory Carrying Costs Transportation Costs Administrative Costs

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Years
Figure 3.2 Share of Logistics Costs in GDP
Source: Silver, Pyke and Thomas (2017).

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Supply Chain Management

Components of Logistics
The outputs of a logistics system are time and place utility, efficient movement of goods to the
customer, competitive advantage to the company, and a mixture of logistics services. With these outputs,
logistics becomes an important asset of the firm. Logistics requires inputs; natural resources including land
facilities and equipment, human resources, financial resources and information resources. Raw materials
and subassemblies are provided by suppliers, and are processed to obtain finished goods for the customers.
During this conversion, from raw materials and subassemblies to finished goods, the company holds
inventory of unfinished products at different levels of the processes. These are called in-process inventory.
The management plans, implements and controls several logistics activities. Figure 3.3 summarizes the
components of logistics management and their relations.
Logistics related costs can be considered as transportation costs, inventory carrying costs, warehousing
costs, order processing costs, customer service costs and lot quantity costs. Figure 3.3 groups main logistics
activities from a cost based perspective.

Management Actions

Inputs Planning Implementation Control Outputs

into logistics of logistics
Natural Marketing
resources orientation
(land, facilities (competitive
and equipment) advantage)

Human Raw In-process Finished Time and place

Suppliers Materials inventory Goods Customers
resources utility
Efficient
Finanical
movement to
resources
customer
Information Proprietary
resources asset

Logistics Activies
(grouped from cost perspective)

Transportation costs Inventory carrying costs

Traficc and transportation Inventory control
Packaging
Customer service levels Salvage and scrap disposal
Customer Service
Parts and service support Warehousing costs
Return goods handling Plant and warehouse site selection
Warehousing and storage
Order processing and information costs
Demand forecasting Lot quantity costs
Distribution communications Material handling
Order processing Procurement

Figure 3.3 Components of Logistics Management

Source: Lambert, Stock and Ellram (1998).

Total logistics cost can be analyzed under four activities; transportation, inventory, warehousing and
administration. Table 3.2 shows the distribution of logistics cost into four activities. Transportation cost has
the highest share and may account up to two-thirds of the total logistics costs. We discuss transportation
in detail later in this chapter.

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 Logistics and Transportation

Table 3.2 Distribution of Logistics Costs in US and EU

Source: Grant (2012).

Objectives of Logistics
Logistics aims for efficient and effective activities. These can be achieved by considering three variables:
profit, cost and service level.
• Profit: Except for the not-for-profit organizations, having a higher profit is desired. However, it is not
easy to quantify the impact of logistics activities on sales (Ghiani, Laporte and Musmanno, 2013, p.12).
• Cost: Every organization aims to minimize the logistics costs. The cost has two components: fixed and
variable. Fixed costs do not change with the level of activity whereas variable costs increase as the level of
activity increases. Table 3.3 summarizes main cost categories and presents related fixed and variable costs.

Table 3.3 Main Cost Categories in A Logistics System

Main cost categories Fixed costs Variable costs
Transport costs • Devaluation of means of transport • Variable transport costs
• Rental of transport means • Insurance
Storage costs • Running costs of storage centers • Insurance
• Administrative costs • Opportunity cost
• Deterioration
• Obsolescence
Plant and equipment • Devaluation of plant • Variable rental fees
costs
Operational • Administrative costs related with • Costs of loading and unloading
management costs order management goods
• Movement costs
• Inventory control and inventory
management costs
• Packaging costs
Stock out costs • Lost sale
• Loss of customer
• Loss of company image
Source: Adapted from Ghiani, Laporte and Musmanno (2013).

• Service level: This measure aims to assess how well the logistics system meets customers’ requirements.
However, there are multiple methods to define and measure customer service level. More importantly,
the customer and the company may have different understandings of customer service, and the same
service may be considered at different service levels, leading to conflicts and problems between the
company and the customer. Companies aim to maximize their customer service levels.

64
Supply Chain Management

The objectives of minimum cost and maximum service

level are conflicting in most of the real life situations.
Customer service level is the performance of
Hence it is not possible to obtain a logistics solution
the logistics system in meeting customers’
that has the minimum cost and the highest customer
requirements.
service level. The logistics manager has to make a decision
considering the trade-offs.
Consider a company that defines the customer service level as the percent of customer demand
satisfied, which is the ratio of sales to demand. Since some demand may not be satisfied and it may be
lost, the company has to observe the lost sales to compute the service level. As the company increases the
customer service level, lost-sales (unsatisfied customer demand) decreases, and also the associated cost,
cost of lost sales decreases. On the other hand, increasing
customer service level is costly and the company incurs important
higher transportation costs for improving the customer
service levels. Figure 3.4 shows the trade-off between the A logistics manager has to analyze the trade-
transportation cost and the service level. For this example, offs among profit, cost and service level.
the logistics manager should consider the total cost of
transportation and lost sales to set a customer service level.
The total cost concept emphasizes that all relevant important
costs of logistics activities should be considered to ensure
the efficient and effective management of the logistics Total cost concept ensures the consideration
system. A logistics manager applies total cost analyses to of all relevant logistics costs in decision
determine the best solution. Considering only some of the making.
cost components may result in inefficiencies.

Transportation Cost Cost of Lost Sales Total Cost

Cost

0 10 20 30 40 50 60 70 80 90 100
Customer service level (%)

Figure 3.4 Total Cost and Customer Service Level

internet
Learn more about development of logistics services in Turkey, http://www.sbb.gov.tr/wp-content/
uploads/2020/04/ LojistikHizmetlerininGelistirilmesiOzelIhtisasKomisyonuRaporu.pdf

65
 Logistics and Transportation

Learning Outcomes

1 To define logistics, its components and objectives

Self Review 1 Relate Tell/Share

Count the five rights of Consider trade-offs in each Tell logistics activities you
logistics. logistics activity. observe in your daily life.

TRANSPORTATION The price of the product is C units at Point A

Movement of goods between facilities and finally
to the point of consumption is crucial. Transportation
plays an important role in logistics for meeting the
customers’ requirements. The share of transportation
costs, being around two-thirds of the total logistics
cost, is another indicator of its importance (see Table
3.2). Transportation deserves a detailed discussion
since any savings in transportation costs or any
improvements in the transportation system are
expected to have significant impacts.
important
and the maximum price people are willing to pay
at Point B is E units. With the current transport
system, the product has a price of H units at point
B. This cost is called as landed cost. Note that
the landed cost of the product is higher than the
maximum price at this point. Figure 3.5a illustrates
this scenario.
Landed cost of a product is the sum of product’s
cost at the origin and the transportation cost
between origin and destination.

Transportation is generally the most costly

activity in logistics, and may account up to
two-thirds of the total logistics cost.
Demand for Transportation
Demand for transportation arises when a good
is demanded in a specific location where its supply
is not adequate. This is a typical situation with the
occupational specialization and the resulting mass
production. Transportation enables the movement
of the good from an oversupplied location (where
there is mass production) to the undersupplied
location (where the good is demanded). The
transportation activity generates a cost and affects
the value of the good.
Consider a simple example represented in
Figure 3.5, a product is available at Point A and
demanded at Point B. The transport system moves
this product from Point A to Point B and it has two
cost components, a fixed cost incurred when the
transportation activity takes place and a variable
cost that increases with the distance traversed.
Assume that, a new transport system is
introduced between Points A and B with the same
fixed cost but a lower variable cost. With the new
transport system, illustrated in Figure 3.5b, the
landed cost at Point B is J units. Hence, people at
Point B may purchase the product. The improved
transport system enables the expansion of market
to Point B.
Reduction in transportation costs has an
important impact on market size. Consider a
simple example, where a product is produced at
Point A with a cost of 90 units and market price
is 200 units. The current transportation system has
a fixed cost of 10 units and a variable cost of 1
unit per km. Given these costs, the producer can
reach a market in the radius of 100 kilometers
([200-90-10]/1). Assume that an improvement in
the transport system reduced the variable cost from
1 unit per km to 0.5 unit per km. With the new
cost structure, the radius of the market increases to
200 kilometers ([200-90-10]/0.5) hence the total
market size is four times the initial market size

66
Supply Chain Management

(from 10 000π to 40 000π). Figure 3.5 shows the important

relation between the market size and the reduction
in the variable transportation cost. The increase in
According to Lardner’s Law, as the
the market size is faster than the reduction in the
transportation cost is halved, the market size
transportation cost; this phenomenon is known as
gets four times larger.
the Lardner’s Law.

Price at Point B
H H with H H
E E Transport Cost
E E
tem J J Price at Point B
Sys
orts m with
nsp yste
Tra spo rts S
Maximum Tran Maximum
Fixed Price at Fixed New Price at
D D
Cost Point B Cost Point B
C C
Price at Price at
Point A Point A

A Distance B A Distance B
a. Current Transport System b. New Transport System

Figure 3.5 Impact of Transport System on Landed Cost

Source: Adapted from Morlok (1978).

700

600

500
Market Size

400

300

200

100

0
0 10 20 30 40 50 60 70
% Reduction in Variable Transportation Cost
Figure 3.6 Lardner’s Law

Transport Measurement Units

Typically, transportation demand is to move either a specific amount of freight or a number of
passengers for a certain distance between two points: origin and destination. The amount of transportation
demand is defined as the multiplication of two values: weight-distance or passenger-distance and ton-
kilometers or passenger-kilometers. For instance, a demand of 500 ton-kilometers is equal to moving
one ton of freight for 500 kilometers, or two tons for 250 kilometers, or 500 tons for one kilometer.
Actually, all combinations where the multiplication of weight and distance is equal to 500 ton-kilometers
are equal for the measurement unit. However two different combinations, say two tons for 250 kilometers
and 50 tons for 10 kilometers may cost different, require different durations and use different means of
transportation. This measurement unit is useful for several purposes, such as analyzing transportation
trends among different time periods, regions and modes of transportation.

67
 Logistics and Transportation

important In freight transportation, there are different

The amount of transportation is measured
in weight-distance (i.e. ton-kilometer) for
freight transportation and passenger-distance
for passenger transportation.
Transportation demand is to move either a
specific amount of freight or a number of
passengers for a certain distance between two
points: origin and destination.
players. Manufacturing companies are shippers
that generate transportation demand. In some
cases, the shippers utilize their private fleet and
carry out the transportation activity with their
own resources. Carriers provide transportation
services to shippers. Governments and international
organizations are responsible to provide the
necessary business environment including the
construction, management and maintenance of
the transportation infrastructure (such as roads,
bridges, ports) and establishment of transportation
policies.

important
important
Shippers, carriers and governments are the
Transportation demand of 500 ton- three key players in freight transportation.
kilometers may refer to moving 500 tons of
freight for one kilometer or moving one ton
of freight for 500 kilometers. The costs of
these two activities may be very different.

Learning Outcomes

2 To understand the importance of transportation

Self Review 2 Relate Tell/Share

Explain Lardner’s law Build a relationship between

Tell important shippers,
and the relation between improved transportation
carriers and logistics
transportation and landed system and the economic
infrastructures in your city.
cost. development.

TRANSPORTATION MODES
There are five modes of freight transportation; road, rail, air, water and pipeline transport. Each
transportation mode has distinct properties and is preferred in certain situations. These modes serve for several
types of transportation demand with their varying characteristics, costs and area of span. In some cases, door-
to-door service with a single transportation mode may not be preferred or it may not be even possible. In such
cases a combination of multiple modes is utilized which is called multimodal transportation.

important

Five modes of freight transport are road, rail, Multimodal transportation combines at least
air, water and pipeline transport. two different modes of transportation.

68
Supply Chain Management

Modal Split
Table 3.4 shows the share of modes in ton-kilometer units for different modes in EU-27 countries for
years 2013 and 2018. During this period, total freight transportation in ton-kilometer units increased
by 12%, roughly corresponding to an annual increase of 2.3% (Eurostat, 2020). The estimated shares
of modes are 72% for water, 24% for road, 3% for pipelines and remaining for other modes in Turkey,
including international freight transportation. In 2017, the total freight transportation is estimated as
1.62 billion ton-kilometers. The annual increase of the measure is around 4.1% for the last 10-year period
(TSKB, 2019, p. 13).

Table 3.4 Modal split of freight transportation (% share of ton-kilometers).

Years
Mode
2013 2018
Road 52.1 52.4
Water* 34.3 34.1
Sea* 29.1 30.0
Inland waterways 5.2 4.1
Rail 13.2 13.0
Air 0.4 0.4
* Only intra-EU transport
Source: Eurostat (2020)

Mode Selection
Mode selection decision is made by considering two main criteria: cost and transit time. A shipper may
prefer to realize the transportation by own resources or may use a carrier. In both cases, the transportation
is costly and the shipper has to consider the costs and the transit time.
• Cost is computed based on the type of the carrier. If shipper realizes the transportation, the cost
components include the depreciation and maintenance of the vehicles, employee salaries, loading
and unloading costs, fuel consumption costs and all related insurances. Based on the specific
requirements of the transportation and the selected mode, additional costs can be incurred.
In case of using a carrier, the cost can be computed based on the rates set by the carrier. Generally
the rates are given as a table based on origin-destination pairs (or distance) and the amount of the
shipment.
Ghiani, Laporte and Musmanno (2013, p. 320) report water to be the cheapest mode of
transportation, followed by pipeline, rail, road and air.
• Transit time is the duration of the movement from the origin to the destination. This duration
includes necessary loading, transport and unloading times. Transit time is affected by several factors
including weather conditions, traffic and legal procedures. A shorter transit time is preferred by a
shipper. However, in addition to the duration of the transit time, the variability of the transit time
is also important for a reliable service. Consider two transportation modes with similar transit
times, say around 25 days. The first mode has transit times in the interval of 23 and 28 days
whereas the second mode may be very fast, up to 10 days, but also very slow, up to 50 days.
In such a setting, the first mode is preferred due
to its reliability. Ghiani, Laporte and Musmanno
(2013, p. 321) report the modes with respect to Transit time is the duration of the movement
their reliability; pipeline being the most reliable, from the origin to the destination.
followed by air, rail, road and water.

69

important
Cost and transit time are important criteria
for mode selection.
important
For a reliable service, the variability in transit
time must be low.
Gleissner and Femerling (2013, p. 56) discuss
a number of additional criteria for mode selection:
• Mass transport capacity: capability to
transport large amounts of goods at low
costs.
• Flexible schedules: capability to adapt to
changes in schedules and requirements.
• Spatial flexibility: capability of changing
locations of transport vehicles and
integrating transport capacities
• Safety: providing a safe transport for
involved people and the shipped goods;
collecting and monitoring safety related
data such as accidents and amount of
damage.
• Environmental impact: monitoring
pollutant and noise emissions and use of
cleaner energy sources.
important
In mode selection decision, the criteria set
may include mass transport capacity, flexible
schedules, spatial flexibility, safety and
environmental impact.
Characteristics of Transportation
Modes
Important: There is no mode better than others
in all criteria. Each mode has special strengths and
is preferred in certain conditions.
Road transportation: This mode is also referred
to as truck, highway or motor carriage. Road
transportation plays an important role in economy
70
Logistics and Transportation
and provides door-to-door services between
origin and destination. Road transportation can
be truckload (TL) or less-than-truckload (LTL).
TL is preferred if the shipment size is close to
truck capacity. Shipment is loaded to a truck at
the origin and unloaded at the destination. Hence
TL does not require any additional unloading and
loading.
In case of a smaller amount of shipment, typically
less than half of the truck capacity, shippers prefer
to use LTL services. In LTL, small shipments with
different destinations are consolidated on a truck.
A shipment may visit multiple cross-docking
terminals before reaching its final destination. At
each terminal, the shipment may be unloaded
from a truck, loaded to another one and possibly
wait for other trucks.
For small sized shipments, LTL is cheaper
compared to TL, however the transit time is
longer. Also due to the additional handling at
cross-docking terminals, the damage risk is higher
in LTL.
Rail transportation: This mode is generally
preferred for long distance movements. Although
the rail network is well-developed to cover many
large cities, it is not as extended as road network.
The transit time is long and quite unreliable
due to three main reasons (Ghiani, Laporte and
Musmanno, 2013, p. 321):
• Passenger trains have higher priority over
freight trains,
• Direct train connections are rare,
• Freight trains are dispatched after enough
number of cars are loaded.
Fixed costs for railroads are high in terms of
equipment and infrastructure; however variable
costs are relatively low. This mode is generally
used for raw materials (such as iron, iron ore,
coal, chemicals), and low valued finished products
(such as plaster, gypsum, sand and construction
materials).
Air transportation: This mode offers the
shortest transit time especially for long distances.
However due to its high cost, it is generally used
for highly valued products, perishable items
and emergency cases. For providing door-to-
door services, this mode is often used with road
transportation.
Supply Chain Management

Although the travel time between two airports is short, a plane may spend time on the ground due
to the congestions at the airports, waiting for other flights and handling operations. These delays result
in longer transit times. For shorter distances, well-organized ground based modes may compete with air
transportation.
Fixed costs for air transportation including aircraft and equipment purchases are generally lower
than the fixed costs for rail, water and pipelines. The variable costs are very high due to fuel costs and
high wages.
Air transportation has a share less than 0.4% in the
modal split (see Table 3.4). However, considering the important
value of the goods transported, its share is around 20%
(Ghiani, Laporte and Musmanno, 2013, p. 322). Due to delays at airports, road transportation
Water transportation: This mode is considered under may provide shorter transit times than air for
four categories; (i) inland waterways, (ii) lakes, (iii) short to medium distances.
coastal and intercoastal sea and (iv) international deep sea
(Lambert et al., 1997, p. 224).
Use of inland waterways, lakes and coastal sea are highly dependent on the regional geography. There are
important inland waterways and lakes available for passenger and freight transportation. Some important
rivers include Danube and Rhine in Europe, Yangtze in China, Mississippi in North America and Amazon
in South America. Inland water transportation may account up to 20% of freight transportation depending
on the accessibility of the water system into high populated regions.
For international and intercontinental transportation, water is the most important mode and
used mainly for shipping bulk materials such as petroleum and coal. Also container ships play an
important role for international shipments. Use of containers reduces the handling costs and shortens
the transit times. Containers also decrease damage and loss and shippers prefer containers for high
valued products.
The average length of transportation changes among these categories. For international deep sea, the
length can be thousands of kilometers whereas it is limited for lakes and inland waters.
Pipeline: Pipelines are generally designed to transport huge amounts of a single type of product over
long distances. Natural gas, crude oil, chemicals and water are typical examples of products transferred
via pipelines. Associated fixed costs are very high for pipelines but variable costs are lowest among all
modes.
Some studies (i.e. Hugos, 2006) consider the electronic/digital transportation as an additional mode
where electrical energy and data are transported. Figure 3.7 summarizes the characteristics of transportation
modes and Table 3.5 provides a detailed comparison of general and service characteristics.

Water Rail Multimodal Road Air

Slower Speed Faster

Slower Service response Quicker
Larger Shipment size Smaller

Less expensive Transportation cost More expensive

Less expensive Handling cost More expensive

Figure 3.7 Characteristics of Transportation Modes

Source: Adapted from Grant (2012, p. 67).

71
 Logistics and Transportation

Table 3.5 General and Service Characteristics of Transportation Modes

Road Rail Air Water Pipeline
General Characteristics
Product options Very broad Broad Narrow Broad Very narrow
High value
Predominant Low-moderate value Low value, Low value
All types Low-moderate
traffic Moderate-high density High density High density
density
Point to Terminal to Terminal to Terminal to Terminal to
Market coverage
Point terminal Terminal Terminal terminal
Average length of Short to Medium to
Medium to long Medium to long Medium to long
haul long long
Capacity Low Moderate Low Very high Very high
Service Characteristics
Cost Moderate Low High Low Low
Speed
Moderate Slow Fast Very slow Very slow
(Transit time)
Transit time
High Moderate High Low-moderate High
reliability
Availability High Moderate Moderate Low Low
Loss and damage Low Moderate-high Low Low-moderate Low
Flexibility High Moderate Low-moderate Low Low
Multimodal
Very high Very high Moderate Very high Very low
capability
Source: Adapted from Farahani et al. (2011).

UTİKAD (2020) computes the per kilogram value

of freight for different modes of transport and directions
of flow, imports to Turkey and exports from Turkey. The
internet
computed values are reported in Table 3.6 for a five-year
Learn more about logistics in Turkey; Logistics
period. In 2018, the value of one kilogram imported
Sector Report and Logistics Trends and
freight is $4.27 for road, $253.14 for air, $0.68 for water
Expectations Survey https://www.utikad.org.
and $1.45 for rail.
tr/Detay/Duyurular/8351/utikad-lojistik-
important sektoru-raporu-2019-ile-lojistik-egilimler-ve-
beklentiler-arastirmasi-2019-yayinlandi
Per kg value of freight is highest in air and
lowest in water (UTİKAD, 2020).

72
Supply Chain Management

Table 3.6 Value of 1 kg Freight ($)

Road Air Water Rail
Years Import Export Import Export Import Export Import Export
2015 4.71 1.91 153.76 15.17 0.66 1.07 1.34 1.67
2016 4.59 1.76 184.65 21.10 0.63 1.02 1.66 1.20
2017 4.36 1.79 259.32 18.15 0.66 1.03 1.45 1.02
2018 4.27 1.80 253.14 13.10 0.68 1.07 1.45 1.20
2019 (Q3)* 4.06 1.79 258.49 11.51 0.56 0.91 1.25 1.45
* Based on data for the first three quarters of 2019.
Source: UTİKAD (2020).

Learning Outcomes

3 To explain transportation modes and their characteristics

Self Review 3 Relate Tell/Share

Consider the consequences Tell the necessity of using

Discuss strengths of each of per kg value difference in multiple criteria (in addition
transportation mode. imports and exports for road to cost and transit time) in
transportation. mode selection decisions.

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 Logistics and Transportation

To define logistics, its components

LO 1 and objectives

Logistics is the part of supply chain management that plans, implements, and controls the efficient,
effective forward and reverse flow and storage of goods, services and related information between the
point of origin and the point of consumption in order to meet customers’ requirements. Natural resources,
human resources, financial resources and information resources are inputs of logistics to generate outputs
that are marketing orientation, time and place utility, efficient movement of goods to customers and
Summary

becoming a proprietary asset of the company. Logistics plans, implements and controls several activities
that include transportation, customer service, parts and service support, return goods handling, demand
forecasting, order processing, warehousing and storage, inventory control, packaging, material handling
and procurement. Logistics considers profit, cost and customer service and aims to optimize these
conflicting objectives simultaneously.

To understand the importance of

LO 2 transportation

Transportation enables the movement of produced goods from their origin to several facilities in the
logistics network and finally to the point of consumption. It generates time and place utility. Transportation
costs get the highest share in logistics costs and any savings in transportation costs has a huge impact in
total logistics costs. Moreover, decreasing transportation costs increases the market size. The amount of
transportation is measured with ton-kilometers for freight and passenger-kilometers for passenger. These
measures enable the analysis of the total transportation among different regions and countries, among
different transportation modes and over a time period.

To explain transportation modes

LO 3 and their characteristics

There are five main modes of transportation. These are road, rail, air, water and pipelines. Each mode
has special characteristics and is preferred to others in certain conditions. In some cases, it is beneficial to
combine two or more modes, which is called multimodal transportation.
Cost and transit time are two criteria generally used in mode selection. In addition to the average transit
time, the variability of the transit time is also considered. Lower is better in all these three criteria. Air is
the most expensive mode of transportation, followed by road, rail, pipeline and water. For transit time, a
similar order is observed as air being the quickest mode of transportation and water being in the last place.

74
Supply Chain Management

1 Which one of the following is not considered 6 A product costs $1000 per unit at Point A
as one of the “five rights” of logistics? and it is demanded at Point B with a maximum
A. At the right time price of $1300. The distance between A and B is
B. In the right place 200 kilometers. The fixed cost of the transportation
system is $150 per unit. What should be the

Test Yourself
C. In the right color
variable transportation cost per unit per kilometer
D. At the right price
so that the product’s landed cost at Point B is
E. In the right quantity $1300 per unit?
A. $1.00 B. $0.75
2 Which of the following statements is used for C. $0.50 D. $1.25
“doing the right job”?
E. $2.00
A. Effectiveness
B. Efficiency
C. Landed cost
7 For freight transportation, the transportation
measurement unit is defined by multiplication of
D. Doing the job right weight and distance. Which one of the following is
E. Modal split not possible with the transportation measurement
unit?
3 Which of the following logistics activities has A. Comparing transportation costs
the highest share in logistics costs? B. Comparing different modes of transportation
A. Inventory management C. Comparisons among regions
B. Warehousing D. Comparisons among years
C. Administration E. Comparisons among countries
D. Order processing
E. Transportation 8 Which one of the following pairs is
considered to be the most important criteria in
4 Customer service level is -------. mode selection?
Which of the following completes the sentence A. Environmental impact and spatial flexibility
above B. Flexible schedules and safety
A. after sales service performance. C. Cost and transit time
B. achieved by low inventory levels. D. Safety and customs
C. not an important objective in logistics. E. Mass transport capacity and damage
D. performance of the logistics system in meeting
customers’ requirements. 9 Which one of the following is not considered
E. an objective to be minimized. as one of the five modes of transportation?
A. Subway B. Rail
5 A product costs $50 per unit at Point A and C. Air D. Water
it is demanded at Point B. The distance between E. Road
A and B is 100 kilometers. The fixed cost of the
transportation system is $10 per unit and the
variable transportation cost is $0.2 per km per unit. 10 Which mode of transportation is most
What is the landed cost of product at Point B? suitable for high-valued products?
A. $60.2 B. $80 A. Rail B. Air
C. $70 D. $90 C. Pipeline D. Road
E. $62 E. Water

75
 Logistics and Transportation

1. C If your answer is wrong, please review the 6. B If your answer is wrong, please review the
“Logistics” section. “Transportation” section.
Answer Key for “Test Yourself”

2. A If your answer is wrong, please review the 7. A If your answer is wrong, please review the
“Logistics” section. “Transportation” section.

3. E If your answer is wrong, please review the 8. C If your answer is wrong, please review the
“Logistics” section. “Transportation Modes” section.

4. D If your answer is wrong, please review the 9. A If your answer is wrong, please review the
“Logistics” section. “Transportation Modes” section.

5. B If your answer is wrong, please review the 10. B If your answer is wrong, please review the
“Transportation” section. “Transportation Modes” section.

Count the five rights of logistics.

Suggested Answers for “Self Review”

Based on the definition of Chartered Institute of Logistics and Transport in

the United Kingdom (CILT-UK), five rights of logistics are:
• right place
• right time
self review 1 • right quantity
• right quality
• right price.
These five rights are related to goods and services. Logistics is the process of
ensuring these five rights are held.

Explain Lardner’s law and the relation between

transportation and landed cost.

Landed cost of a product is the sum of product’s cost at the origin and the
transportation cost between origin and destination. Landed cost can decrease
with savings in the transportation cost and new markets can be opened for
self review 2 the product. Lardner’s law simply explains the relation between savings in
transportation cost and the increase in the market size. Market size expands
much faster than the saving in transportation cost. This important observation
provides a motivation to improve the transportation system and expand the
market size.

76
Supply Chain Management

Discuss strengths of each transportation mode.

Suggested Answers for “Self Review”

Each transportation mode has strengths and weaknesses. For road
transportation, the most important strength can be considered as its door-to-
door delivery option and flexibility. Rail provides a cost advantage especially
for long distances and it has high capability for multimodal transportation.
self review 3 Air’s main strength is its speed, which is crucial in emergency cases. Air is also
preferred for high-valued products. Water is preferred for its low cost and high
capacity. The product range for pipeline is very narrow but the low cost and
high capacity are the strengths of this mode.

References
Drucker, P. F. (1963). Managing for business
effectiveness. Harvard Business Review, 41(3),
53–60.
Farahani Z. R., Rezapour, S. and Kardar, L. (2011).
“Overview”. Farahani Z. R., Rezapour, S.
and Kardar, L. (Eds), Logistics Operations and
Management in (pp. 3–9). Elsevier.
Ghiani, G., Laporte, G. and Musmanno, R. (2013).
Introduction to logistics systems planning and control
(2nd ed.). Wiley.
Gleissner, H. and Femerling, J. C. (2013). Logistics:
Basics - Exercises - Case Studies. Springer, Cham.
Grant, D. B. (2012). Logistics Management. Pearson
Education.
Hugos, M. (2006). Essentials of Supply Chain
Management (2nd ed.). John Wiley and Sons.
Lambert, M. D., Stock R. J. and Ellram M. L. (1998).
Fundamentals of Logistics Management, Irwin/
McGraw-Hill Publishing.
Murphy, P. R., Jr. and Knemeyer, A. M. (2018).
Contemporary Logistics (12th ed.). Pearson
Education.
Morlok, E. (1978). Introduction to Transportation
Engineering and Planning. McGraw-Hill
Publishing.
Silver, E. R., Pyke, D. F. and Thomas, D. J. (2017).
Inventory and Production Management in Supply
Chains (4th ed.). CRC Press.
Thomas, A. S. and Kopczak, L. R. (2005). From
Logistics to Supply Chain Management: The
Path Forward in the Humanitarian Sector. Fritz
Institute, San Francisco, CA.
Türkiye Sınai Kalkınma Bankası - TSKB, (2018),
Sektörel Görünüm: Yük Taşımacılığı ve Limancılık.
TSKB Ekonomik Araştırmalar, İstanbul.
Uluslararası Taşımacılık ve Lojistik Hizmet Üretenleri
Derneği - UTİKAD (2020). UTİKAD Lojistik
Sektörü Raporu 2019, UTİKAD, İstanbul.

Online References
R. M. Leighton (2017, June 26). Logistic. https://www.britannica.com/topic/logistics-military
Council of Supply Chain Management Professionals (2020, April 21). CSCMP Supply Chain Management
Definitions and Glossary. https://cscmp.org/CSCMP/Academia/SCM_Definitions_and_Glossary_of_
Terms/CSCMP/Educate/SCM_Definitions_and_Glossary_of_Terms.aspx
The Chartered Institute of Logistics and Transport in the UK (2020, April 21). Careers in Logistics Management.
https://ciltuk.org.uk/Careers/Online-Careers-Service/Career-Pathways/Logistics-Management
EuroStat (2020, April 30). Freight transport statistics - modal split, Modal split based on five transport modes: road
competes with maritime at intra-EU level, https://ec.europa.eu/eurostat/statistics-explained/index.php/Freight_
transport_statistics_-_modal_split

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 Production Planning in
Chapter 4 Supply Chains
After completing this chapter, you will able to;
Learning Outcomes

1 Understand production planning

2 Define forecasting and use some forecasting
methods

3 Understand push and pull production control

systems 4 Make workforce plans by using chase strategy
and level strategy

Key Terms
Chapter Outline Production Planning
Introduction Forecasting
What is Production Planning? Push Production System
Forecasting Pull Production System
Push and Pull Production Control Systems: Material Requirement Planning (MRP)
MRP and JIT Just in Time (JIT)
Workforce Planning Chase Strategy
Level Strategy

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Supply Chain Management
INTRODUCTION
A supply chain’s success strongly depends
on providing the right amount of products to
customers at the time they are requested. For
example, if a customer has a demand of 200 units
in month 3, providing 150 units at that month or
providing those products in month 4 is generally
not acceptable. Hence, the manufacturer should
create a plan for a period, which states what to
produce, when to produce and how much to
produce in order to achieve the company goals.
A plan answering these questions is known
as a production plan. This chapter begins by
introducing the common concepts and definitions
related to production planning.
Unfortunately, in most cases demands of
customers in next periods are uncertain. For
example, suppose that a company manufactures
washing machines. Since the customers do not
go to the company and say that “I will buy a
washing machine next year”, the company does
not know the exact demands of customers. In
such a case, the company tries to estimate the
demand by using some forecasting tools. Hence,
forecasting plays an important role in production
planning. Definition of forecasting and some
basic forecasting techniques are introduced in the
forecasting section. After making the production
plan, the next job may be making the explosion
calculus and determining the requirements for sub-
level row materials or components. We focus on
this issue in the Push and Pull Production Control
Systems: MRP and JIT section. In that section,
we also give some definitions related to push and
pull production systems and compare MRP and
JIT systems with each other. Finally, another
aspect of the production planning is the workforce
planning which deals with the determination of
the workforce level in each period. In this section,
in order to determine the workforce level, we
mainly focus on two heuristic approaches, the
constant workforce plan, which is also known as
level strategy and the zero inventory plan which is
also known as chase strategy.
WHAT IS PRODUCTION
PLANNING?
Production planning can be broadly defined as
a management process in manufacturing industries
which focuses on the decisions regarding the
4
procurement of components and raw materials and
adjustment of workforce level, machines and other
necessary resources to make sure that company
goals are achieved. In this context, a production
plan can be considered as a guide for the company.
Hence, a company’s success or failure strongly
depends on its production plan.
Production planning is the management of
production process in line with company
goals.
In order to make a production plan, it is necessary
to know the demand of the final product. For
example, suppose that the company manufactures
personal computers. In order to make a production
plan, more particularly, in order to determine how
many motherboards, RAM and graphics cards
are needed, how many machines are needed, how
many workers are needed etc. the company must
first know how many computers will be sold in
next years. However, in real life, demand of the
finished goods (final products) is generally not
known certainly, but this does not mean that the
company does not have any clue about the selling
quantities in the following years. By using the
previous data, at least an estimation can be made
about the next year’s demand. For example, if the
selling quantities in 2017, 2018 and 2019 are 2000
units, 3000 units and 2500 units, the company, at
least, knows that selling quantities in 2020 may
be around 2000 and 3000 units. This process is
called forecasting. A typical production planning
process generally begins with forecasting. By this
way, estimations of demands for the final product
are determined. After determination of these
estimations of demand, the next step will be the
planning of manufacturing processes, procurement
of components and adjustment of workforce.
important
Production planning generally begins with
forecasting.
In real life, a typical manufacturing company
deals with dozens or even hundreds of processes
and in those processes hundreds or even thousands
of components are used. In such a case, it becomes
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Production Planning in Supply Chains

difficult for the company to make the production plan by hand. For this reason, some software solutions
such as Enterprise Resource Planning (ERP) solutions are widely used. These solutions allow the users to
manage, control and monitor all the processes ranging from manufacturing to distribution, from sales to
warehousing in an integrated manner.

Learning Outcomes

1 To understand production planning

Self Review 1 Relate Tell/Share

Why do we need to make Associate forecasting and Tell a software that may be
forecasts? production planning. used in production planning.

FORECASTING
“My concern is with the future since I plan to spend the rest of my life there” says Charles F. Kettering,
referring to the importance of the future. On the other hand, we can never know the future and that
is why we make forecasts. We can classify forecasting methods as subjective ones and objective ones. A
subjective forecasting method is based on human judgment. There are several techniques for soliciting
opinions for forecasting purposes. Customer surveys, the Delphi method and jury of executive opinion
can be examples to these techniques. On the other hand, objective forecasting methods are those in which
the forecast is derived from an analysis of data. A time series method is the one that uses only past values
of the phenomenon we are predicting. Causal models are the ones that use data from sources other than
the series being predicted; that is, there may be other variables with values that are linked in some way to
what is being forecasted (Nahmias and Olsen, 2015). In this chapter our focus will be more on time series
forecasting methods. For a detailed discussion about other subjective or objective forecasting techniques,
please refer to Nahmias and Olsen (2015).
As mentioned earlier, time series forecasting is a technique which uses the historical data as input and
presents data about the future as output. For example, if we want to make a demand forecast, our inputs
will be demands in previous years and our output will be
demands in next years. There are many forecasting methods
which use basic or complicated algorithms. Unfortunately, Time series forecasting is a technique which
it is not possible to make a generalization about the success uses existing data as input and provides data
of these methods, their success strongly depends on the about the future as output.
data. Hence, selection of the forecasting method which fits
the considered data best is crucial.
Based on Nahmias and Olsen (2015) forecasts have the following characteristics.
• They are almost always going to be wrong.
• A good forecast also gives some measure of error.
• Forecasting aggregate units is generally easier than
important
forecasting individual units.
• Forecasts made further out into the future are less
accurate. Forecasts are almost always wrong.
• A forecasting technique should not be used to the
exclusion of known information.

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As mentioned earlier, there are many forecasting methods. In this chapter, we will study three well-
known and widely used methods: moving average, exponential smoothing and double exponential
smoothing with Holt’s method. These methods are discussed in the following subsections but before
introducing them, it may be beneficial to discuss how we can evaluate a forecast.

Evaluating Forecasts
Suppose that you make a forecast about the next year, i.e. you estimate the demand for a product in
the next year by using two different forecasting methods. Those methods give two different demand values
for the next year. In such a case, how can you be sure that one is better than the other? How can you
measure the success of your forecast? In this subsection we
will focus on this issue and present two simple approaches important
to evaluate forecasts. We will use these two approaches in
the following subsections to evaluate the forecasts made Mean Absolute Deviation and Mean Squared
by different methods. These two approaches are the Mean Error are two of the most frequently used
Absolute Deviation (MAD) and the Mean Squared Error methods to evaluate forecasts.
(MSE). Before introducing these approaches let us define
the error term.
Let Ft be the forecasted demand value in period t obtained by using a forecasting method, Dt be the
actual demand value in period t and et be the forecast error in period t. We can define the forecast error as
the difference between actual demand value and forecasted demand value. Then, we can formulate et in
terms of actual and forecasted demands as follows.

et = Ft - Dt

Since we define et as the forecast error in period t, e1 refers to the forecast error in period 1, e2 refers
to the forecast error in period 2, and en refers to the forecast error in period n. By considering the forecast
errors in n periods, we can define the Mean Absolute Deviation as follows.
n
1
MAD =
n
∑e i
i=1

In the above formula, ei refers to the absolute value of the error. Hence, in this approach, we basically
sum the absolute values of errors up to period n and we divide it by n. By this way, we actually find the
mean of absolute deviations, which is actually the reason why we call this method the Mean Absolute
Deviation method.

Example 1: Suppose that actual demand for a product is as given in Table 4.1. Moreover, by using a
forecasting method forecasted demands are also obtained as in that table. Calculate the Mean Absolute
Deviation for the data in Table 4.1.

Table 4.1 Actual and Forecasted Demands

1 2 3 4 5 6
Actual Demand 2000 3000 2500 1500 3500 5200
Forecasted Demand 2500 2000 3000 1000 4000 4000

Solution: Based on the data in Table 4.1, we can calculate the errors and absolute errors for each period
as given in Table 4.2.

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Production Planning in Supply Chains

Table 4.2 Errors and Absolute Errors

1 2 3 4 5 6
Error 500 -1000 500 -500 500 -1200
Absolute Error 500 1000 500 500 500 1200

Since et = Ft - Dt , in the above table error term in first period is obtained as 2500 - 2000 = 500, whereas
error term in second period is obtained as 2000 - 3000 = -1000. Similarly, we obtain the error terms in
other periods. Next, we obtain the absolute error, ei for each period based on the error terms. Note that
since the absolute value cannot be negative, we have 1000 instead of -1000 in the second period. Same
is valid also for other negative error values. After obtaining the absolute errors, we can now calculate the
Mean Absolute Deviation as follows.

1 4200
MAD = (500 +1000 +500 +500 +500 +1200)= =700
6 6

As another approach for evaluating forecasts, we will discuss the Mean Squared Error. It is actually
pretty similar to Mean Absolute Deviation except the fact that in this approach, instead of absolute errors,
we sum squared errors. In this context, we can formulate MSE as follows.
n
1 2
MSE =
n
∑e 1
i =1

As the formula above indicates, in this method, we simply sum the squares of errors in all periods and
then in order to find the mean value, we divide them by n.

Example 2: Considering the data given in Table 4.1, calculate the Mean Squared Error (MSE).
Solution: Based on the data in Table 4.1, we can obtain the errors and squared errors for each period
as given in Table 4.3.

Table 4.3 Errors and Squared Errors

1 2 3 4 5 6
Error 500 -1000 500 -500 500 -1200
Squared Error 250,000 1,000,000 250,000 250,000 250,000 1,440,000

After obtaining the squared errors, we can now calculate the Mean Squared Error (MSE) as follows:

1 3, 440, 000
MSE = (250, 000 +1, 000, 000 +250, 000 +250, 000 +250, 000 +1, 440, 000)= =573, 333.3
6 6

Apart from these two approaches, there are other approaches such as the Mean Absolute Percentage
Error (MAPE), but we will not discuss them in this chapter. In the next subsections, we use MAD and
MSE approaches to evaluate the forecasts made by using different approaches.

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Moving Average
Moving average can be considered as one of the simplest and mostly used forecasting methods. In
this approach, only N most recent observations are put into account and arithmetic average of these
N observations is determined as the forecast value. Note
that here N can be an arbitrary value that is determined
by the person who makes the forecast. For example, if Moving average is a method which uses
N is 3, then 3 most recent observations are considered. the arithmetic average of N most recent
On the other hand, if N is 5, we must consider 5 most observations as the forecast value.
recent observations. Generally, moving average forecasts
are denoted as MA (N) to indicate how many periods are
considered while making the forecast.
Let Ft be the forecast value obtained for period t and let Di be the actual demand value obtained in
period i. Then, we can formulate Ft by using MA (N) as follows.
t −1
1
Ft = ∑
N i=t − N
Di

For example, if we let N = 3, then the formula above can be modified as follows.

1
Ft =
3
(Dt -3
+Dt -2 +Dt -1 )
Example 3: Actual demand for a product in different months are observed as follows in Table 4.4.

Table 4.4 Actual Demand Values

Month 1 2 3 4 5 6 7 8 9 10 11 12
Demand 20 30 36 42 40 36 44 50 56 48 60 64

Use three-month moving average, MA(3), and four-month moving average MA(4) to forecast the
demands in appropriate months. Calculate the MAD and MSE values corresponding to these forecasts.

Solution: In order to make forecasts by using three-month moving average, we must have historical
data related to the past three months. Hence, we cannot make any forecast for month 1, month 2 and
month 3 by using three month moving average. However, we can make a forecast for month 4 since we
have the actual demand values for month 1, month 2 and month 3. Moreover, observe that we can make
a forecast for month 13 by using three month moving average since we have actual demand values for
month 10, month 11 and month 12, but we cannot make any forecast for month 14 since we do not have
actual demand value for month 13. Similar comments can also be made for four month moving average.
Briefly, we can make forecasts for months 4 to 13 by using three month moving average and we can make
forecasts for months 5 to 13 by using four month moving average.
20 +30 +36
Three month moving average forecast for month 4 can be obtained as =28.67 . Similarly,
3
20 +30 +36 +42
four month moving average forecast for month 5 can be obtained as =32 . Other forecast
4
values are obtained in a similar manner and presented in Table 4.5.

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Production Planning in Supply Chains

Table 4.5 Forecast Values and Errors Corresponding to MA(3) and MA(4)
Month Actual Demand MA(3) Error Squared Error MA(4) Error Squared Error
1 20 - - - - -
2 30 - - - - -
3 36 - - - - -
4 42 28.67 13.33 177.69 - -
5 40 36.00 4.00 16.00 32.00 8.00 64.00
6 36 39.33 -3.33 11.09 37.00 -1.00 1.00
7 44 39.33 4.67 21.81 38.50 5.50 30.25
8 50 40.00 10.00 100.00 40.50 9.50 90.25
9 56 43.33 12.67 160.53 42.50 13.50 182.25
10 48 50.00 -2.00 4.00 46.50 1.50 2.25
11 60 51.33 8.67 75.17 49.50 10.50 110.25
12 64 54.67 9.33 87.05 53.50 10.50 110.25
13 - 57.33 - - 57.00 - -

As it is seen in Table 4.5, three month moving average and four month moving average give different
forecasts. For example, for month 12, three month moving average gives a forecast value of 54.67 but four
month moving average gives a forecast value of 53.50. Now we will evaluate the forecasts by using the
MAD and MSE methods, which were discussed in the previous subsection. We can determine the error
values for each period by using the formula et = Ft - Dt as presented in Table 4.5. After determining error
values, we can obtain the MAD values for MA(3) and MA(4) as follows:

68 60
MAD for MA(3)= =7.56 MAD for MA(4)= =7.50
9 8

Note that we have 9 error terms for MA(3) but 8 error terms for MA(4). That is why we divide the sum
of absolute errors by 9 in MA(3) and by 8 in MA(4). Based on the calculated MAD values, we observe
that MA(4) performs better than MA(3) since MAD for MA(4) is less than MAD for MA(3). Similarly,
we can calculate MSE values as follows:

653.3 590.5
MSE for MA(3)= =72.59 MSE for MA(4)= =73.81
9 8

Calculated MSE values show that based on MSE values MA(3) is better than MA(4) since MSE value
for MA(3) is less than the MSE value for MA(4). Hence, we can conclude that in terms of MSE values
MA(3) is better than MA(4). Finally, these MAD and MSE values also show that a forecast may be better
than the other in terms of MAD values but may be worse than the other in terms of MSE values.

Exponential Smoothing
Exponential smoothing is another well known and widely used forecasting method. Let Ft-1 be the
forecast value obtained for period t - 1 and Dt-1 be the actual demand value for period t - 1. Then, we can
formulate the Ft, the forecast value for period t based on exponential smoothing as follows:

Ft = α Dt-1 + (1 - α) Ft-1

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In the above equation, α is called smoothing constant which takes a value between zero and one.

Example 4: Suppose that actual demand for a product in different months is observed as in Table 4.4.
Use exponential smoothing with α = 0.5 and α = 0.8 to forecast the demands in each month. Calculate the
MAD and MSE values corresponding to these forecasts.
Solution: In order to start the forecasting procedure, we first need to find a value for the forecast of the
first month. A simple approach in this issue is assuming that the first month forecast is the same as the first
month demand. Hence, we can assume that the forecast made for the first period is 20 for both α = 0.5
and α = 0.8. Now, we have the forecast value for month 1 and we have the actual demand value for month
1. Then, we can make a forecast for month 2 and the subsequent months. For month 2, we can make the
forecast for α = 0.5 and α = 0.8 as follows:

F2 = 0.5 (20) + 0.5 (20) = 20

F2 = 0.8 (20) + 0.2 (20) = 20

In a similar manner, we can make the forecasts for subsequent periods as presented in Table 4.6.

Table 4.6 Forecast Values and Errors Corresponding to ES (α = 0.5) and ES (α = 0.8)

Actual ES Squared ES Squared

Month Error Error
Demand α = 0.5 Error α = 0.8 Error
1 20 20.00 0.00 0.00 20.00 0.00 0.00
2 30 20.00 10.00 100.00 20.00 10.00 100.00
3 36 25.00 11.00 121.00 28.00 8.00 64.00
4 42 30.50 11.50 132.25 34.40 7.60 57.76
5 40 36.25 3.75 14.06 40.48 -0.48 0.23
6 36 38.13 -2.13 4.52 40.10 -4.10 16.78
7 44 37.06 6.94 48.13 36.82 7.18 51.56
8 50 40.53 9.47 89.66 42.56 7.44 55.30
9 56 45.27 10.73 115.23 48.51 7.49 56.06
10 48 50.63 -2.63 6.93 54.50 -6.50 42.28
11 60 49.32 10.68 114.14 49.30 10.70 114.48
12 64 54.66 9.34 87.27 57.86 6.14 37.70
13 59.33 62.77

After determining the forecast values, we also calculate the errors by using the formula et = Ft - Dt and
2
obtain the squared errors, et as in Table 4.6. We use these error and squared error values in our MAD and
MSE calculations. By using the absolute errors MAD for ES (α = 0.5) and ES (α = 0.8) can be calculated
as follows:

88.17 75.62
MAD for ES (α =0.5)= =7.35 MAD for ES (α =0.8)= =6.30
12 12

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Production Planning in Supply Chains

Based on the MAD calculations above, it is seen that ES (α = 0.8) performs better than ES (α = 0.5).
Moreover, we can also calculate the MSE values as follows:

833.18 596.15
MSE for ES (α =0.5)= =69.43 MSE for ES (α =0.8)= =49.68
12 12

Similar to MAD values, MSE values also show that in our problem, ES (α = 0.8) performs better than
ES (α = 0.5) since MSE for ES (α = 0.8) is less than the MSE for ES (α = 0.5).

Double Exponential Smoothing With Holt’s Method

Holt’s method is a forecasting technique that is generally used when the data has a certain trend, such
as the values either increase or decrease over time. This method requires two smoothing constants, α and
β and has two smoothing equations. The first equation is used for the value of the series and the second
equation is used for the trend. These equations can be presented as follows:

St = αDt-1 + (1 - α)(St-1 + Gt-1)

Gt = β(St - St-1) + (1 - β) Gt-1

Based on the above two equations, τ step ahead forecast can be made by using the following equation.

Ft,t+τ = St + τGt

Note that if we want to make a one-step ahead forecast,

we should set τ = 1. In such a case the forecast will be Both one step ahead and multiple step
simply the sum of St and Gt. In the following example, we ahead forecasts can be made by using Holt’s
numerically show how one-step ahead and multiple step method.
ahead forecasts can be made by using Holt’s method.

Example 4: Suppose that actual demand for a product in different months is observed as in Table 4.4.
Use Holt’s method with parameters α = 0.2, β = 0.2, S1 = 20 and G1 = 2 to make one step ahead forecasts
for the demands in each month. Calculate the MAD and MSE values corresponding to these forecasts.
Solution
We can assume that F1 = 20, namely forecast in month 1 is equal to the actual demand in month 1. In
order to make the forecast for month 2, we can use the formula, Ft,t+τ = St + τGt. In our case, since we make
one step ahead forecast, τ will be 1 and for the forecast of second period made in first period, the formula will
be, F1,2 = S1 + G1. Since S1 is given as 20 and G1 is given as 2, we have F1,2 = 20 + 2 = 22. Next, we need to
find the forecast for the third period made in the second period, F2,3. However, since F2,3 = S2 + G2 we need
to find the S2 and G2 values first. Since the formula of St is given as St = αDt-1 + (1 - α)(St-1 + Gt-1), we have
S2 = 0.2(20) + 0.8(20 + 2) = 21.6. Moreover, since Gt = β(St- St-1) + (1 - β) Gt-1, we have G2 = 0.2(21.6 - 20)
+ (0.8(2) = 1.92. After obtaining S2 and G2 we can now calculate F2,3 by using the formula F2,3 = S2 + G2 as
21.6 + 1.92 = 23.52. In a similar manner, St and Gt values and one-step ahead forecasts for other months are
calculated and presented in Table 4.7.

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Table 4.7 Forecast Values and Errors Corresponding to Holt’s Method

Month Actual Demand St Gt Ft,t+1 Error Squared Error

1 20 20.00 2.00 20.00 0.00 0.00
2 30 21.60 1.92 22.00 8.00 64.00
3 36 24.82 2.18 23.52 12.48 155.75
4 42 28.80 2.54 27.00 15.00 225.00
5 40 33.47 2.97 31.34 8.66 75.07
6 36 37.15 3.11 36.43 -0.43 0.19
7 44 39.40 2.94 40.26 3.74 14.02
8 50 42.67 3.00 42.34 7.66 58.63
9 56 46.54 3.18 45.68 10.32 106.52
10 48 50.98 3.43 49.72 -1.72 2.96
11 60 53.12 3.17 54.41 5.59 31.30
12 64 57.04 3.32 56.30 7.70 59.34
13 - 60.36

Note that in the above table we make one step ahead forecast only, i.e. we estimate the demand for
second month by using the St and Gt values corresponding to the first month. However, this approach can
also be used to make multiple step ahead forecasts. For example, by using the St and Gt values corresponding
to the first month, we can estimate the forecast corresponding to the thirteenth month as follows:

Ft,t+τ = St + τGt = > F1,1+12 = S1 + 12G1 = 20 +24 = 44

Finally, by using the absolute and squared errors in Table 4.7, we can calculate the MAD and MSE
values as follows:

81.32 792.78
MAD = =6.78 MSE = =66.06
12 12

In addition to the above models, if there is both trend and seasonality in the data, a more advanced
model called Winter’s model (also called trend and seasonality corrected exponential smoothing model)
can be used to forecast the future values. Several other advanced methods are also developed in the literature
that utilize regression, simulation, data mining or machine learning techniques for improved forecasting.

Learning Outcomes

2 To define forecasting and use some forecasting methods

Self Review 2 Relate Tell/Share

Relate Mean Absolute De-

Why do we need to evaluate Tell a case in which you
viation (MAD) and Mean
forecasts? make a forecast.
Squared Error (MSE).

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PUSH AND PULL PRODUCTION
CONTROL SYSTEMS: MRP AND
JIT
There are mainly two philosophies for the
movement of products in a factory as push system
and pull system. In the push system, production
plans are done for all levels before the observation of
actual demand. Once the production is completed,
they are pushed to the next level. Material
Requirements Planning (MRP) is the basic push
system. MRP determines the manufacturing
amounts for each level of the system by considering
the forecasts for finished goods over a predetermined
planning horizon. For example, suppose that a
company manufactures washing machines. The
company may manufacture a certain amount of
washing machines based on their forecasts before
observing the actual demand. This is an example of
the push system. In MRP, manufacturing amounts
in each level are determined by using a method
called explosion calculus.
Push systems are the systems in which
production planning is done before the
observation of actual demand.
Different from the push systems, in pull
systems, products are moved to the next level only
when they are requested. In pull systems, first
the orders are received from the customers and
then the manufacturing is started based on the
customer orders. The earliest of the pull systems is
Kanban developed by Toyota, which has exploded
into the Just-in-Time (JIT) and lean production
movements (Nahmias and Olsen, 2018). Main
goal of pull systems is reducing the work-in-process
inventory to a predetermined minimum level. In
order to achieve this goal, products are moved only
when they are requested by the higher level, i.e.
there is a demand for that product.
Pull systems are the systems in which
products are moved to the next level only if
there is a demand for that product.
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Production Planning in Supply Chains
Advantages of JIT and MRP
Nahmias and Olsen (2018) state that both JIT
and MRP have some advantages as production
planning systems. We can summarize some of the
advantages of JIT as follows:
1. Reduce work-in-process inventories, thus
decreasing inventory costs and waste,
2. Easy to quickly identify quality problems
before large inventories of defective parts
are manufactured
3. When coordinated with a JIT purchasing
program, ensures the smooth flow of
materials throughout the entire production
process.
important
Reduction of work-in-process inventory
and quick identification of quality problems
before large inventories accumulate are
among the advantages of JIT.
On the other hand, advantages of MRP can be
summarized as follows:
1. The ability to react to changes in demand,
since demand forecasts are an integral part
of the system (as opposed to JIT which does
no look-ahead planning)
2. Allowance for lot sizing at the various levels
of the system, thus affording the opportunity
to reduce setups and setup costs
3. Planning of production levels at all levels of
the firm for several periods into the future,
thus affording the firm the opportunity
to look ahead to better schedule shifts
and adjust workforce levels in the face of
changing demand.
important
Reaction to changes and allowance for lot
sizing are among the advantages of MRP.
The Explosion Calculus
Before introducing the explosion calculus, it
may be beneficial to give some basic definitions
about the terms that may be faced in an MRP table.

Supply Chain Management
Scheduled receipt: These are items due to be
received in a particular time period. For example,
200 units of products will be received in period 6.
On hand inventory: This is the quantity that is
physically present in your warehouse. For example,
you may have 100 units of products that are not
sold in previous periods and hence available in the
warehouse.
Gross requirements: These are the requirements
before the netting of on-hand inventory and
scheduled receipts.
Net requirements: These are the requirements
after netting of on-hand inventory and scheduled
receipts. For example, assume that your gross
requirement for period 1 is 380, you have 20
units of scheduled receipt and 50 units of on hand
inventory for period 1. Then, your net requirement
will be 380 - 20 - 50 = 310 units.
Net requirement is the requirement obtained
by subtracting the on-hand inventory and
scheduled receipt from gross requirement.
Lead time: A lead time is the latency between
the initiation and completion of a process. For
example, if the lead time of manufacturing is 2
periods, you should begin manufacturing in period
1 to obtain the manufactured products in period 3.
Lead time is the time between beginning and
end of a process.
Lot size: Lot size is the quantity of product
ordered for delivery in a specific period or
manufactured in a single run. In real life, different
lot size constraints can be observed. For example,
a supplier may force producers to procure at
least 250 units. In such a case, it is not possible
to purchase 200 or 150 units from the supplier.
Even if the demand is 1 unit, the manufacturer
still must purchase 250 units. Similarly, another
supplier may force the manufacturers to purchase
100 or multiples of 100 units. In such a case if the
demand is less than 100 units, the manufacturer
must purchase 100 units, but if the demand is
between 100 and 200 units, the manufacturer must
4
purchase 200 units and so on. In this chapter, while
making our calculations, we will assume that the
lot size constraint is Lot-for-Lot (also stated as L4L
in some references). L4L basically means that there
is not a lot size constraint and the manufacturer or
the supplier can manufacture exactly the required
quantity. For example, if the demand for a product
is 167 units, the manufacturer can manufacture
exactly 167 units. Similarly, if the demand for a
raw material is 203 units, the supplier can provide
exactly 203 units.
Lot size can be defined as the amount of
product that can be ordered or manufactured
at one time.
Product structure tree: It is a hierarchical
structure of the raw materials or components that
form a certain finished good/final product. A sample
product structure tree is presented in Figure 4.1.
A Level 0
B (1) C (2) Level 1
Figure 4.1 Product Structure Tree
In the product structure tree in Figure 4.1, A is
the final product. B and C are the components or
raw materials that are needed to manufacture A.
Values in brackets near B and C show how many
B and C are needed in order to manufacture 1 unit
of A. Based on the information in Figure 4.1, one
unit of A needs one unit of B and two units of C
to be manufactured. In this context, for example if
we want to manufacture 200 units of A, we need
200 units of B and 400 units of C. Level of the
final product in a product structure tree is generally
referred as Level 0. Then, subsequent levels
are called Level 1, Level 2 and so on. Note that
although in our example, our structure has 2 levels
only (Level 0 and Level 1), in real life there are
instances in which product structure trees include
hundreds or even thousands of levels.
After presenting some basic definitions, we are
now ready to focus on the explosion calculus. We
will explain this with an example:
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Example 5: Suppose that a product has a product structure tree as presented in Figure 4.1. Demand
for product A in different periods are assumed to be as presented in Table 4.8.

Table 4.8 Demand for Product A in Different Periods

Period 1 2 3 4 5 6 7 8 9 10
Demand 200 300 250 150 400 300 380 400 200 180

Moreover, information about on hand inventories, scheduled receipts, lead times and lot sizes are
presented in Table 4.9.

Table 4.9 Information About Products

Product Amount on Hand Scheduled Receipt Lead Time Lot Sizing Rule
A 600 0 0 Lot-for-lot
B 0 50 on period 2 0 Lot-for-lot
C 30 0 0 Lot-for-lot

Based on the above information, generate the MRP tables for product A, B and C.

Solution: Since based on the product structure tree in Figure 4.1 product A is the final product, we will
begin our calculations by determining the gross requirements for product A. As mentioned earlier, gross
requirements are the requirements before netting of on-hand inventory and scheduled receipts. Hence,
gross requirements for product A are actually the same as the demands presented in Table 4.8 and can be
presented as in Table 4.10.

Table 4.10 Gross Requirements for Product A

Product A 1 2 3 4 5 6 7 8 9 10
Gross Requirements 200 300 250 150 400 300 380 400 200 180

After determining the gross requirements, we should determine the scheduled receipts and on hand
inventories for product A. We do not have a scheduled receipt for product A, but we have 600 units of on
hand inventory as seen in Table 4.9. This on hand inventory must be placed in period 1 since we have it
in the beginning. Finally, after placing the scheduled receipts and on hand inventories, we can determine
the net requirements as in Table 4.11.

Table 4.11 Net Requirements for Product A

Product A 1 2 3 4 5 6 7 8 9 10
Gross Requirements 200 300 250 150 400 300 380 400 200 180
Scheduled Receipts
On hand from prior period 600 400 100
Net requirements 150 150 400 300 380 400 200 180

Generally, in MRP tables, instead of writing zero the cell is left blank, that is why we left blank the
scheduled receipts row in Table 4.11. Since we have 600 units of on hand inventory in period 1, we can
use 200 units of it to satisfy the demand in period 1. Hence, we have 600 - 200 = 400 units of on hand

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inventory in period 2. In period 2, the demand is 300 units and we have 400 units on hand. Hence, we can
use 300 of that 400 units to satisfy the demand in period 2 and we have 100 units of on hand inventory in
period 3. Since the demand in period 3 is 250 units and since we have 100 units of on hand inventory in
period 3, we can satisfy 100 units of the demand from the on hand inventory. Hence, our net requirement
will be 250 - 100 = 150 units. Finally, since we do not have any scheduled receipt or on hand inventory for
periods 4 to 10, our net requirements in these periods will be the same as our gross requirements.
After determining the net requirements for product A, we can now determine the net requirements for
product B and product C. Note that since here we assume that all the lead times are zero and all the lot
sizing rules are lot for lot, we can directly use the net requirements of A to determine the gross requirements
of B and C. If the lead time was greater than zero or lot sizing rule was different than lot-for-lot, lead time
and lot sizing rules would also need to be considered while determining the gross requirements of B and C.
Based on the product structure tree in Figure 4.1, we know that one unit of A needs one unit of B. Hence,
gross requirements of B are actually the same with the net requirements of A. In this context, MRP table
for product B can be created as in Table 4.12.

Table 4.12 Net Requirements for Product B

Product B 1 2 3 4 5 6 7 8 9 10
Gross Requirements 150 150 400 300 380 400 200 180
Scheduled Receipts 50
On hand from prior period 50
Net requirements 100 150 400 300 380 400 200 180

Note that since we have 50 units of scheduled receipt on period 2 (see Table 4.9) and since we have no
demand for B in period 2, we have 50 units of on hand inventory in period 3. Hence, net requirement
in period 3 is 150 - 50 = 100 units. Moreover, since we do not have any scheduled receipt or on hand
inventory for period 4 to 10, net requirements are the same with gross requirements.
Finally, based on the product structure tree in Figure 4.1, we can create the MRP table for product C.
Based on that figure, we know that one unit of A needs two units of C. Hence, gross requirements of C
can be obtained by multiplying the net requirements of A with 2 as in Table 4.13.

Table 4.13 Net Requirements for Product C

Product C 1 2 3 4 5 6 7 8 9 10
Gross Requirements 300 300 800 600 760 800 400 360
Scheduled Receipts
On hand from prior period 30 30 30
Net requirements 270 300 800 600 760 800 400 360

Table 4.9 shows that we have 30 units of product C on hand and since we do not have any demand in
period 1 or period 2, this 30 units will still be available at the beginning of period 3. Since the demand in
period 3 is 300 units and since we have 30 units on hand, net requirement in period 3 will be 300 - 30 =
270 units. Moreover, since we do not have any scheduled receipt or on hand inventory for periods 4 to 10,
net requirements in these periods will be the same as the gross requirements.

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Shortcomings of MRP
Nahmias and Olsen (2018) state that MRP has various shortcomings which can be summarized as
follows:
• Uncertainty: MRP ignores demand uncertainty, supply uncertainty, and internal uncertainties
that arise in the manufacturing process.
• Capacity Planning: Basic MRP does not take capacity constraints into account.
• Rolling Horizons: MRP is treated as a static system with a fixed horizon of periods. The choice of
is arbitrary and can affect the results.
• Lead Times Dependent on Lot Sizes: In MRP, lead times are assumed fixed, but they clearly
depend on the size of the lot required.
• Quality Problems: Defective items can destroy the
linking of the levels in an MRP system. important
• Data Integrity: Real MRP systems are big (perhaps
more than 20 levels deep) and the integrity of the Ignorance of uncertainty, ignorance of
data can be a serious problem. capacity constraints and being a static system
• Order Pegging: A single component may be used are among the shortcomings of MRP.
in multiple end items, and each lot must then be
pegged to the appropriate item.
In order to overcome these shortcomings of MRP, later on more advanced systems such as MRP-II and
ERP were developed, which are much more complex systems than MRP.

Learning Outcomes

3 To understand push and pull production control systems

Self Review 3 Relate Tell/Share

What is the difference bet- Give an example to com-

Associate gross requirement
ween the push system and panies that use the pull
and net requirement.
the pull system? system.

WORKFORCE PLANNING
In this section, we mainly focus on two strategies for important
capacity and workforce planning. These are chase strategy,
which is also known as zero inventory plan, and level
Chase strategy is also known as zero inventory
strategy, which is also known as constant workforce plan.
plan and level strategy is also known as
Under zero inventory plan, the main aim of the company constant workforce plan.
is to manufacture as close as possible to the existing demand
pattern. For example, if the demands in the first month
and second month are 200 units and 500 units, respectively, the company should manufacture as close as
possible to 200 units in the first month and as close as possible to 500 units in the second month. Since
200 units and 500 units are very different quantities, they need very different capacities (i.e. workers).
Hence, in zero inventory plan, workers can be hired or fired frequently to adjust the capacity to existing
demand.

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Example 6: A tomato manufacturer tries to “plan

ahead” in order to effectively address the seasonal
Zero inventory plan is a plan which aims to
variation appearing in the annual demand of its
manufacture closely with the demand.
products. Aggregate demand forecast for a product
in the next six months and number of working
On the other hand, under constant workforce days in each month are presented in Table 4.14. For
plan, the main aim of the company is to keep the example, in January, forecasted demand is 2000 units
capacity (i.e. the number of workers) constant and the workers can work 22 days (January includes
during the entire planning period. Hence, once 31 days but the remaining 9 days are holiday).
the number of workers is determined in the
beginning, no workers are hired or fired during Table 4.14 Forecasted Demands and Number of
the planning period. Of course, different demand Working Days in Each Month
and different capacity needs may be observed in
different periods and since no hiring is allowed, the Number of
Month Demand Forecast
number of existing workers must ensure that no Working Days
shortages are observed in any period. In addition, January 2000 22
in this plan, inventory will be accumulated over
February 3000 20
time at periods when demand is less than the
manufactured quantity and that inventory will be March 2500 22
used later on at periods when demand is higher April 3500 21
than the manufactured amount. May 3800 21
June 2200 22

Constant workforce plan is a plan which Moreover, the company’s current condition
aims to keep the capacity constant during (current inventory, workforce etc.) is presented in
the planning period. Table 4.15.

Note that the two strategies mentioned above Table 4.15 Current Condition of the Company
are extreme heuristic strategies, one aiming no
Current inventory 500 units
inventory and one aiming no hiring or firing of
workers. Hence, generally neither of them gives Current workforce 50 workers
the optimal plan. An optimal strategy is generally a Labor hours per unit 4 employee-hours/unit
combination of these methods and can be obtained Regular labor time
8 hours
by creating a mathematical model which finds a per employee per day
trade-off between conflicting objectives. However,
these two strategies can be a beneficial and easy way Finally, material, hiring, firing and regular labor
to find a reasonably good solution to workforce costs are presented in Table 4.16. Note that all
planning problems. We will explain step-by-step other costs are assumed to be negligible.
these two strategies by using the following example.
Table 4.16 Costs
important
Cost Item Cost ($)
Both chase strategy and level strategy are Material cost $50 per unit
heuristic approaches for workforce planning Hiring cost $1000 per worker
problems. Firing cost $2000 per worker
Regular labor cost $10 per employee per hour

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a. Develop an aggregate plan using chase strategy (zero inventory plan). Calculate the total cost
including material cost, hiring cost, firing cost and regular labor cost.
b. Develop an aggregate plan using level strategy (constant workforce plan). Calculate the total cost
including material cost, hiring cost, firing cost and regular labor cost.
c. Compare the costs found in first and second parts of the question and interpret the results.

Solution:
a. As we discussed earlier, in chase strategy, our aim is closely matching the demand in each period and
adjusting the workforce according to the demand. Hence, we need to determine the minimum number
of workers that can satisfy the demand in each month. We first present the summary of calculations and
then explain step by step how we obtain these values. Calculations to determine the minimum number of
workers required are presented in Table 4.17 below.

Table 4.17 Number of Workers Required in Chase Strategy

Number of Number of Units Forecast Net Minimum number of
Working Days Produced per worker Demand workers required
Jan 22 44 1500 35
Feb 20 40 3000 75
Mar 22 44 2500 57
Apr 21 42 3500 84
May 21 42 3800 91
Jun 22 44 2200 50

Now, let us explain how we obtain the values in Table 4.17. The first column in the table is the number
of working days. This data is obtained directly from Table 4.14. The second column is the number of units
produced per worker. In Table 4.15, labor hours per unit is given as 4 employee-hours/unit. That means
a worker spends exactly 4 hours to produce one unit. Moreover, it is given in the same table that regular
labor time per employee per day is 8 hours, that means a worker works 8 hours in a day. Then, since it takes
4 hours for a worker to produce one unit and since a worker works 8 hours in a day, a worker can produce
exactly 8 / 4 = 2 units in a day. Now, if we multiply this value with the number of working days in each
month, we can find the number of units produced per worker in each month. For example, in January,
number of working days is 22 and since a worker produces 2 units in a day, he can produce 22 * 2 = 44
units in January. Similarly, since in February number of working days is 20, number of units produced
per worker in February is 40. We calculate the number of units per worker in other months in a similar
manner as in Table 4.17.
After calculating the number of units per worker, the next column is the forecasted net demand. In
order to determine the net demand, we should consider the forecasted demands and on hand inventories.
Forecasted demands are given in Table 4.14. It is also noted in Table 4.15 that we have 500 units of
inventory and we can use this inventory to satisfy a fraction of the demand. Since the forecasted demand in
January is 2000 units and since we have 500 units of on hand inventory, we need actually 1500 units to be
produced in January. Hence, our net demand in January is 1500 units. Net demands in other months are
the same as the forecasted demands. Hence, we can directly use the forecasted demands between February
and June as net demands.
Finally, the last column in Table 4.17 is the minimum number of workers required. Since we know the
forecasted net demands and number of units produced per worker in a month, we can easily determine
the number of workers required in each month. For example, for January, we know that forecasted net
demand is 1500 units and the number of units produced per worker is 44 units. Hence, when we divide

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1500
1500 by 44 we can obtain how many workers are needed, =34.09 but note that the number of
44
workers must be an integer. Hence, we must always round it to upper integer value (rounding to lower
integer value brings infeasible production plans). In this context, minimum number of workers in January
can be determined as 35. Similar calculations are made also for months between February and June and
presented in Table 4.17.
After determining the number of workers that will work in each month, we can now make the
production plan. The production quantity and number of hired/fired workers in each month is presented
in Table 4.18.

Table 4.18 Production Plan in Chase Strategy

Num of Num of
Num of Num Num Cum. Cum. Ending
Units Per Units
Workers Hired Fired Prod. Dem. Inv.
Worker produced
Jan 35 15 44 1540 1540 1500 40
Feb 75 40 40 3000 4540 4500 40
Mar 57 18 44 2508 7048 7000 48
Apr 84 27 42 3528 10576 10500 76
May 91 7 42 3822 14398 14300 98
Jun 50 41 44 2200 16598 16500 98

Number of workers column in Table 4.18. is directly obtained from Table 4.17. Next two columns are
number hired and number fired columns. We determine these values based on the number of workers. It
is stated in Table 4.15 that the company currently has 50 workers but in January 35 workers are needed.
Hence, we fire 15 workers and decrease the number of workers to 35 in January. At the end of January,
we have 35 workers. In February, we need 75 workers but we have 35 workers. Hence, we hire 40 more
workers and at the end of February we have 75 workers. In March, we need 57 workers but we have 75
workers. Hence, we fire 18 workers. In a similar manner, we determine the number of hired and fired
workers in April, May and June and present them in Table 4.18.
After determining the hired/fired workers in each month, we can also determine the number of units
produced. This amount is determined simply by multiplying the number of units produced per worker
(which is determined in Table 4.17) and number of workers in each month. For example, in January, we have
35 workers and a worker produces 44 units. Hence, number of units produced in January is 35.44 = 1540.
Production amounts in other months are also determined in a similar manner and presented in Table 4.18.
Next column in Table 4.18 is the cumulative production, that is the sum of the productions up to that month.
In January it is 1540 units, the production of January. In February it is 1540 + 3000 = 4540, the sum of
productions in January and February. Similarly, cumulative productions in other months can also be obtained
as presented in Table 4.18. Note that cumulative production in June is the sum of productions in all months.
After determining the cumulative productions, the next column is the cumulative demand. We have
the net demands in Table 4.17 and we can determine the cumulative demands in a way similar to the
cumulative production. For example, cumulative demand in February is the sum of demands of January
and February. Finally, when we subtract cumulative demand from cumulative production, we can obtain
the ending inventory in each month. For example, cumulative production in January is 1540 units and
cumulative demand in January is 1500 units. Hence, we have 1540 - 1500 = 40 units of ending inventory
in January. Ending inventories in other months are calculated in a similar manner and presented in Table

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Production Planning in Supply Chains

4.18. Although in this question we ignore the inventory cost, in the problems where this cost is not
ignored, it can be calculated based on this ending inventories.
After creating the production plan, we can now calculate the costs in chase strategy. Based on Table
4.18, sum of hired workers is 40 + 27 + 7 = 74 and sum of fired workers is 15 + 18 + 41 = 74. Since unit
hiring and firing costs are given as $1000 and $2000 in Table 4.16, total hiring cost will be 74.1000 =
$74,000 and total firing cost will be 74.2000 = $148,000. Moreover, since material cost is given as $50
per unit in Table 4.16 and since total production is 16598 units (see Table 4.18), we can calculate the total
material cost as 50.16598 = $829,900. Finally, we calculate the labor cost. Regular labor cost is given as
$10 per employee per hour in Table 4.16, a worker spends 4 hours for one unit of product and 16598 units
of products are produced in total. Hence, total labor cost will be 10.4.16598 = $663,920. In this context,
total cost in chase strategy will be 74000 + 148000 + 829900 + 663920 = $1,715,820.
b. As mentioned earlier, in level strategy (constant workforce plan) main aim of the company is keeping
the capacity constant in the planning horizon. Hence, we need to determine that constant number of
workers which will work between January and June. Determination of this number slightly differs from
the previous policy. We will first present the summary of calculations and then explain how we obtained
those values. Calculations are presented in Table 4.19.

Table 4.19 Number of Workers Required in Level Strategy

Cumulative
Net Cum. Net Num of Units/Month Num of workers
Units/month
Demand Demand Days per Worker required
per Worker
Jan 1500 1500 22 44 44 35
Feb 3000 4500 20 40 84 54
Mar 2500 7000 22 44 128 55
Apr 3500 10500 21 42 170 62
May 3800 14300 21 42 212 68
Jun 2200 16500 22 44 256 65

The first column in Table 4.19 is the net demand. This demand is determined as we discuss in the
previous part of the question. In January, forecasted demand is 2000 units but we have 500 units of on
hand inventory. Hence, our net demand in January becomes 1500 units. Net demands in other months
are the same as the forecasted demands presented in Table 4.14. In the second column of Table 4.19, we
present the cumulative net demands. Again, as we discussed in the previous part of the question, these
demands are sum of the demands up to that month. For example, for February, cumulative demand is
4500, which is the sum of the demands in January and February. In this context, cumulative demand in
June is the sum of all demands. The third data column is the number of working days in each month,
which are obtained from the given problem data in Table 4.14.
After placing the number of working days in Table 4.19, the next column is the units/month per worker.
As we discussed in the previous part of the question, we know that a worker spends 4 hours for producing
one unit of product and a worker works 8 hours in a day. Hence, a worker produces 2 units in a day. By
using this data and number of working days, we can determine the units/month per worker in each month.
For example, in January, number of working days is 22 days and a worker produces 2 units in a day. Hence,
units/month per worker is 22.2 = 44 units in January. Similarly, since the number of working days in
February is 20 days, a worker can produce 20.2 = 40 units in February, which is the units/month per worker
in February. Units/month per worker in other months are also obtained in a similar manner and presented
in Table 4.19. After obtaining the units/month per worker for each month, our next step is obtaining the
cumulative units/month per worker which is the sum of units/month values up to that month. For January
it is the same as the value of January, 44. For February, it is the sum of the values of January and February,

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44 + 40 = 84 units. In a similar manner, cumulative units/month values in other months are obtained as
presented in Table 4.19.
Finally, our last step is determining the number of workers required by using the cumulative demand
and cumulative units/month. For example, in January, cumulative demand is 1500 and cumulative units/
month is 44. Hence, number of workers required can be obtained by dividing 1500 by 44 as 34.09 As we
discussed in the previous part of the question, number of workers must be integer and in order to obtain
feasible solutions we must always round the non-integer values to upper integer value. Hence, number
of workers required in January will be 35. We obtain the number of workers in other months in a similar
manner by dividing the cumulative demand in that month by the cumulative units/month and rounding
it to upper integer if the obtained value is non-integer. Computational results are presented in Table 4.19.
Last column of Table 4.19 shows how many workers are needed each month. For example, in January it
is 35, in February it is 54 and so on. However, as we mentioned earlier, in level strategy we cannot hire or fire
workers anymore once we determine our constant workforce level. Then, the following question may raise,
what should our constant workforce number be? If we set it 40 for example, it will be sufficient for January
but not sufficient for February. If we set it 60, it will be sufficient for January, February and March since in
those months less than 60 workers are needed but will be insufficient for April, May and June since in those
months more than 60 workers are needed. Determined constant workforce number must be enough for all
months. Hence, we must select the highest number in the number of workers required column, which is 68
in our example. If we set the constant workforce level as 68, we can be sure that it will be sufficient for all
months. Hence, we determine the constant workforce level as 68. Since Table 4.15 shows that we currently
have 50 workers, we hire 18 more workers to increase the number of workers to 68, but once we hire these
18 workers in the beginning of January, we will no longer hire or fire workers in the planning horizon.
After determining the constant number of workers, we can now create the production plan and
determine the ending inventories. These calculations are presented in Table 4.20.

Table 4.20 Production Plan in Level Strategy

Cum. Net Units/Month
Production Cum. Prod Inventory
Demand per worker
Jan 1500 44 2992 2992 1492
Feb 4500 40 2720 5712 1212
Mar 7000 44 2992 8704 1704
Apr 10500 42 2856 11560 1060
May 14300 42 2856 14416 116
Jun 16500 44 2992 17408 908

Cumulative net demand and units/month values in Table 4.19 are obtained directly from Table 18,
please refer to discussions below Table 4.18 for a detailed explanation about how we obtained them. Next
step is the determination of production in each month. This value is determined by using the units/month
and number of workers, which is constant in this strategy as 68 workers. For example, since a worker can
produce 44 units in January as shown in units/month per worker column and since there are 68 workers,
production in January can be determined as 68.44 = 2992. Similarly, since a worker can produce 40 units
in February and since we have 68 workers, production in February can be obtained as 68.40 = 2720. We
obtain the production quantities in other months in a similar manner and present in Table 4.20. Next, we
determine the cumulative productions in each month by summing the productions up to that month. For
example, in February it is obtained by summing the productions of January and February as 5712. Finally,
our last step is obtaining the ending inventories by subtracting cumulative net demand from cumulative
production. For instance, for January, it is obtained as 2992 - 1500 = 1492. Similar calculations are also
made for other months as presented in Table 4.20.

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After determining the production plan, we can calculate the costs as follows: Since we only hire 18
workers and we do not fire any workers in this strategy, hiring cost will be 18.1000 = $18,000. Moreover,
since material cost is given as $50 per unit in Table 4.16 and since total production is 17408 units based on
Table 4.20, we can calculate the total material cost as 50.17408 = $870,400. Finally, we can calculate the
labor cost as follows. Regular labor cost is $10 per employee per hour (see Table 4.16), a worker spends 4
hours for one unit of product and 17408 units of products are produced in total. Hence, total labor cost will
be 10.4.17408 = $696,320. In this context, total cost in level strategy will be 18000 + 870400 + 696320 =
$1,584,720.
c. We find the total cost in chase strategy as $1,715,820 and total cost in level strategy as $1,584,720.
Based on these findings, we can conclude that in our example level strategy provides a better solution
than chase strategy. However, this does not mean that level strategy always provides a better solution than
chase strategy. The results strongly depend on the problem
and considered costs. For instance, in our example we do important
not consider the inventory costs. Since the inventories in
level strategy are higher than those in the chase strategy, Performances of chase strategy and level
considering this cost may yield a different result. As we strategy strongly depend on the considered
mentioned, these are two heuristics and never guarantee problem and costs.
that the best possible solution is obtained. Optimal solution
is generally a hybrid approach which provides a trade-off
between these two extreme strategies.

Further Reading

Challenges and Factors Affecting Production Planning and Control in Pharmaceutical Industry
In any manufacturing industry, production is the driving force to which most other functions react.
The changing business environment in which pharmaceutical manufacturers are acting creates the need
for more effective production processes planning and control methods, which are able to deal with
uncertainties in internal processes and external deliveries. In this article, we have briefly highlighted the
challenges and factors affecting Production Planning and Control (PPC) and role of Master Production
Schedule (MPS). We will begin this article with the objective of PPC.
The ultimate objective of PPC is to contribute to the profit of organization accomplished by
keeping the customers satisfied through the meeting of delivery schedules. The specific objective is to
establish routes and schedules for work that will ensure the optimum utilization of materials, workers
and machines.
Challenges in production planning and control can be listed as follows.
• Combining Functions: It is desirable that minimum changes are made after schedules are
established. This objective can be approached if the amount of work scheduled for the factory
or department is equal to or slightly greater than the production cycle.
• Follow-up: When jobs are started and completed on schedule, there should be very little concern
about the meeting of commitments. Optimum operation of the plant is attained only if the
original plan has been carefully prepared to utilize the manufacturing facilities fully and effectively.
• Re-planning: Often required in manufacturing. Changes in market conditions, manufacturing
methods, etc. affecting the plant will often indicate that a new manufacturing plan is required.
Moreover, factors affecting production planning and control can be summarized as follows.
• Market Forecast: It will indicate future trends in demand for manufactured products. Work
shift policies, plans for an increase or decrease in manufacturing activity are based on the
market forecast and in turn affect the production planning and control.

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• Sales Order: It is a rewrite of the customer order specifying what has been purchased (product,
quantity and authorizing shipment of the goods to the customer). Variation or changes in sales
order will drastically affect production planning and control.
• Standard Process Sheet: It is prepared by process engineering group or process owner and it
is the source of basic data which may include type of machine to be used, time required for
processing, etc. For example, if any machine is under breakdown, the standard process sheet
will be disturbed which in turn affect production planning and control.
• Load Charts: These charts are prepared for each workstation or machine in the plant or may be
for groups of machines or departments.
• Project Planning Method: The product to be produced are manufactured in quantities and
their total processing time can be measured. The best-known methods are Critical Path Method
(CPM) and Program Evaluation and Review Technique (PERT).
Planning is the process of selecting and sequencing activities such that they achieve one or more
goals and satisfy a set of domain constraints. Schedules should reflect the temporal relationships
between activities and the capacity limitations of a set of shared resources. Master Production Schedule
is main driver and information source for further material requirements planning and accompanying
calls or supplies and allows making detailed production schedules for production system. The high re-
planning frequency in order to overcome the uncertainty induces the system nervousness. The system
nervousness can be defined as state of a system when minor changes in Master Production Schedule
creates significant changes in Materials Requirement Planning (MRP). The following critical points can
be considered in Master Production Schedule:
• Frequent changes in MPS result in due-date changes in open orders, quantity and timing for
planned order of end products.
• Mentioned changes are translated into gross requirements changes for products and timing of
their delivery.
• Unexpected changes in MPS affect that materials, needed for a particular order may not be
available. The availability of materials is often limited due to the fact that suppliers have similar
bottlenecks.
The following questions can be considered while scheduling MPS:
• How to make initial MPS that is as feasible as possible?
• How to limit the number of re-planning activities?
• How to be reactive to disturbances in materials flow?
• How to provide planners accurate information about material resources available?

Source:https://learnaboutgmp.com/good-manufacturing-practices-cgmp/challenges-and-factors-
affecting-production-planning-and-control-in-pharmaceutical-industry/

Learning Outcomes

4 To make workforce plans by using chase strategy and level strategy

Self Review 4 Relate Tell/Share

In which cases should a Tell a case in which chase

Relate constant workforce
company use constant strategy may bring signifi-
plan and zero inventory plan.
workforce plan? cant extra costs.

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Production Planning in Supply Chains

LO 1 To understand production planning

Production planning is the management process which focuses on the decisions regarding the
procurement of components and raw materials, production of finished goods and adjustment
of workforce levels, machines and other necessary resources to ensure that the company
achieves its goals. A production plan is a guide for the company, which plays an important
role on both success and failure of the company. In order to make a production plan, it is
necessary to know the demand of the final product. However, in real life, demand of finished
goods (final products) is generally not known certainly. In such cases, common approach is
Summary

making forecasts by using the previous data. Once demand of the final product is determined
by making forecasts, the next step is the planning of manufacturing processes, procurement
of components and adjustment of workforce level based on the forecasted demand. Since in
real life a manufacturing company deals with dozens or even hundreds of processes in which
hundreds or even thousands of components are used, it becomes difficult for a company
to make the production plan by hand. Hence, some software solutions such as Enterprise
Resource Planning (ERP) solutions are used. These ERP solutions allow the users to manage,
control and monitor existing processes.

To define forecasting and use some forecasting

LO 2 methods

Forecasting is a technique which uses historical data as input and present data about the
future as output. There are many different forecasting methods which use basic or advanced
algorithms. A method’s success strongly depends on the data. Hence, it is not possible to make
a generalization about the success of these methods, the methods should be selected carefully
based on the considered data. Characteristics of forecasts can be summarized as follows based
on Nahmias and Olsen (2015): (1) They are generally wrong. (2) A good forecast also gives
some measure of error. (3) Forecasting aggregate units is generally easier than forecasting
individual units. (4) Forecasts made further out into the future are less accurate. (5) A
forecasting technique should not be used to the exclusion of known information.

Mean Absolute Deviation (MAD) and Mean Squared Error (MSE) are two commonly used
approaches to evaluate the forecasts. Let Ft be the demand forecast made for period t, which
is obtained by using a forecasting method, Dt be the actual demand in period t and et be the
forecast error in period t. Based on these notations, forecast error can be defined as, et = Ft - Dt,
which is actually the difference between forecasted demand and actual demand in a period.
1 n
In this context, Mean Absolute Deviation (MAD) can be defined as MAD =
n
∑ i=1
e ,
i
which is obtained by dividing the sum of absolute errors by the number of periods. Similarly,
based on the error value in each period, Mean Squared Error, MSE can be defined as
1 n 2
MSE =
n
∑ i=1
e , which is obtained by dividing the sum of squares by the number of
i
periods.

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To define forecasting and use some forecasting

LO 2 methods

Moving average is one of the easiest and mostly used forecasting techniques. In this approach,
we consider N most recent observations and we obtain the forecast value by taking the
arithmetic average of these N observations. In this context, we can formulate Ft based on
1 T -1
moving average as Ft =
N
∑ i=t-N Di. As an example, let the number of periods, N be 3. Then
the moving average formula can be simplified as Ft = 1 (Dt-3 + Dt-2 + Dt-1).

Summary
3
Another well-known forecasting method is the exponential smoothing. It considers the
forecast value and actual demand value in the previous period. More specifically, if we let Ft-1
be the forecast value corresponding to period t - 1, and Dt-1 be the actual demand value in
period t - 1, Ft , the forecast value for period can be defined as Ft = αDt-1 + (1 - α) Ft-1 based
on exponential smoothing. In this formulation, α is called smoothing constant and it takes a
value between zero and one.

Next, we consider the double exponential smoothing with Holt’s method. This method
requires two smoothing constants, α and β and has two smoothing equations. First equation
is St = αDt-1 + (1 - α)(St-1 + Gt-1) and this equation is used for the value of the series and
second equation is Gt = β(St - St-1) + (1 - β) Gt-1 and this equation is used for the trend. Based
on these two equations, we can make the step ahead forecast by using Holt’s method with the
formula Ft,t+τ = St + τGt. For example, if we want to make a one step-ahead forecast, in this
case will be 1 and the formula will be Ft,t+1 = St + Gt.

To understand push and pull production control

LO 3 systems

Two main philosophies are considered for the movements of products in a company. These are
the push system and the pull system. In the push system, production plans are done before the
observation of actual demand. After the production is completed, they are pushed to the next
level. The basic push system is Material Requirements Planning (MRP) which determines the
manufacturing quantities for each level of the system based on the forecasts for final products.
In MRP systems, manufacturing quantities in each level are determined by some calculations
called explosion calculus. On the other hand, in pull systems, products are moved to the next
level only when there is an actual order. Main objective in a pull system is the reduction of
the work-in-process inventory to a predetermined minimum level. In order to achieve this
objective, products are moved only when they are demanded by the higher level.
Nahmias and Olsen (2015) state that both JIT and MRP have some advantages as production
planning systems. Reducing the work-in-process inventories and decreasing inventory costs
and waste, and quick identification of quality problems are among the advantages of JIT. On
the other hand, the ability to react to changes in demand, allowance for lot sizing and planning
of production levels at all levels can be considered as the advantages of MRP. Although MRP
has these advantages, it also has some shortcomings such as ignorance of various uncertainties
in the system, ignorance of the capacity constraints and fixed lead time assumption.

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Production Planning in Supply Chains

To make workforce plans by using chase strategy

LO 4 and level strategy

In this chapter, we mainly focus on two heuristic approaches for workforce planning. These
are chase strategy, which is also known as zero inventory plan, and level strategy, which is
also known as constant workforce plan. Under chase strategy (zero inventory plan), the
main objective of the company is to reduce the inventory levels by closely meeting with the
demand. Since demands in different periods can be very different, workers can be hired or
fired frequently under this strategy to adjust the workforce level to the changing demand. On
the other hand, under level strategy (constant workforce plan), the main aim of the company
Summary

is to keep the number of workers constant during the entire planning period. For this reason,
after determining the number of workers in the beginning, no more workers are hired or fired
during the planning horizon. Since the demands in different periods may be very different
and since no hiring is allowed under this policy, the company must determine that constant
workforce level such as the number of workers is enough to satisfy the demands in all periods.
It should also be noted that these two strategies are extreme strategies. Chase strategy aims zero
inventory and level strategy aims constant workforce. In a problem setting, one can give lower
total cost compared to other but generally they both do not provide the optimal workforce
plan. An optimal strategy is generally a combination of these strategies and can be obtained by
creating a mathematical model which considers the constraints and finds a trade-off between
zero inventory and constant workforce. However, this does not mean that these strategies
are useless. They are beneficial for obtaining reasonably good solutions and finding an upper
bound for the total cost.

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Supply Chain Management

1 What should be the first step of production
planning if the future demand for the final product
is not known?
A. Workforce planning
6 Which of the following statements is true
about push systems?
A. Main goal is reducing the work-in-process in-

B. Machine scheduling
C. Demand forecasting
D.Procurement of components
E. Facility design
2 Which of the following is not a characteristic
of forecasts?
A. Forecasts are almost always true.
B. A good forecast also gives some measure of error.
C. Forecasts made further out into the future are
less accurate.
D.A forecasting technique should not be used to
the exclusion of known information.
E. Forecasting aggregate units is generally easier
than forecasting individual units.
Test Yourself
ventory
B. Products are moved only when they are reques-
ted by the higher level
C. Easy to quickly identify quality problems before
large inventories
D.The earliest is kanban developed by Toyota
E. Production plans are done for all levels before
the observation of actual demand
7 Suppose that gross requirement for a product
is 200 units in period 1. In the same period, there
are 80 units of on hand inventory and 30 units of
scheduled receipt. Based on this information, what
is the net requirement in period 1?
A. 90 B. 120 C. 170
D.230 E. 310

3 Suppose that demand for a product was 20, 8 What is the latency between the initiation
30 and 40 units in period 1, period 2 and period and completion of a process?
3 respectively. What is the forecasted demand in A. Gross requirement B.Net requirement
period 4 if we use three month moving average? C. On hand inventory D. Lead time
A. 20 B. 30 C. 40 E. Lot size
D.50 E. 60
9 Which of the following is true about chase
4 Suppose that actual demand for a product strategy?
was 200 units and forecasted demand for a pro-
A. Also known as level strategy
duct was 220 units in period 1. Assuming α = 0.5,
what is the forecasted demand in period 2 if we use B. Main aim is manufacturing as close as possible
exponential smoothing? to demand
C. Hiring or firing is not allowed in different periods
A. 202 B. 204 C. 206 D.Always gives the plan with lowest possible (op-
D.208 E. 210 timal) cost
E. Inventory costs are generally very high
5 If we let S1 = 400 and G1 = 30, what is the fo-
recast of period 5 made in period 1 by using Holt’s 10 Suppose that the number of units produced
method? per worker is found as 40 units in June and fore-
A. 430 casted net demand is determined as 1700 units in
B. 460 June. Based on this information, what is the mini-
mum number of workers required if the company
C. 490
uses zero inventory plan?
D.520
E. 550 A. 40 B. 41 C. 42
D.43 E. 44

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Production Planning in Supply Chains

If your answer is wrong, please review the

1. C If your answer is wrong, please review the 6. E
“Push and Pull Production Control Systems:
“What is Production Planning?” section.
MRP and JIT” section.
Answer Key for “Test Yourself”

If your answer is wrong, please review the

2. A If your answer is wrong, please review the 7. A
“Push and Pull Production Control Systems:
“Forecasting?” section.
MRP and JIT” section.

If your answer is wrong, please review the

3. B If your answer is wrong, please review the 8. D
“Push and Pull Production Control Systems:
“Forecasting?” section.
MRP and JIT” section.

4. E If your answer is wrong, please review the 9. B If your answer is wrong, please review the
“Forecasting?” section. “Workforce Planning” section.

5. D If your answer is wrong, please review the 10. D If your answer is wrong, please review the
“Forecasting?” section. “Workforce Planning” section.
Suggested Answer for “Self Review”

Why do we need to make forecasts?

In order to make a production plan we need to know how many products

we will sell in next years. For example, suppose that we are manufacturing
television. This product includes various components and some of these com-
ponents may be needed to be procured from different suppliers. If we know
how many televisions we will sell, we can also know how many components
we are needing. Moreover, we should also determine the number of workers
that will work next year and number of machines that are needed. All these
capacity adjustments are also made based on the amount of televisions we will
self review 1 sell. For example, if we are planning to manufacture and sell 3000 televisions,
40 workers and 10 machines may be enough whereas if we are planning to sell
9000 televisions, 100 workers and 30 machines may be needed. Hence, we
first need to know how many products we will sell. On the other hand, un-
fortunately it is difficult or sometimes impossible to know the exact demand
that will be observed in the future. For example, a customer does not come
and tell us that she will purchase a new television from us next year. Hence, we
should make a forecast and determine the demand for our final product. After
forecasting the demand, based on that forecast we can make our production
plan and capacity adjustments.

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Supply Chain Management

Why do we need to evaluate forecasts?

Suggested Answer for “Self Review”

Although in this chapter we focus only on three well-known and widely used
forecasting methods, there are numerous other forecasting methods and unfortu-
nately it is not possible to make a generalization about the performances of these
methods, i.e. we cannot say that a method is better than the others. Performances
of these methods strongly depend on the considered problem. In such a case,
the following question may arise: Which method or methods are better for this
self review 2 problem or how can we compare the performances of two methods on this data?
Forecast evaluation is used for this purpose. Moreover, note that even for the same
forecasting method, using different parameters may bring very different results.
For example, suppose that we decide to use exponential smoothing. Using α = 0.2
and α = 0.8 may bring very different results although exponential smoothing is
used in both cases. In such a case, we may need to know which α value provides
better results. Briefly, forecasts are evaluated to observe whether a method works
well in the considered data and whether the selected parameters are appropriate.

What is the difference between the push system and the

pull system?

Main aim in the pull system is reducing the work-in-process inventory to a pre-
determined minimum level. For this purpose, products are moved to the next
self review 3 level only if there is an actual order for that product in the next level. On the
other hand, in the push system, production plans are done for all levels based on
forecasts, before the observation of actual demand. Once the production is comp-
leted, they are pushed to the next level.

In which cases should a company use constant

workforce plan?

In constant workforce plan, main aim of the company is to keep the capacity (the
number of workers) constant in the considered planning horizon. Hence, once
the capacity adjustment is made, it does not change, i.e. workers are no longer
hired or fired during the entire planning horizon. Since no workers are hired in
self review 4 the subsequent periods, the capacity should be adjusted such that the demand in
all periods including the period with highest demand must be satisfied. For this
reason, in some other periods, a very high amount of inventories may be observed
in the warehouse. Hence, this strategy should be used in the cases where inventory
holding cost is low but hiring and firing costs are high.

References
Nahmias, S. and Olsen, T. L. (2015). Production and Operations Analysis. Waveland Press.

Internet References
Patil, R. Challenges and Factors Affecting Production Planning and Control in Pharmaceutical Industry.
https://learnaboutgmp.com/good-manufacturing-practices-cgmp/challenges-and-factors-affecting-
production-planning-and-control-in-pharmaceutical-industry/.

105
 Inventory Management in
Chapter 5 Supply Chains
After completing this chapter, you will able to;
Learning Outcomes

1 2
Understand the role and importance of
inventory in supply chains and list the reasons Differentiate the inventory costs and their
for keeping inventory relationships to inventory decisions

3
Describe the rationale and logic behind the
basic inventory models, and be able to solve
some problems
4 Understand the complexity of supply chains

5 Understand the alternative inventory

management approaches for supply chains

Chapter Outline Key Terms

Introduction Economic Order Quantity (EOQ)
What is Inventory? Economic Production Quantity (EPQ)
Inventory
Inventory Costs
Reorder Point
Inventory Models Multi-echelon inventory
Multi-Echelon Inventory Management Just in Time
Additional Approaches to Inventory Distribution Requirement Planning (DPR)
Management Vendor-Managed Inventory (VMI)

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Supply Chain Management
INTRODUCTION
The main purpose of the supply chains is to
provide the customers’ demand at the right time, in
the right place and at the right quality. Decrease in
lead times and expenses, enrichment of customer
service levels and advanced product quality are the
characteristics that determine the competitiveness
of a company in the contemporary market place
(Liu et.al., 2000). Inventory management plays an
important role in supply chain management for
this purpose.
While customer relations are managed in the
supply chains, relationships with all suppliers
should be managed at the same time. This can be
considered as the core of supply chain management.
Coordination of inventory policies of all supply
chain actors, such as suppliers, manufacturers and
distributors, should be ensured to ensure material
flow and minimize costs to meet customer demand
in the supply chain. Therefore, it is important
to manage inventory decisions in an integrated
manner at all stages of the supply chain. The scope
of inventory management concerns the fine lines
between replenishment lead time, carrying costs of
inventory, asset management, inventory forecasting,
inventory valuation, inventory visibility, future
inventory price forecasting, physical inventory,
available physical space, quality management,
replenishment, returns and defective goods, and
demand forecasting (Singh and Verma, 2018).
In order to minimize inventory costs at each stage,
it is very important to determine the stock amounts
correctly. This situation can be explained by the loss
of customers with understocking and storage costs
with overstocking. There are two basic decisions that
should be made to avoid these unwanted situations
and to minimize total inventory costs: How much
to order? and When to order? In this chapter, firstly
inventory and inventory models will be discussed.
Then, some alternative approaches such as JIT,
VMI, and DRP developed
important
for inventory management
will be introduced. At the
It is undesirable end of this chapter, we will
to be stock-out, understand the impact and
in which case, the importance of variations
customer can go to and fluctuations in demand
the competitors.
and order cycle length on
inventory decision making.
5
important
Basic decisions in the inventory models:
How much to order?
When to order?
Understocking (Stockout): Demand exceeds
the amount of available stock status.
Overstocking: Existing stock quantity exceeds
demand.
WHAT IS INVENTORY?
Toomey (2000) defined the inventory as a stock
or item used to support production (raw materials
and work-in-process items), supporting activities
(maintenance, repair, and operating supplies) and
customer service (finished goods and spare parts).
Thus, inventory can be classified into four main
categories:
1. Raw materials and purchased parts
2. Partially completed goods (work in process)
3. Finished-goods inventories
4. Goods-in-transit to warehouses or customers
Raw materials, semi-finished products, finished
products in manufacturing companies; medicines,
surgical tools and equipment in hospitals; cleaning
and hygiene materials and stationery in schools
can be given as examples of the inventory held in
different types of businesses.
Inventory: a stock or store of goods or services,
kept for use or sale in the future.
Work in process (WIP): partially completed
goods, which are typically turned from raw material
to finished product in a short period of time.
important
Raw materials and/or some parts are bought
and then delivered to the warehouse.
107
5
Businesses have inventory mainly because of
the following reasons:
1. to protect against fluctuations and
uncertainties in demand
2. to protect against uncertainties in supply
3. to satisfy seasonal demand
4. economies of scale in procurement
Procurement: the process that a
manufacturer, a wholesaler, or retailer, buys
materials and/or services from the suppliers.
Apart from these points, issues such as the
structure of the industry, the length and reliability
of the lead time, and closeness to the international
market and suppliers are also of great importance
for the businesses.
The inventory and supply chain managers are
mainly concerned about the estimation of the exact
amount of inventory at each point in the supply
chain free of excesses and shortages although the
total supply chain cost is minimized. Owing to the
fact that shortage of inventory yields to lost sales,
whereas excess of inventory may result in pointless
storage costs, the precise estimation of optimal
inventory is indispensable. In other words, there
is a cost involved in manufacturing any product
in the factory as well as in holding any product in
the distribution center and agent shop. The more
the products manufactured or held, the higher
the holding cost will be. Meanwhile, there is a
possibility for the shortage of products. For the
shortage of each product there will be a shortage
cost. Holding excess stock levels as well as the
occurrence of shortage for products lead to the
increase in the supply chain cost (Radhaskrishnan
et al., 2009).
When we examine the inventory in terms of its
role in the competitive strategy, it is seen that its
form, location and quantity change from a very low
cost to a very responsive supply chain. Large stock
of finished products close to customers leads to a
high cost, but a responsive supply chain. Central
inventory in the form of raw materials allows a
supply chain to have lower costs but at the expense
of responding later to demand. The purpose of
108
Inventory Management in Supply Chains
an effective supply chain design is to find the
right amount of form, location, and quantity that
provides the right level of responsiveness at the
minimum cost (Chopra and Meindl, 2013).
For the role of inventory in competitive strategy,
Chopra and Meindl (2013) give the example of
Amazon. Amazon changes its inventory format,
location, and quantity based on the sales level of
a product to ensure the right balance of response
and efficiency. From these products, when we
examine the books, we see that Amazon is trying
to provide a wide variety of books to its customers.
Amazon provides high responsiveness by storing
best-selling books in multiple regional warehouses
close to customers. Slow-moving books are stored
in fewer warehouses to reduce inventory costs, but
customers may experience a loss in response level.
For some of the slowest moving books, no inventory
is kept. The relevant book is taken directly from the
publisher or distributor if a customer requests it.
Types of Inventory
Businesses have different types of inventory.
These types of inventory can be given as follows:
1. Raw material stocks: These substances,
which are the input of the production
process, are used to obtain the final
product. For example, clay is a raw material
for a firm that produces floor tiles and sheet
plates are raw materials for a company that
produces refrigerators.
2. Semi-finished product stocks: These
are substances that are being processed or
waiting to be processed, but not yet final
products. Such stocks are also defined as
work-in-process (WIP) stock.
3. Finished product stocks: These are the
stocks that have completed the production
process. These products are the products
waiting for shipment to be sent to the
customer. They are also kept in the
inventory against demand uncertainties.
For example, it is expected that there will
be a big increase in sun cream demand
in summer. Therefore, manufacturer
companies can increase the number of
products in stock before the related period
comes. In some cases, a finished product
may be a raw material or a semi-finished

Supply Chain Management
product for another company.
4. Consumables: Cleaning and hygiene
materials not used directly in the production
process, stationery materials such as paper
and envelopes, cutting fluid, machine oil
etc. materials.
5. Service, maintenance, replacement parts
and spare parts.
important
WIP inventories, inventories associated
with manufacturing, can be significant if
the inventory waits in a manufacturing
facility for a long time, and thus should
be carefully evaluated in relationship to
scheduling techniques and the actual
manufacturing/assembly technology.
Apart from these mentioned inventory types,
another inventory type that should be taken into
consideration is the dedicated inventory. Dedicated
inventory is an inventory that has been committed
to a particular market, use, or customer and cannot
be freely used for other purposes. Countries where
products can and cannot be sold appear as another
classification criterion. For example, some foreign
vehicles cannot be sold in the United States due
to emission controls and crash safety requirements.
Another distinctive feature is the use of special
languages ​​in the product package and/or catalog.
Dedicated inventory: An inventory that has been
committed to a particular market, use or customer
and cannot be freely used for other purposes.
The Role of İnventory
Management
When effective management of inventory is
carried out along the supply chain, the quality
of service provided to the customer and the
customer satisfaction will increase as a result. It
5
is essential to determine the most appropriate
quantities of inventory that are kept at different
levels to minimize costs throughout the supply
chain. Therefore, minimizing the total cost of the
supply chain means minimizing inventory costs
throughout the supply chain.
important
Inventory optimization is one of the
issues that supply chain management
emphasizes most, as it directly affects
supply chain costs.
As part of the supply chain, inventory
management includes several different aspects.
Inventory management in the supply chain
covers controlling the purchases from suppliers
and customers, maintaining inventory storage,
controlling the quantity of products for sales, and
fulfilling the order issues. A single stage inventory
management is given in Figure 5.1.
There are three core steps of inventory
management (https://www.ibm.com/se-en/supply-
chain/inventory-management):
1. Purchasing inventory: raw materials or
components are bought and delivered to
the warehouse.
2. Storing inventory: inventory is stored
until needed. Raw materials are moved
to production facilities to be made into
finished goods and returned to stock areas
until ready for shipment.
3. Profiting from inventory: the amount of
product for sale is controlled. Finished
goods are pulled to fulfill orders. Products
are shipped to customers.
important
Clear visibility into transactions that
positively impacts the entire process of
ordering, storing and using inventory
is essential to the companies’ long-
term growth.
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5
Inventory Management in Supply Chains

Raw Materials and Components Finished Products

Warehouse

Shipping

Production Quality Check

Figure 5.1 Inventory Management in The Supply Chain

Source: https://tallyfy.com/inventory-process-management/ (Access: 20.03.2020)

When we look at inventory management throughout the supply chain, it should not be forgotten
that there is also a cost included in manufacturing any product in the factory as well as in holding any
product in the distribution center and agent shop (see the Figure 5.2). We can explain this situation
with the example given by Coyle et al. (2016): “Consumer packaged goods firms and the wholesalers
and retailers that are a part of their distribution channels face a special challenge in keeping inventories
at acceptable levels because of the difficulty of forecasting demand and the increasing expectations from
customers concerning product availability. Both of these factors are magnified by these firms increasing the
complexity of their product offerings. For example, if Hershey forecasted aggregate demand for KissesTM
for the first quarter next year to be 1 million cases, it would have to break this number down by stock-
keeping unit, packaging level of inventory and safety stock. Consumer preferences can change quickly,
which makes managing inventory levels a special challenge.”

Input Transformation Output

Material flow / Energy flow

Information flow / Financial flow

Supermarket

Distribution Supermarket
Center

Distribution Supermarket
Center

Supermarket

Suppliers Producers Distribution Centers Warehouses Supermarkets Customers

Figure 5.2 A Schematic View of Supply Chain

Source: Inavov and Schönberger (2017).

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Supply Chain Management

As a conclusion it can be emphasized that, whether it is a factory or a distribution center, excess stock
and out-of-stock are cost elements in the entire supply chain.

Inventory Decisions
From the perspective of inventory management, company decisions often change with trade-offs
between lower risk and reduced inventory costs with higher inventory levels. In this section, important
decisions regarding the inventory to create more responsive and efficient supply chains are examined.
Cycle Inventory arises from procurement, production and transportation. It is held primarily to take
advantage of economies of scale in the supply chain and reduce the costs. The quantity of cycle inventory
is calculated as the average amount of inventory used to satisfy demand between
orders or between the production cycles. As Chopra and Meindl (2013) emphasize,
companies produce or purchase in large lots to exploit economies of scale in the
Lot: Quantity of
production, transportation, or purchasing process. When cycle inventory is low, the
products bought/
order costs will increase due to the frequency of the order, otherwise, the cost will
increase due to the high amount of inventory. So, any stock manager in the supply produced together.
chain should determine how often he should give an order and their lot sizes.
Uncertainty can occur in every organization. In order
to avoid being affected by the fluctuations that may occur
in demand and also in lead times, safety inventory is the
amount of inventory that companies always keep. It is internet
also called “buffer inventory”. Companies keeping safety Read more: Inventory Cycle for
inventory have a trade-off between the inventory costs Manufacturers, Retailers, and Distributors;
of having high inventory levels and the costs of losing https://www.thebalancesmb.com/inventory-
customers because of stockouts. Although safety inventory cycle-393299
is a need for uncertainties and fluctuations, it should not be
forgotten that it also brings additional costs. The more this
inventory amounts in the warehouses, the more costs it will bring. These costs can be the cost of money
tied in inventory, rental cost of new storage space arising from the increased inventory amount, warehouse
personnel wages, security costs, and the costs of obsolescence or value decrease.
Seasonal Inventory is used to respond to predictable seasonal variability in demand. In each season,
some products specific to that season come to the fore. For example, in the summer season, sales of
products such as water, ice cream and air conditioner increase. In this case, seasonal stocks are the type
of stocks that companies hold in excess to meet the demand that will occur during the season before
the season begins. Seasonality can occur both in the supply of raw materials, and in the demand for
finished products. Those faced with seasonality issues are constantly challenged with determining how
much inventory to accumulate.
Learning Outcomes
1 To understand the role and importance of inventory in supply chains and list the reasons
for keeping inventory

Self Review 1 Relate Tell/Share

Which businesses should Build a relationship between Tell the impact of

increase their inventory inventory and business’ uncertainties of a supply
according to seasonal effects? profit. chain on the safety inventory.

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5
INVENTORY COSTS
There are different inventory views throughout
the supply chain. In order to meet all demands
instantly, the production department wants the
inventory level to be high so that the production
process is not interrupted, and the finance
department wants the investment in inventory to
be at the minimum level to ensure the best use of
the working capital.
Inventory, which directly affects the production
performance of businesses, also affects businesses
financially. In addition to the costs of being out
of stock or holding excess stock, the costs such
as quality control, warehouse personnel, etc. also
rise. There are various inventory holding costs for
businesses. These costs are divided into four basic
classes: purchasing, ordering, carrying inventory
and out of stock.
Part of the efforts of companies trying to reduce
these four cost items to reduce their inventory costs
in their supply chain networks is to consolidate
their facilities on the network. As given in Figure
5.3, inventory costs increase as the number of
facilities increases.
Inventory
Costs
Number of Facilities compartments etc. in cargo vehicles are needed
Figure 5.3 Relationship Between Number of Facilities and
Inventory Costs
Source: Chopra and Meindl (2013).
Purchase Costs
Raw materials and materials of a product to be
produced can be obtained from different suppliers.
Purchase cost is the unit or batch costs paid when
purchasing these materials. In some cases, it may
be decided to produce related materials instead of
112
Inventory Management in Supply Chains
purchasing them. In this case, the purchase cost
appears as the production cost.
There may be some difficulties in determining
the inventory value of purchases in case the suppliers
are international companies. The relevant product
can be evaluated according to the currency of the
country of manufacturing. However, there may be
fluctuations in the value of the product compared
to the currency of the country of purchase. Import
quotas are another factor that affects the product
value. While the products accepted under the
specified quota are sold, the products over the
quota must wait.
Ordering Costs
Ordering costs are the costs of ordering
and obtaining, such as expenditures for doing
paperwork such as conducting market research,
collecting offers, processing orders, determining the
amount of inventory required, preparing invoices,
transportation costs, controlling goods in terms
of quality and quantity, and moving goods to the
buffer stock area. Ordering costs are determined as
a fixed amount per order, regardless of order size.
Transportation costs become more
important in case of international orders.
When moving inventory from one country
to another, there are risks such as inventory
depreciation and loss of inventory depending
on the type of transportation and length of
periods. For this reason, the standard rules
set for transportation must be followed. In
addition, transportation costs increase as
distances increase in global transportation. For
example, during the transportation of products
such as medicines and food, refrigerated
due to long distances. The necessity of having
such requirements is one of the factors that
increase transportation costs.
If a firm produces its own inventory
rather than obtaining it from a supplier, it
incurs production preparation costs (set-up costs)
instead of the cost of ordering the supplier. These
costs are the costs that need to be incurred to start
production, such as machine settings, changing
molds, etc. In this case, the cost of preparation for
production is a fixed amount for each production
cycle, regardless of the size of the production.

Supply Chain Management
important
The cost of ordering depends not on the size
of the order, but on the number of orders.
Inventory Holding Costs
Inventory holding costs are the cost of physically
keeping inventory items in stock. Therefore,
they’re called as the cost of holding. They include
four main costs: capital, inventory service, storage
space, and inventory risk costs.
Inventory investment costs are considered as
capital costs. It also includes the opportunity cost
of money allocated to the inventory. Insurance,
taxes are the inventory service costs. Heating,
cooling, lighting, renting, and security expenses
are the storage space costs. Obsolescence or value
decrease due to the aging of technology, damage,
shrinkage, relocation costs are considered as the
inventory risk cost. Shrinkage is a term for lost or
damaged material that occurs while the material
is in inventory. Any loss or scrapped material is a
loss of value from the investments in the inventory
and thus will not be able to return the value or
investment.
As the distances increase along the supply
chain, the risks such as inventory wear and loss of
inventory increase even more. Especially in food
products, increasing distance and procurement time
should be taken into consideration and accordingly,
the time of inventory should be determined by
considering the expiration dates. Otherwise,
businesses have to bear huge costs due to the
deterioration in food products. Similarly, keeping
Learning Outcomes
2 To differentiate the inventory costs and their relationships to inventory decisions
Self Review 2 Relate
Build a relationship between
What are the inventory
ordering and purchasing
holding costs?
costs.
5
pharmaceutical products in stock requires separate
care. Many drugs should be stored at a certain
temperature range due to the risk of deterioration.
For this reason, operations such as the establishment
of different stocking departments bring additional
inventory holding costs to the businesses. Holding
costs can be determined in two different ways as
the percentage of unit price or an amount per unit.
The annual holding cost of an inventory item varies
between 20% and 40% of its value.
Shrinkage: Shrinkage is a term for lost or damaged
material that occurs while the material is in inventory.
Stockout Costs
Stockout costs are costs that arise if the demand
is greater than the current inventory. It is not
desired to be out of stock in terms of customer
satisfaction. If the current inventory amount fails
to meet the demand, either orders will be met at
a later date or lost sales will occur. Customers’
waiting for products and lost sales can also lead to
direct customer losses.
In addition to these costs, if the out-of-stock
situation occurs on the production line, the cost
of downtime and lost production costs are also
considered as out-of-stock costs due to the waiting
of production because of missing materials. So,
even within a few minutes, out-of-stock costs can
reach to thousands of dollars.
As the number of facilities in a supply chain
increases, it is inevitable that inventory and
associated inventory costs will increase.
Tell/Share
Share the impact of usage of
3PL on inventory holding
costs.
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Inventory Management in Supply Chains

INVENTORY MODELS
In this section, the inventory models that determine the most suitable inventory amount to be ordered
or produced will be discussed in accordance with the relevant system. In the literature, these models can
be considered as static or dynamic models. Static models are the models that have a constant demand over
time. In dynamic models, demand varies over time. Here, the common static inventory models will be
examined.

Economic Order Quantity (EOQ) Model

The basic economic order quantity model (EOQ) is the simplest model used to determine a fixed order
quantity that minimizes the total of annual purchase, ordering, and inventory handling costs. EOQ model
provides a guideline for managers to use when ordering items from their suppliers.
Assumptions of the EOQ model are given as follows:
1. Model is valid for only one product
2. Annual demand requirements are known
3. The demand is deterministic and constant throughout the year
4. The lead time for receiving orders is known precisely and is considered to be unchanged throughout
the year.
5. The order quantity is received all at once.
6. Unit prices are fixed, no quantity discount.
7. No stockouts are allowed.
The basic inventory model, where the
Usage order quantity is Q, assumes the ideal
Q (Demand) conditions specified in Figure 5.4, where
rate
the amount of inventory is shown on the
vertical axis and time on the horizontal
axis. At the beginning of the one-year
planning period, i.e. at time zero, the
system starts with an inventory amount of
Q units. When the inventory is depleted,
B
new Q units will arrive and the inventory
level becomes Q units. Fixed demand rate
is shown with negative sloping lines.
Receive order Receive order Receive order time
If there is a lead time in the ordering
Give order Give order process such that a certain time passes
between the ordering time and the arrival
Lead time Lead time time of products to the system, the orders
must be placed before the inventory level
T T
drops to zero. This means the ordering
Figure 5.4 Inventory Pattern for The EOQ Model point that is called as reordering point
should be determined by considering the
lead time and demand rate such that the products will arrive to the system
exactly when the inventory drops to zero. When the inventory amount at
hand reaches the point of reordering B, a new order of Q units is given.
Reorder point: When the
quantity on hand of an
Figure 5.4 also shows the inventory cycles. Each cycle begins with the
item drops to this amount,
fixed order quantity of Q units. When the inventory level reaches to reorder
the item is reordered.
point B, reordering occurs. According to EOQ model, the demand rate
and lead time are constant. So, the length of each cycle is also fixed with a
duration of T.

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Supply Chain Management

After a fixed lead time has passed, the entire order is taken at once and placed in the inventory.
Acceptance of the order to the inventory is also shown with perpendicular lines. Since we assume that the
rate of use and lead time will not change, the new order is received as soon as the available inventory is
zero. This situation provides the average inventory level as given in Equation 1.

Average inventory level :

(Q + 0 ) = Q (1)
2 2

Based on the EOQ model assumptions, important

the managers try to obtain the optimal
order quantity Q* to minimize the total
annual cost. The notations used in the Q In
ve
model are given as follows: to
r yd
TAC: Total annual cost (TL per year) ep
le
te
d
D: Annual demand (units)
Q: Order quantity (units)

replenished
Inventory
r: Annual holding cost rate
H: Inventory holding cost per unit
per year (TL per unit per year) time
A: The cost of ordering (TL per
order)
C: Unit purchase cost

Each cost item that constitutes the total annual cost is given in equations 2, 3 and 4, respectively.

Annual Purchase Cost: (annual demand) * (unit purchase cost) = DC (2)

D
Annual Ordering Cost: (number of orders per year) * (cost per order) = A (3)
Q
Annual Inventory (average inventory level) *
Holding Cost: (cost of holding a unit in inventory for a year) = Q H (4)
2

Because of the fact that the inventory level is changing important

constantly, the holding cost is calculated by multiplying
unit inventory holding cost by average inventory level, in Inventory holding costs increase as the average
Equation (4). Finally, the total annual cost (TAC) is given order quantity in each order increases.
by Equation (5). A graphical representation of the total
annual cost and its components is given in Figure 5.5.

Annual Total Annual Purchase Cost + Annual Ordering Cost + Annual Inventory Holding Cost
Cost: D Q
TAC = DC + A + H (5)
Q 2

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Inventory Management in Supply Chains

important
The best order quantity
is at the point where the
inventory carrying cost is
equal to the ordering cost.
The basic EOQ model determines the best order quantity (Q*) that will
minimize the total cost. The best order quantity is at the point where the
inventory carrying cost is equal to the ordering cost ( Q H = D A ). In other
2 Q
words, this is the point where the total cost function takes the smallest value.
To find the optimal value, the derivative of the total cost function (Eq. 2) is set
to zero and the obtained equation is solved. Then, the best order quantity (Q*)
value can be obtained by Equation 6.

2AD
(6)
Q* =
H

The minimum total annual cost value is obtained by replacing Q* with Q in the total cost function
TAC.

TAC=DC+ D A+ Q H
Q 2

QH
2
Cost

AD
Q
DC

Q* Q

Figure 5.5 Cost Curves of The EOQ Model

In some cases, the inventory holding costs are determined as a percentage of the unit cost. If so, the unit
cost is indirectly added to the total cost as part of the total costs.
After determining the economic order quantity Q*, the number
of annual orders and the time between orders can be calculated by
Equations 7 and 8, respectively. The number of annual orders (m)
Number of replenishment cycles
is obtained by dividing the annual demand by the economic order
per year: Number of orders per year.
quantity. The number of annual orders is also called as number of
replenishment cycles.
D
m=
(7)
Q*

Due to the constant demand, the time between the orders (T) is easily determined by Equation 8.
1 Q*
T=
(8)
=
M D

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Supply Chain Management

Example 5.1: A car company uses 80,000 rearview mirrors every year. The company provides the
necessary rear-view mirror from its supplier. Each ordering cost is 50 liras. Each rearview mirror is 60 liras
and unit holding cost is 2 liras per year. What is the economic order quantity, minimum annual total cost
and the number of orders per year?
First of all, let’s determine the parameters given in the case:
D: 80.000 (mirror/year)
A: 50 (Tk /order)
C: 60 (Tk /mirror)
H: 2 (Tk / mirror-year)

2AD 2 * 50 * 80.000
EOQ = Q* = Q= = 2000 mirrors
H 2

TAC = Annual Purchase Cost + Annual Ordering Cost + Annual Inventory Holding Cost

D Q
TAC = DC + A+ H
Q 2
80.000 2.000 ⎛ TL ⎞
TAC = 80.000 * 60 + * 50 + * 2 = 4.804.000 ⎜ ⎟
2.000 2 ⎝ year ⎠
Since the company will order 2000 mirrors each time, it will order the mirrors 40 times a year.

D 80.000
m= = = 40
Q * 2.000

Sometimes, inventory transportation costs can be calculated as a certain proportion (i) of unit costs,
rather than being determined per unit. In the next example, this situation is discussed.

Example 5.2: A company estimates that the annual demand for the product it produces will be 20.000
units. The raw material required for production is obtained from a supplier. The cost of ordering raw
materials is 10 liras and the unit cost of raw materials is 10 liras. Inventory holding cost is 25% of the
annual unit cost. Let’s determine the economic order amount of the raw material for the company that
wants to minimize total annual cost.
C: 10
i: 0.25
D: 20.000
A: 10
First of all, the value of H will be calculated.

H = i ∗ C = 0.25 ∗10 = 2.5

2AD 2 ∗10 ∗ 20.000
EOQ = Q* = , Q* = = 400
H 2.5

Economic Production Quantity (EPQ) Model

If a product is purchased, the Economic Order Quantity Model (EOQ) is used to determine the
optimal order quantity. However, if the businesses make production instead of purchasing, in this case,
they try to find the answer to the question “what is the optimal production quantity?”.

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Inventory Management in Supply Chains

Economic Production Quantity Model (EPQ) is the model used to determine a fixed production
quantity that minimizes the sum of production set-up costs, production costs and inventory holding costs.
Since the production is made in batches according to this model, the optimal production amount to be
determined is the production volume of each lot. The EPQ model is also built under certain assumptions.
These assumptions are determined as follows:
1. Model is valid for only one.
2. Annual demand is known.
3. Usage (consumption) rate is constant.
4. Use is constantly occurring.
5. Production rate is constant.
6. The lead time is constant.
7. There is no discount due to the amount.
8. No shortages are allowed.
Unlike the basic EOQ model, due to production instead of ordering, instead of ordering costs, set-
up costs have been added to the model. In the EPQ model, since production is done in batches, the
production preparation processes are carried out after each batch of production is finished.
As given in Figure 5.6 while production is being carried out in the area of “production and usage”, since
production rate is higher than the demand rate, the inventory accumulates at a certain rate and reaches the
predetermined maximum inventory level (Imax). Then, in the area of “just usage”, production is stopped
and the demand is met only from the accumulated inventory.

Q
Production

Production

Production
and usage

and usage

and usage
Just usage Just usage
area area
area

area

area

I max

time
Current inventory level

Figure 5.6 Inventory Pattern for The EPQ Model

In Figure 5.7, when the periodic demand

Q and production amounts are D and P
units, respectively, the annual production
and consumption rates are given. In the
I max
area of production and use, demand is
(P-D) met with rate of D, while production with
D
rate of P continues. Therefore, inventory
accumulation is provided by the rate of (P-
D). In the period after production stops,
the inventory accumulation is decreased
time
with rate of D. For example, if the daily
Figure 5.7 Periodic Production and Consumption Rates Graph in production amount is 100 units and the
EPQ Model usage amount is 60 units, daily inventory
accumulation is provided with 40 (100 – 60

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Supply Chain Management

= 40) pieces per day. With production, the inventory reaches its highest level, and after production stops, the
inventory level decreases as demand is met. Production starts again when the inventory level at hand is zero.
Since the business manufactures itself, no ordering costs are incurred. However, production set-up
costs occur in each production period. Since set-up costs and ordering costs are independent of production
amount, they are in a similar structure. As the amount of production increases, the number of production
periods decreases, thereby the total annual set-up costs also decrease.
Based on the EPQ model assumptions, the managers try to obtain the optimal production quantity Q*
to minimize the total annual cost. The notations used in the model are given as follows:
TAC: Total annual cost
Q: Batch production quantity
D: Annual demand
H: Inventory holding cost per unit per year
C: Unit production cost
S: Set-up cost per production
p: Production rate
u: Usage rate
Imax: Maximum inventory level
Each cost item that constitutes the total annual cost is given in Equations (9), (10) and (11), respectively.

D
Annual Set-up Cost: (number of production periods) * (set-up cost per production) = S (9)
Q
Annual Production
(number of orders per year) * (cost per production) = D * C (10)
Cost:
Annual Inventory (average inventory level) * (cost of holding a unit in inventory for a year)
Holding Cost: = I max H (11)
2
important
Finally, the total annual cost (TAC) is given by
Equation (12).
Inventory holding costs increase as the average
The minimum total annual cost value is obtained by order quantity in each order increases.
replacing Q* with Q in the total cost function TAC.

Annual Annual Set-up Cost + Annual Production Cost + Annual Inventory Holding Cost
Total Cost: D I
TAC = S + D∗C + max H (12)
Q 2

The maximum inventory level is calculated by Equation (13):

Q
I max = ∗ ( p − u ) (13)
p

After obtaining the maximum inventory level, the average inventory level is calculated by Equation (14):

I Q
I average = max =
∗ ( p − u) (14)
2 2p

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Inventory Management in Supply Chains

The basic EPQ model determines the best economic production quantity (Q*) that will minimize the
total cost. The best production quantity is at the point where the total cost function takes the smallest value.
To find the optimal value, the derivative of the total cost function (Eq. 12) is set to zero and the obtained
equation is solved. Then, the best production quantity (Q*) value can be obtained by Equation (15).

2DS p
Q* =

∗ (15)
H p−u

The time between two production start times, given in Equation (16), is a function of the amount of
economic production and the rate of usage (demand). The time elapsed between the production processes
is the total number of production days and the number of days in which only inventory is used without
production.
Q*
The time elapsed between the production processes =
(16)
u

Production time is also a function of optimal economic production quantity and the production rate,
as given in Equation (17).

Q*
Production time =
(17)
p

Example 5.3: A company with a daily production rate of 200 units plans to produce 20.000 units
next year. Set-up cost for this product is 1000, unit production cost is 500, and unit inventory holding
cost is 100 liras. Let’s calculate the economical production amount and the minimum total annual cost
of the product in case of working 250 days in a year. In addition, let’s determine how many batches
can be produced for this product in a year, the time elapsed between the production processes, and the
production time.
First of all, let’s determine the parameters given in the case:
D = 20.000 unit/year
p = 200 unit/day
S = 1000 TL
C = 500 TL/unit
H = 100 TL/unit
Since the annual demand is 20.000 pieces, the daily usage rate is u = 20.000 = 80 .
250
Economic production quantity of each batch of production is:

2DS p
Q* = ∗
H p−u
2 ∗ 20.000 ∗1.000 200
Q* = ∗ = 817 units
100 ( 200 − 80)

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Supply Chain Management

Annual Total
Cost: Annual Set-up Cost + Annual Production Cost + Annual Inventory Holding Cost
The minimum total annual cost value is obtained by replacing Q with Q* in TAC function.

D I Q
TAC = S + D ∗ C + max H and I max = ∗ ( p − u )
Q 2 p
20.000 817
TAC = ∗1.000 + 20.000 ∗ 500 + ∗ ( 200 − 80 ) ∗100 = 10.048.990 TL
817 2 ∗ 200
Q * 817
The time elapsed between the production processes = = = 10,21 days
u 90
Q * 817
Production time = = = 4,1 days
p 200

Reorder Point (ROP) Model

One of the decisions that determines the order policy applied to meet the product demand received by
the businesses is when the orders will be given. The answer depends on the businesses’ inventory systems.
If the inventory system requires a periodic review model, the beginning of the periods coincides with the
arrival of new orders. If the inventory system is based on a continuous review model, new orders are given
when the inventory level drops to below a predetermined level called a re-order point (B).
While the basic EOQ model determines how much to order, it does not determine when to order.
The purpose of the ROP model is to determine the stock level that the order needs to be renewed. The
system is based on ordering a certain amount of predefined orders in order to minimize the total inventory
cost when the stock amount is reduced to a certain level. The amount of re-ordering (B) includes the
demand for the duration of the supply and the amount of safety stock to avoid stockouts. The value that
corresponds to this amount is the point of reordering.
As given in Figure 5.8, if the lead time is fixed and known, the optimal reorder point can be calculated
by considering the demand rate and the lead time. However, in general, there are four factors that determine
the amount of reorder points:
1. Demand rate. important
2. Lead time.
3. The degree of demand and/or lead time variability. Reorder point gives the following:
4. The degree of acceptable stockouts. 1. When it is the right time to order
Reorder point B is obtained by determining the demand materials from suppliers
during the lead time. When the inventory level reaches point 2. When it is the right time to produce
B, an order of Q* is ordered. If the lead time (L) is considered more products
monthly while the demand (D) is given annually, the re-ordering
point is determined by Equation (18).
D∗L
B=
(18)
12

If the lead time is considered weekly, the point B is determined by Equation (19).
D∗L
B=
(19)
52

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Inventory Management in Supply Chains

time
Receive order Receive order Receive order

Give order Give order

Lead time Lead time

T

Figure 5.8 Inventory Pattern for The ROP Model

Example 5.4: The annual demand of a company is 100,000 units and the raw material supplied from
its supplier comes in 2 weeks. Let’s calculate the re-ordering point for this company.
D: 100.000 (unit/year)
L: 2 (week)
D∗L 10.000 ∗ 2
B=

= = 3846,15 (17)
52 52
Therefore, when the available inventory amount is approximately 3846 units, a new order will be given.

Example 5.5: Daily yoghurt demand of the market is 100 cups. The supplier sends the yoghurts to the
market in 2 days. Let’s calculate the re-ordering point for yoghurt orders.
L = 2 days
D = 100 cup/day
B=D*L
B = 100 cup/day * 2 day = 200 cups
Therefore, when 200 cups of yoghurt remain in the market, the manufacturer should be ordered again.

Learning Outcomes
3 To describe the rationale and logic behind the basic inventory models, and be able to solve
some problems

Self Review 3 Relate Tell/Share

Build a relation between the Tell what if the demand is

Which inventory decision
EOQ and EPQ inventory not constant in the EOQ
is about reorder point?
models. model?

122

Supply Chain Management
MULTI-ECHELON INVENTORY
MANAGEMENT
Supply chain management is a set of
synchronized decisions and activities utilized to
efficiently integrate suppliers, manufacturers,
warehouses, transporters, retailers, and customers
so that the right product or service is distributed
at the right quantities, to the right locations, and
at the right time, in order to minimize system-
wide costs while satisfying customer service level
requirements (Balaji Reddy et al., 2011). Until this
section of the chapter, inventory control systems
related to a single product, especially at a single
location have been examined. However, there are
multiple stages with multiple locations (facilities)
at each stage in a supply chain, as given in Figure
5.2. Therefore, it should be discussed here how
the other points of the chain like distribution
centers and/or supermarkets will be affected if
the manufacturer is out of stock. So, in a multi-
echelon supply chain, each stage represents a
process, such as the procurement, manufacturing
or transportation of items. And also, each stage is
considered as a potential location for holding the
stock of the item processed at this stage (Eruguz
et al., 2016). Figure 5.9 gives an example for a
multi-echelon system, where the squares, triangles
and circles represent suppliers, warehouses, and
customers, respectively.
Echelon 1
Echelon 2
Echelon 3
Echelon 4
Figure 5.9 A general Framework for Multi-echelon
Systems.
5
The inventory models at multiple locations
are called multi-echelon inventory models. At
each stage, processes such as supply, production
or transportation of the products are interrelated.
The echelon inventory is defined as the inventory
between a stage in the supply chain and the final
customer. The echelon inventory at each stage of
the system is equal to the inventory on hand at
that echelon, plus all downstream inventory. For
example, the echelon inventory at the warehouse is
a summation of the inventory at the warehouse, all
inventory in transit to and in stock at the retailers.
Echelon inventory: The inventory between a
stage in the supply chain and the final customer.
Echelon stock policies enable the utilization
of the information related to other stocks and,
in general, to the entire supply chain (Dolgui &
Proth, 2010). The goal in a multi-echelon system is
to decrease total costs by coordinating orders across
the supply chain. Chopra and Meindl (2013)
explain this system with the following scenario:
“Consider a simple multi-echelon system with one
manufacturer supplying one retailer. Assume that
production is instantaneous, so the manufacturer
can produce a lot when needed. If the two stages are
not synchronized, the manufacturer can produce a
new lot of size Q right after shipping a lot of size
Q to the retailer. Inventory at the two stages, in
this case, is given in Figure 5.10. In this case, the
retailer carries an average inventory of Q and the
2
manufacturer carries an average inventory of about
Q.” The most obvious uncertainties encountered in
such multi-echelon supply chains occur in customer
demand, lead times and inventory holding costs.
Against these uncertainties, the safety stocks that
we discussed in the previous sections come into
play. In many multi-echelon supply chains, safety
stock is kept at each stage and precautions are taken
against these uncertainties.
important
In multi-echelon systems, the inventory
decision of a given stage affects the other stages.
123
5
Manufacturer
Inventory
Retailer lot is shipped
Q
Retailer
Inventory
Figure 5.10 Inventory Profile at Retailer and Manufacturer with no Synchronization
Source: Chopra and Meindl (2013).
As also Balaji Reedy et al. (2011) mention in
their study, one-warehouse and multi-retailer
systems have attracted much research attention
in the literature because of their application in all
business models. Silver et al. (2017) consider the
simplest form of multi-echelon situation and call
this as “serially connected”. They give an example
with one central warehouse, one retailer warehouse,
and one retail outlet.
The multi-echelon inventory can be considered
also within the same firm. In this structure,
inventory is stored at more than one geographic
location, and one must account for the possibility
that the supplying location is out of stock when an
order is placed. It is clear that decisions concerning
the same item at different locations should not be
made independently.
Multi-echelon systems, regardless of their
structure, are quite complex systems considering
the uncertainties in the system. Materials
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Inventory Management in Supply Chains
Manufacturer lot arrives
Time
Time
requirement planning (MRP) is an approach to
coordinate the decisions made at different levels
of the supply chain. Controlling not only what
item is purchased and in what quantities, but also
the timing of its arrival through computerized
systems is called materials requirements planning
(Muller, 2003). If MRP is used in multi-echelon
inventory control, all data about raw material,
semi-finished products, set-up costs, inventory
costs should be known. The supply chains may
prefer to use MRP approach because of its
advantages of reducing inventory levels, reducing
late deliveries, and better usage of resources.
Schoenfeldt (2008) gives three sources of input
of MRP as:
1. The master schedule that gives the items to
be produced with their production times
and quantities.
2. The bill of materials.
3. Inventory records.

Supply Chain Management
However, besides these advantages, MRP assumes
that the quantity of demand and lead times are
known. These deterministic data limit the efficiency
of MRP because of the fact that replenishment of the
order dates is determined based on the demand and
lead times. Another disadvantage of the MRP is that
it does not consider the production capacity. MRP
II approach has been developed to overcome the
disadvantages of MRP.
Further Reading
Supply Chain Profile
Inventory Management Requires an End-
to-End Approach
“At the operational level, key logistics
capabilities, including order management,
inventory visibility, and inventory allocation,
play an important role in the effective use
of inventory. Assuming a simple, make-to-
stock scenario, customers’ orders are received,
inventory is allocated, and orders are fulfilled to
arrive in full at the customer by the promised
date. However, in spite of diligent planning
at the tactical level, inventory may still not be
available at the right time, place, and quantity
to achieve perfect order fulfillment. Having
real-time visibility to inventory, whether
in-transit or at stocking locations, helps to
manage potential issues. For example, knowing
the position and estimated arrival time of an
inventory replenishment shipment can enable
expedited fulfillment of the customer order once
inventory arrives. Alternatively, a replenishment
order could be diverted while in transit from
its original destination to a higher-priority
location.
5
internet
Read more: What is MRP II? – Manufacturing Resource
Planning; source: https://www.erp-information.com/
manufacturing-resource-planning.html
In the case of distributed order management
(DOM), orders can be fulfilled from alternative
stocking locations, which could include a
different distribution center, a vendor or even a
retail store location, depending on the situation.
A sophisticated technology, DOM leverages
visibility across the extended supply chain
network and business rules to determine how
best to fulfill customer orders across multiple
channels from multiple inventory sources.
Its embedded business rules consider
inventory availability across stocking locations,
fulfillment costs, and capacity constraints to
make the appropriate fulfillment decisions. These
business rules also help manage decisions regarding
inventory allocation by customer segment, so
the decisions are aligned with strategic priorities.
Ultimately, having real-time visibility to inventory
and the means to fulfill orders from multiple nodes
in the extended supply chain can help to reduce
safety stock requirements across the network.”
Source: Coyle, J. J., Langley, C. J., Novack,
R. A. and Gibson, B. J. (2016). Supply Chain
Management: A Logistics Perspective (Tenth
Edition), Boston: Cengage Learning.
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Inventory Management in Supply Chains

Learning Outcomes
4 To understand the complexity of supply chains

Self Review 4 Relate Tell/Share

Build a relationship betwe- Tell the benefits of reducing

What are the inputs of an en the importance of safety demand uncertainty and
MRP system? inventory and multi-eche- lead time.
lon supply chains.

ADDITIONAL APPROACHES TO • reduction of material handling equipment

INVENTORY MANAGEMENT
In this section, some alternative inventory
management approaches are introduced.
Just-In-Time (JIT) Inventory
Systems
The idea behind the management philosophy
of Just-in-Time (JIT) is managing lead times and
eliminating waste. JIT decreases the waste and
directly inventory costs by receiving the items just
when they’re needed. JIT not only provides the right
inventory, at the right amount, at the right time, but
also in the right place. Thus, an inventory can be
accessed exactly as needed; neither before nor later.
JIT turns the EOQ formula around. Instead
of accepting setup times as fixed, companies work
to reduce setup times and reduce lot sizes (Jaber,
2009). This suggested small size of lots provides
flexibility. So, JIT can substantially reduce
inventory and its related costs.
While the EOQ assumes the lead times are
known and constant, JIT aims to minimize the
lead times. In JIT an inventory can be accessed
exactly when it’s needed; neither before nor later.
Manufacturers satisfy this by being very close to
its suppliers. From the perspective of the suppliers,
they’re located very close to their customers. This
closeness shortens the lead times, and the short
lead times cause short cycle stock inventories.
Muller (2003) lists the benefits of JIT as:
• reduction of stockouts
• reduction of inventory levels (zero
inventory) for part and materials, WIP, and
finished products.
• reduction of time frames between delivery
and production (short lead times)
• improvement of quality (with zero
defect)
important
Major elements of JIT are;
1. zero inventories
2. short, consistent lead times
3. frequent number of replenishment
4. high quality
Distribution Requirement Planning
(DPR)
Distribution requirement planning (DRP) can
be regarded as the extension of manufacturing
requirement planning (MRP) in the logical view.
DRP, starting from customers’ requirements, is
used to solve distribution problems of material
resources according to time, quantity and location
in the field of circulation. It is a typical problem in
supply chain management (Lei et al., 2001).
important
Distribution is a responsible part for planning,
executing, and controlling the flow of material
from producer to consumer.

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Supply Chain Management

DRP is used to minimize the shortage of products in the distribution location and reduce ordering
cost, transportation cost and inventory cost. As given by Rizkya et al. (2018), in DRP, product demand at
the final distribution point determines demand at intermediate distribution centers.
Recall that in multi-echelon supply chains, the decision
important
made at each echelon also affects the next echelon. Here,
DRP decides on a certain echelon to give orders on the
next echelon. These decisions are the best quantity of the The underlying rationale for DRP is to more
items, the locations of delivery, and the arrival times. Based accurately forecast demand and to explode
on DRP in supply chain, it is expected to utilize demand that information back for use in developing
forecasting, minimize inventory costs, and enhance the production schedules (Coyle et.al., 2009).
customer services.

Vendor-Managed Inventory (VMI)

It is often difficult for businesses to predict future demand due to changing conditions. For this reason,
it was discussed in the previous sections that a certain amount of safety stock is available in order not to be
out of stock. Vendor-Managed Inventory (VMI) systems are used to leave the management of inventory
to reliable suppliers. This means a kind of partnership with the supplier.
In VMI, sales and inventory information of the companies are sent to the selected supplier. The supplier
produces and sends the orders based on this information. It is responsible for managing consignment stocks.
Consignment means that the customer sends the product from the warehouse as it pulls it. Payment of the
products is made to the supplier after the products are being sold. In other words, with the change in demand
rate of the customer and the change of stock quantity in the warehouse, the supplier automatically prepares
orders and ships them. It is evident that mutual trust and accuracy are also important in the VMI system.
Lakra and Bedi (2014) give the advantages of VMI as follows:
1. By receiving timely information directly from cash registers, suppliers can better respond to
customers’ inventory needs in terms of both quantity and location. So, customer satisfaction is
provided.
2. As the supplier constantly monitors the inventory and demand flow of customers, the imbalance
and uncertainty in customer orders decreases.
3. Because the supplier knows the customer’s stock level, the supplier’s own stock requirements are
reduced because the need for safety stock is reduced or eliminated.

Further Reading
Modeling a Coordinated Manufacturer–
Buyer Single-Item System Under Vendor-
Managed Inventory
“The models presented in this paper
analyze a two-level supply chain in which
external demand for a single item occurs at
the purchaser. The paper proposes an analysis
of total, ordering, and inventory holding costs
for each agent and the supply chain with and
without VMI. The general basis of this work is
the classic theory of economic order quantity
(EOQ). These models complement some
previous works (Van der Vlist et al. 2007; Yao et
al. 2007 ), including research associated to both
productive (uptime) and non-productive times.
The use of these times facilitates control of
inventories in our coordinated manufacturer–
buyer single-item VMI-conducted system. Our
VMI approach includes a new manufacturer–
buyer synchronization scheme that makes
logistics coordination in the VMI environment
between manufacturer and buyer much easier.

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5
The supply chain we study consists of a
manufacturer and a buyer implementing VMI for
a single product. This problem has been studied
by Dong and Chu (2002), Choi et al. (2004), and
Yao et al. (2007). These approaches propose an
implicit coordination strategy between supplier
and buyer, but the studied models do not include
explicit synchronization and coordination
mechanisms between buyer and supplier. In
our approach, as an alternative, we propose an
unambiguous coordination scheme between
manufacturer and buyer by means of which a
coherent and realistic VMI implementation can
be achieved. A key difference is that we clearly
model this coordination strategy by means of a
synchronization mechanism between the buyer
and manufacturer replenishment cycles. The
proposed coordinated manufacturer–buyer VMI
model contains the design parameters of the
synchronization scheme between manufacturer
and buyer, ordering and holding cost in VMI
and non-VMI conditions, and production and
demand rates. The decision variables of the model
include batch sizes, manufacturer production
uptime, manufacturer and buyer inventory
replenishment times, and integer coordination
and synchronization constants.
This article analyzes the performance of a
supply chain under a coordinated manufacturer–
buyer VMI approach. The main contribution
of the proposed model is that it includes an
explicitly coordinated manufacturer–buyer VMI
scheme related to the manufacturer’s uptime
Learning Outcomes
5 To understand the alternative inventory management approaches for supply chains
Self Review 5 Relate
What are the benefits of JIT Build a relation between
systems? MRP and DRP.
128
Inventory Management in Supply Chains
and non-productive time. The model proposes
synchronization between the manufacturer’s and
the buyer’s replenishment cycles. The realistic
manufacturer–buyer coordination scheme
makes VMI logistics implementation much
easier, which is not the case in other related
VMI approaches. Our proposed synchronization
scheme was modeled and optimized. Studying
the supply chain under ordering and holding cost
optimization, mathematical expressions were
deduced for:
• Buyer and manufacturer lot sizes
• Inventory replenishment times
• Buyer and manufacturer average inventory
levels
• Manufacturer uptimes
• Integer coordination constants
• Buyer and manufacturer total, holding
and ordering costs
In conclusion, we have presented and
developed a comprehensive model showing
an explicit manufacturer–buyer coordination
mechanism for a VMI implementation.”
Source: Torres F., Ballesteros F., Villa M. (2014).
“Modeling a Coordinated Manufacturer–Buyer
Single-Item System Under Vendor-Managed
Inventory”. Choi T. M. (eds.) Handbook
of EOQ Inventory Problems. International
Series in Operations Research & Management
Science, vol 197. Springer, Boston, MA.
Tell/Share
Tell the attributes of reliable
suppliers for VMI systems.
 5
Supply Chain Management

To understand the role and

importance of inventory in supply
LO 1 chains and list the reasons for
keeping inventory

Inventory management is an important component in supply chain management. It is not a desired

situation for businesses to have inventory due to cost burden. However, with an effective inventory
management, the effect of variability and fluctuations in the supply chain is minimized and it is tried to
reach a high level of customer service.

Summary
To differentiate the inventory

LO 2 costs and their relationships to

inventory decisions

There are various costs of holding inventory for businesses. These can be classified as purchasing, ordering,
carrying inventory and out of stock costs.

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Inventory Management in Supply Chains

To describe the rationale and

logic behind the basic inventory
LO 3 models, and be able to solve some
problems

The Economic Order Quantity Model (EOQ) is the simplest model used to determine a fixed order
quantity that minimizes the sum of annual purchasing, ordering, and inventory holding costs when
inventory is purchased. In cases where exclusion is not allowed, the total annual inventory cost is
determined by the TAC cost function.
Summary

D Q TAC: Total annual cost (TL per year)

TAC = DC + A+ H
Q 2 D: Annual demand (units)
2AD Q: Order quantity (units)
EOQ = Q* =
H r: Annual holding cost rate
D H: Inventory holding cost per unit per
m=
Q* year (TL per unit per year)
1 Q* A: The cost of ordering (TL per order)
T= =
m D C: Unit purchase cost
EOQ: Economic order quantity
m: number of replenishment cycles
T: time between the orders

The Economic Production Quantity Model (EPQ) is the model used to determine a fixed production
quantity that minimizes the sum of set up costs and inventory holding costs if inventory is produced at
the business. Since the production is made in batches according to this model, the economic production
amount to be determined is the production volume of each lot.

D I TAC: Total annual cost

TAC = S + D ∗ C + max H
Q 2 Q: Batch production quantity
Q D: Annual demand
I max = ∗ ( p − u)
p H: Inventory holding cost per unit
2DS p per year
Q* = ∗
H p−u C: Unit production cost
S: Set-up cost per production
p: Production rate
u: Usage rate
Imax: Maximum inventory level

When the amount of inventory on hand reaches a predetermined amount, it is reordered. In addition to the
EOQ model, reorder point (ROP) model determines the quantity of the reorder (B). If the lead time (L) is
D∗L D∗L
determined monthly, B equals to . On the other hand, if L is determined weekly, B equals to .
12 52

130
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Supply Chain Management

To understand the complexity of

LO 4 supply chains

The finished product of a company in the supply chain enters the inventory stock of other companies
after it. Since inventories of raw materials or finished products move across the entire chain, inventory
management should be handled in an integrated manner across the supply chain. Considering the system
in a multi-echelon manner ensures that all factors related to inventory optimization are taken into account.

Summary
To understand the alternative

LO 5 inventory management
approaches for supply chains

Businesses adopt a form of inventory management for the purposes of the supply chain in which they are
involved. Depending on the developments in technology, new approaches are being developed that will
effectively manage the inventory of the entire chain.
The idea behind the management philosophy of Just-in-Time (JIT) is managing lead times and eliminating
waste. DRP is used to determine the quantity of replenishment for a certain time period between a
business’s manufacturing facilities and distribution centers. Vendor-Managed Inventory (VMI) systems
are used to leave the management to reliable suppliers.

131
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Inventory Management in Supply Chains

1 Which of the following belongs to cycle 6 A company with a daily production rate of
inventory? 200 units works a total of 250 days a year. What is
A. Production the daily usage rate of this company, which has an
annual demand of 100,000 units?
B. Transportation
C. Procurement A. 400
Test Yourself

D.Procurement and transportation B. 500

E. Procurement, production, and transportation C. 4.800
D.10.000
2 E. 20.000
Which of the following costs are related to
having more than enough inventory?
A. Inventory holding costs 7 What is the name of the approach to
coordinate the decisions made at different levels of
B. Stockout costs
the supply chain?
C. Overstock costs
D.Set-up costs A. DRP B. SCM
E. Ordering costs C. VMI D. MRP
E. JIT
3 Which of the following statements is true?
8 Which of the following inventory is the
A. Interest and insurance are about inventory hol- inventory between a stage in the supply chain and
ding costs. the final customer?
B. Larger order quantities cause less inventory carr-
ying cost A. Safety stock
C. The demand rate doesn’t have a role in ROP de- B. Seasonal stock
termination. C. Echelon inventory
D.Ordering costs increase with lot size D.Raw material inventory
E. Economic order quantity has maximum total E. Work in process inventory
cost per order
9 Which of the following inventory
4 The economic order quantity of a company management system transfers the management to
with an annual demand of 45,000 is 9000. What is a reliable supplier?
the number of annual orders? A. Just-in-Time
A. 3 B. Distribution Requirement Planning
B. 5 C. Manufacturing Requirement Planning
C. 10 D.Manufacturing Requirement Planning II
D.30 E. Vendor-Managed Inventory
E. 60
10 Just-in-Time systems result in -------.
5 The annual demand of a company for a Which of the following completes the sentence
product with a lead time of 3 months is 200,000. above?
What is the reorder point for this company?
A. Larger inventory levels
A. 11.538
B. Quality decrease
B. 30.000
C. Right item and right quality
C. 50.000
D.Right item, right quantity, and right place
D.100.000
E. Right item, right quantity, right place, and right
E. 600.000 time.

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Supply Chain Management

1. E If your answer is wrong, please review the 6. A If your answer is wrong, please review the
“What is Inventory” section. “Inventory Models” section.

Answer Key for “Test Yourself”

If your answer is wrong, please review the
2. C If your answer is wrong, please review the 7. D
“Multi-Echelon Inventory Management”
“Inventory Costs” section.
section.

If your answer is wrong, please review the

3. A If your answer is wrong, please review the 8. C
“Multi-Echelon Inventory Management”
“Inventory Costs” section.
section.

If your answer is wrong, please review the

4. B If your answer is wrong, please review the 9. E
“Additional Approaches to Inventory Man-
“Inventory Models” section.
agement” section.

If your answer is wrong, please review the

5. C If your answer is wrong, please review the 10. E
“Additional Approaches to Inventory Man-
“Inventory Models” section.
agement” section.

Suggested Answers for “Self Review”

Which businesses should increase their inventory according to
seasonal effects?

Demands for water and cold drinks in the summer; demands for hot beverage
self review 1 types such as herbal tea in winter increase. Similarly, children’s toy demands
increase during the summer and winter holidays. These examples can be further
increased.

What are the inventory holding costs?

Inventory holding costs are the costs of physically keeping inventory items in
self review 2 stock. Therefore, they’re called as the cost of holding. They include four main
costs: capital, inventory service, storage space, and inventory risk costs.

Which inventory decision is about reorder point?

self review 3 “When to order” decision is usually related to the reorder point.

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Inventory Management in Supply Chains

What are the inputs of an MRP system?

Suggested Answers for “Self Review”

Input of MRP is the master schedule that gives the items to be produced with
self review 4 their production times and quantities, the bill of materials, and inventory
records.

What are the benefits of JIT systems?

The benefits of JIT are:

1. reduction of stockouts
2. reduction of inventory levels (zero inventory) for part and materials, WIP,
self review 5 and finished products.
3. reduction of material handling equipment
4. reduction of time frames between delivery and production (short lead
times) improvement of quality (with zero defect)

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Supply Chain Management
References
Balaji Reedy, K., Narayanan, S. and Pandian, P.
(2011). Single-Echelon Supply Chain Two Stage
Distribution Inventory Optimization Model for
the Confectionery Industry. Applied Mathematical
Sciences, 5(50), 2491-2504.
Chopra, S. and Meindl, P. (2013). Supply Chain
Management: Strategy, Planning, and Operation
(5th Edition), Pearson.
Coyle, J. J., Langley, C. J., Novack, R. A. and Gibson,
B. J. (2016). Supply Chain Management: a Logistics
Perspective (Tenth Edition), Boston: Cengage
Learning.
Dolgui, A. and Proth, J. (2010). Supply Chain
Engineering: Useful Methods and Techniques.
Springer.
Eruguz, A. S., Sahin, E., Jemai, Z. and Dallery, Y.
(2016). A Comprehensive Survey of Guaranteed-
Service Models for Multi-Echelon Inventory
Optimization. International Journal of Production
Economics, 172, 110-125.
Inavov, D. and Schönberger, J. (2017). Basics of Supply
Chain and Operations Management, In: Global
Supply Chain and Operations Management.
Ivanov D., Tsipoulanidis A., Schönberger J.
(Eds.), Springer.
Jaber, M. Y. (2009). Modeling Hidden Costs of
Inventory Systems: A Thermodynamic Approach.
In: Inventory Management Non-Classical Views
(Eds: Jaber, M.Y.). CRC Press Taylor & Francis
Group.
Muller, M. (2003). Essentials of Inventory Management.
AMACOM, New York.
Lakra, P. and Bedi, P. (2014). The Comparative
Study of Consignment and Vendor Managed
Inventory with Special Reference of Cost
Structure. International Journal of Advancements
in Research & Technology, 3(3), 142-146.
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Lei, L., Liu, W-H., Ren, S-J. and Wang, W. (2001).
Distribution requirement planning approach
based on limited supply capacity in supply chain.
In the procedings of the 2001 IEEE International
Conference on Systems, Man and Cybernetics.
e-Systems and e-Man for Cybernetics in Cyberspace
(Cat.No.01CH37236), Tucson, AZ, USA, Vol. 3,
1801-1805.
Liu, J., Gao, H. and Wang, J. (2000). Air material
inventory optimization model based on genetic
algorithm. In the proceedings of the 3rd World
Congress on Intelligent Control and Automation,
June 28- July 2, Hefei, China, 1903-1904.
Radhakrishnan, P., Prasad, V. M. and Gopalan,
M. R. (2009). Optimizing Inventory Using
Genetic Algorithm for Efficient Supply Chain
Management. Journal of Computer Science, 5(3),
233–241.
Rizkya, I., Syahputri, K., Sari, R. M., Siregar, I.
and Tambunan, M. M. (2018). DRP: Joint
Requirement Planning in Distribution Centre
and Manufacturing. In IOP Conference Series:
Materials Science and Engineering (Vol. 434, No.
1, p. 012243). IOP Publishing.
Schoenfeldt, T. I. (2008). A Practical Application of
Supply Chain Management Principles. American
Society for Quality Press, Milwaukee.
Silver, E. A., Pyke, D. F. and Thomas, D. J. (2017).
Inventory and Production Management in Supply
Chains. CRC Press.
Singh, D. and Verma, A. (2018). Inventory
Management in Supply Chain. Materials Today:
Proceedings, 5(2), 3867–3872.
Toomey, J. W. (2000). Inventory Management:
Principles, Concepts and Techniques. Kluwer
Academic Publishers, Norwell.
https://www.ibm.com/se-en/supply-chain/inventory-
management
135
 Procurement and
Chapter 6 Supplier Selection
After completing this chapter, you will be able to;
Learning Outcomes

1 Understand the importance and steps of the

procurement process 2 Understand the criteria of supplier selection

3 Understand the tools and techniques in the

supplier selection process

Chapter Outline
Introduction Key Terms
Procurement Cycle
Procurement Process
Criteria of Supplier Selection
Supplier Selection Multi-criteria Decision Making
Tools and Techniques in the Supplier Selection TOPSIS
Process

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Supply Chain Management
INTRODUCTION
Firms may not be able to realize all of the
production or service themselves for various
reasons. In this case, they need suppliers to
purchase them. For a company, the process of
procurement is an essential process in many
respects. One of the most critical stages of this
process is the determination of suitable suppliers.
In this section, first of all, the importance and
fundamentals of the procurement process will be
introduced, and criteria that can be taken into
consideration in selecting suppliers will be added.
Finally, after presenting some tools and techniques
that can be used in supplier selection, an example
of supplier selection will be given by using one of
these techniques, the TOPSIS method.
PROCUREMENT PROCESS
Along with the developing economies,
companies had to reduce their production and
material costs to maintain their competitive
structure. The fact that the ratio of purchasing
within the total cost has reached very high has
caused the enterprises to focus on the product or
service supply process.
The process of obtaining some products
or services from other companies is called the
procurement process. Companies that ensure
products or services are called suppliers. While
some companies supply only a few products or
small services from their suppliers, others may
choose to hand over an entire primary process
such as logistics management and warehouse
management. Whether small or large purchases are
made from suppliers, the procurement process is a
critical process for all companies.
The procurement process is to obtain
some needed products or services from
suppliers
Procurement accounts for spending an
organization’s revenue on acquiring products and
services. It has a direct impact on cost savings.
Apart from achieving cost savings, an effective
procurement process helps an organization
6
enhance supplier performance, compliance, risk
management, contract utilization, and sourcing
cycle time.
important
An effective procurement process helps
an organization to save costs, improve
its suppliers’ performance, manage
risk successfully, fulfill its contractual
requirements, and shorten the lead time.
A procurement cycle is the transition of
tasks and processes that need to be performed
throughout the procurement process. A successful
and well thought out procurement and supply
cycle can be the difference between success
and failure. The procurement cycle steps and
procedures in place may vary depending on each
company’s requirements and objectives. The typical
procurement cycle includes nine steps. They are
given in Figure 6.1 and explained below:
Step 1: Identify the need
The procurement cycle starts with identifying
a need for a product or service by the company.
This need may be an existing product that simply
needs to be reordered or the introduction of a new
product or service.
Step 2: Outline a procurement plan
The next step in the procurement cycle is to
develop a general strategy to supply the product
or service. Documentations such as terms and
conditions, product specifications, volumes, and
service agreements should be prepared in this step.
These documenting will help the suppliers to quote
according to fulfill company requirements.
Step 3: Select suppliers
One of the most critical steps of the procurement
cycle is supplier selection. In this step, a list of
potential vendors who may supply the products
or services is created. The objective of this step is
to determine proper suppliers. Criteria of supplier
selection include pricing, quality of service,
industrial reputation and recognitions, warranty
and guarantee provisions, and customer service.
After the assessment is complete, the supplier or
suppliers who offer maximum value and the best
market pricing are selected.
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6
Identify need
Asset
management
Warehouse
management
Supply chain
management
Contract
terms &
conditions
Figure 6.1 Example of Procurement Cycle Steps
Source: https://www.codelessplatforms.com/blog/procurement-process-flow/
important
Supplier selection is one of the essential steps
of the procurement cycle.
Step 4: Issue a Request for Quotation (RFQ).
An RFQ is sent to selected suppliers, and
it includes details for the required products or
services. The RFQ step can be initiated through a
head to head auction or direct negotiation.
A Request for Quotation (RFQ) includes
details for the required products or services.
Step 5: Tender evaluation process
A tender evaluation process starts when a
supplier has submitted its tender bid. The tender
evaluation includes assessing the supplier’s quality
of products or services, fulfillment capabilities,
timescales, and financial details. Additional
considerations can consist of the overall costs and
any terms and conditions that may have been
included.
138
Procurement and Supplier Selection
Qutline
procurement
plan
Select
suppliers
Issue RFQ
Tender
evaluation
Typically, a tender evaluation process includes
price comparison, fulfillment capabilities, quality
of products or services, reference checking, credit
and financial checks, supplier audit, products or
services samples or trials.
Step 6: Contract terms and conditions
After the tender evaluation step, a procurement
contract will need to be arranged. The procurement
contract will specify terms and conditions,
including agreed timescales, costs, and required
stock levels to minimize risk.
Step 7: Supply chain management
Supply chain management is the management
of the flow of goods and services and includes all
processes that transform raw materials into final
products. It involves the active streamlining of
a company’s supply-side activities to maximize
customer value and gain a competitive advantage
in the marketplace. In this step, the supply chain
management policy of the firm should be considered.
Supply chain management is the management
of the flow of goods and services and includes
all processes that transform raw materials
into final products.
 6
Supply Chain Management

Step 8: Warehouse management

Additional considerations within the procurement cycle include managing warehouse expectations. In
this step, the fundamentals of warehouse management such as storage, product codes, delivery times, and
order processing should be considered.
Step 9: Asset management
Assets will need to be monitored and reported against sales and marketing trends to assess existing and
future business requirements for the product and services provided.

Learning Outcomes

1 To understand the importance and steps of the procurement process

Self Review 1 Relate Tell/Share

Associate procurement Share a procurement

What are the steps of a
process and supplier process that you observe in
typical procurement cycle?
selection with each other. real life.

SUPPLIER SELECTION
In today’s competitive conditions, valid supplier
selection, and supplier management are of great importance
Supplier selection is the process of selecting
for companies to achieve their goals. A supply chain consists
suppliers to purchase the needed products or
of many interconnected rings, and suppliers are one of these
services to support the outputs of companies
rings. This chain is as strong as its weakest link. Therefore,
and also includes the evaluation of the
no matter how carefully the businesses manage their
performance of current suppliers.
processes, all processes may be affected due to any supplier-
related disruption. important
The main aim of the supplier selection process is to
determine the proper suppliers that can meet the needs The supplier selection process does not
of a company. However, this process does not end with end with the determination of suppliers.
the determination of suppliers, on the contrary, it is a Performances of suppliers should be
continuous process that aims to monitor and develop the monitored continuously, and unsuccessful
existing suppliers, and if they are not successful, to replace suppliers should be replaced with new ones.
them with new suppliers that can benefit more.
Companies use some criteria to select their suppliers
and monitor their performance. The criteria depend on
Cost, quality, design capability, manufacturing
the product or service to be supplied and the purpose and
capability, technical capability, technological
should be defined accordingly. Some of the criteria that
capability, performance history, management
can be used for supplier selection and monitoring are
capability, degree of cooperation, financial
cost, quality, design capability, manufacturing capability,
performance, and proximity degree are some
technical capability, technological capability, performance
of the criteria that can be used for supplier
history, management capability, degree of cooperation,
selection and monitoring.
financial performance, and proximity degree.

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Procurement and Supplier Selection

Since suppliers are an integral part of the supply chain, a good relationship with them is critically
important for the success of the supply chain. Supply chain strategy is an important factor in supplier
selection decisions. For example, some companies choose to work with a few suppliers and build strong
relationships with them, while others choose to buy from many different suppliers at the same time to
distribute the risk. In addition, if responsiveness is more important for the supply chain, then suppliers
that are faster and more flexible in delivery might be chosen even if they are more expensive. However,
if efficiency is more important, then lower price suppliers can be more suitable to work with. Supplier
selection is one of the most critical decisions for a company and the choice of a wrong supplier might harm
the supply chain significantly.
Supplier Relationship Management (SRM) deals with all interactions between the companies and the
organizations that supply goods or services. It basically aims to improve the processes and interactions
between buyers and suppliers to maximize the value of those interactions. For a successful supply chain
management, each supply chain member needs to develop a mutually beneficial relationship with its
suppliers, especially with the ones that are seen to be most
important
strategic to the company, in order to improve efficiency,
quality, responsiveness and other benefits. Thus, companies
need to consider these coordination and collaboration Supplier Relationship Management basically
issues when selecting their suppliers. Selecting the suppliers aims to improve the processes and interactions
that can work in coordination with the whole supply chain between buyers and suppliers to maximize
would improve the supply chain performance. the value of those interactions.

Further Reading

Critical Factors when Selecting Your
Suppliers
August 9, 2018
By Euan Granger
Procurement exists in a dynamic, fast-
paced, constantly changing environment. So
surely the reasons we use to select our suppliers
and supply partners would change over time
too? Wouldn’t they?
The world has moved on a-pace in the
intervening period and it’s interesting to take an
inward look to see if procurement has developed
at the same pace, particularly in its supplier
selection processes.
Gone are the days of the cheapest price (or
at least they should be!). Gone, and consigned
to a very dark part of history, are the days where
supply decisions were made over lunch or in
private meetings, and related more to who you
knew than what you knew, which golf course or
members’ club you were part of. Or even (sharp
intake of breath) what you might be offering the
buyers in return.
Even the list below, the key factors highlighted
last time out, may have been superseded. So what
are the new criteria? Or, if they are still the same,
why is this the case?
Cost and Quality vs. Social Value and
#MeToo?
If we take a look back at the responses from
the network in 2015, we find ourselves looking
at a list with a number of the usual suspects on it:
Cultural Fit – including values; Cost – covering
price, Total Cost of Opportunity/Ownership;
Value – value for money and value generation
opportunities; Experience in the market and
current references; Flexibility; Response to change
– in orders and products; Quality – covering
products and service quality and quality history
In addition to this, some that didn’t make the
top 7 as it was included trust and professionalism,
strategic process alignment and technical ability.
There’s nothing that looks out of place on the
list. In fact, they’re all eminently sensible and fair
criteria to be considering. The problem is it that
it reflects a very traditional view of procurement.

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Given the changing environment that
procurement operates in, wouldn’t we expect to
see these criteria changing too? In the past couple
of years, geo-political instability has dominated
the landscape and shows no sign of disappearing
soon with Brexit and a potential trade war between
USA and the rest of the world just two examples.
But what about the other factors we need to
be considering? Social value has jumped to the top
of many organisations’ lists, increasing work with
SMEs and Social Enterprises. And let’s not forget
an increased focus on harassment, discrimination
and equal opportunities following #MeToo.
What Does the Network Say?
When asked their opinions on what the
critical factors were, the network highlighted the
following:
Previous Safety Performance, Service
Delivery, Efficiencies, Cultural Fit, Price/Cost,
Flexibility, Ethics, Quality and Consistency,
Supply Chain, Financial Stability, Environmental
Policies, Communication.
It doesn’t appear that other factors in line
with Sustainability, Social Value and Equal
Opportunities (to name but a few) are getting
much of a look in. However, we’d need a much
bigger sample to be sure. And that’s where the
wider knowledge base comes in.
Procurement’s Response
Having a trawl through the latest articles
on supplier selection and key criteria two things
struck me. One, there were very few articles,
blogs, thought leadership posts or even research
papers from the past couple of years. The most
recent one I found was from early 2017 and
even using a broad range of search terms, it was
difficult to find anything relevant.
The second, and perhaps most surprising/
concerning, thing was how few mentioned any
different criteria for suppliers. Only one article
I could find mentioned Social Responsibility or
Environmental Performance/Sustainability. The
remainder still focused on the criteria commonly
found in a Commercial or Technical/Quality
evaluation. The most common criteria still were:
6
Years in business and financial stability;
Price/Cost; Quality and Delivery; Reliability;
Communication; Cultural Match.
What does this say about procurement? Is the
profession still falling back on the old favourites
when it comes to supplier selection? Or could it be
that traditional “thought leadership” is no longer
leading the way, and organisations are working
differently without shouting it from the rooftops?
For me, it’s a combination of all of the above.
There’s no denying that it’s hard to separate
procurement from cost and quality (after all,
it’s what we’re there to do). And why wouldn’t
professionals use criteria that are both reliable
and easy to measure, particularly when time and
resources are tight?
Getting our Message Across
Speaking from experience, however,
there are areas in which overall value is much
more prevalent. In the Scottish public sector,
organisations are mandating Community Benefits
for contracts above a certain value. These can
cover everything from creating apprenticeships
to financially supporting community projects.
In addition, Local Authorities have started
to mandate evaluation of ‘Fair Work Practices’ in
all procurement exercises. Again, this can cover a
multitude of elements, such as paying the living
wage, no zero-hour contracts, equal opportunities,
and good training and development. Suppliers
are being forced to consider these criteria to the
benefit of their employees and the wider society.
There is good work going on in procurement,
but maybe we aren’t making the most of
communicating our message to the wider market.
And if communication is one of the key factors
in supplier selection and subsequent relationship
management, it’s high time the profession started
telling suppliers what is important to us and
seeing what they have to offer.
Source: Granger, E. (2018, August 9). Critical
Factors when Selecting Your Suppliers.
Retrieved from: https://www.procurious.com/
procurement-news/critical-factors-when-
selecting-your-suppliers
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Procurement and Supplier Selection

Learning Outcomes

2 To understand the criteria of supplier selection

Self Review 2 Relate Tell/Share

Associate companies’
Share a supplier selection
What is the main aim of the requirements and supplier
process that you observe in
supplier selection process? selection process with each
real life.
other.

TOOLS AND TECHNIQUES IN THE SUPPLIER SELECTION

PROCESS
Nowadays, supplier selection has become essential for companies. With the increasing importance
of the supplier selection problem, many tools and methods have been developed that can be used in
the solution of this problem. Supplier selection is a multi-criterion problem. To solve this problem, it is
necessary to make a tradeoff between the criteria which may cause conflicts.

Multi-criteria Decision Making

Decision-making techniques that can be used for supplier selection can be divided into three
streams, namely, multi-criteria decision making (MCDM), artificial intelligence (AI), and mathematical
programming (MP) (Chai & Ngai, 2020). Among these streams, MCDM, which is used to determine the
most suitable one among the alternatives by considering many criteria, stands out.
There are many MCDM methods such as Analytic
important
Hierarchy Process (AHP), ELECTRE, PROMETHEE,
and Technique for Order Preferences by Similarity to
Ideal Solutions (TOPSIS), etc. in the literature. Chai and TOPSIS is one of the most preferred MSDM
Ngai (2020) and Velasquez and Hester (2013) examined methods because of its features, such as its
these techniques in detail in their papers. One of these simple process, ease of use, the fact that the
techniques, TOPSIS, has a simple process, it is easy to use, number of steps does not increase regardless
and the number of steps remains the same regardless of the of the number of criteria, and use of Euclidean
number of criteria. Its use of Euclidean Distance does not Distance.
consider the correlation of attributes; it is difficult to weigh
and keep the consistency of judgment.

TOPSIS Method
TOPSIS is ‘an approach to identify an alternative which is closest to the ideal solution and farthest to
the negative ideal solution in a multi-dimensional computing space’ (Qin et al., 2008). It has numerous
advantages. For example, it has a simple process. It is easy to use and programmable. The number of steps
remains the same regardless of the number of attributes (Ic, 2012). TOPSIS has been used in supply chain
management and logistics, design, engineering and manufacturing systems, business and management,
environmental management, human resources management, and water resources management. This is
another method where its ease of use has kept its application popular. Many of the uses seen in the literature

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Supply Chain Management
review had TOPSIS confirm the answers proposed
by other MCDM methods. The advantage of its
simplicity and its ability to maintain the same
amount of steps regardless of problem size has
allowed it to be utilized quickly to review other
methods or to stand on its own as a decision-
making tool.
TOPSIS is ‘an approach to identify an
alternative which is closest to the ideal
solution and farthest to the negative ideal
solution in a multi-dimensional computing
space’ (Qin et al., 2008).
An ideal solution for multi-criteria decision
problems, the hypothetical option with the best
values that can be reached in all criteria; the anti-
ideal solution is defined as the hypothetical option
with the worst values in all criteria. The option
chosen with TOPSIS should be both the closest to
the ideal solution and the farthest to the anti-ideal
solution. The method consists of six steps.
Before proceeding to the first step, the decision
matrix must be created by the decision-maker. The
rows of the decision matrix correspond to options,
and the columns correspond to criteria to be used
in decision making. It is created by evaluating each
option according to each criterion. The size of the
matrix is m×n to indicate the number of options,
m, n the number of criteria.
Step 1: Creating the standard decision matrix.
The standard decision matrix (Rmxn), is calculated
using the decision matrix (Xmxn) according to the
formula below.
xij
rij =
∑ i=1
m
xij2
Step 2: Creating the weighted standard
decision matrix. Firstly, the weight values (wj) of
the criteria are determined as 0 ≤ wj ≤1 and ∑ nj=1
wj=1. Then the elements in each column of the
matrix Rmxn is multiplied by the corresponding
value of wj for creating the Vmxn matrix.
v ij =w j r ij
6
Step 3: Determination of ideal and anti-ideal
solutions. In this step, the ideal solution (A+) and
anti-ideal solution (A–), are defined as follows. A+
is the hypothetical option that takes ‘best’ values in
each criterion. A– is another hypothetical option
that takes ‘worst’ values in each criterion. The best
values of each column of the matrix Vmxn constitute
the best values, A+ and the worst values are A–.
Step 4: Calculation of the separation measure.
In this step, Euclidian distance relation is used for
the measure of separation between alternatives. The
distances of each option from the ideal solution
(Si+ ) and anti-ideal solution (Si− ) are calculated
by the following formulas.
Si+ = ∑ nj=1 (vij − v +j )2 , Si− = ∑ nj=1 (vij − v −j )2
Step 5: Calculating the relative closeness to
the ideal solution. The relative closeness to the
ideal solution (Gi) is calculated as follows:
Si−
Gi =
Si+ + Si−
Here Gi will take a value in the range [0,1].
Step 6: Sorting options. When the relative
closeness to the ideal solution (Gi) values of the
options are sorted from large to small, and the
most preferred options will be in the top rows.
important
As an option approaches the ideal solution,
the relative proximity value to the ideal
solution (Gi) approaches 1. If Gi = 1, the
option is equal to the ideal solution.
An Example to Solve the Supplier
Selection Problem With TOPSIS
Method
To select the most proper supplier among
ten candidate suppliers, the decision-maker has
determined three criteria as the capacity of the
supplier, the distance from the supplier to the
company, and the lead time. The decision matrix
(x10x3) is given below.
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Procurement and Supplier Selection

The decision-maker has wanted the supplier capacity to be large and the distance from the supplier
to the company and the lead time to be small. Weights representing the importance of these criteria were
determined as w1=0.20 w2=0.50 and w3=0.30, respectively. In this case, the decision-maker should select
which supplier by using the TOPSIS method.

110 3 1
210 15 4
180 5 2
160 10 0
x10x3 = 150 7 6
90 9 2
190 5 2
120 2 5
145 8 0
135 7 3

0,2271 0,1194 0,1005 0,0454 0,0597 0,03015

0,4336 0,5971 0,4020 0,0867 0,2986 0,12060
0,3717 0,1990 0,2010 0,0743 0,0995 0,06030
0,3304 0,3981 0,0000 0,0661 0,1990 0,00000
R10x3 = 0,3097 0,2787 0,6030 V10x3 = 0,0619 0,1393 0,18091
0,1858 0,3583 0,2010 0,0372 0,1791 0,06030
0,3923 0,1990 0,2010 0,0785 0,0995 0,06030
0,2478 0,0796 0,5025 0,0496 0,0398 0,15076
0,2994 0,3185 0,0000 0,0599 0,1592 0,00000
0,2788 0,2787 0,3015 0,0558 0,1393 0,09045

The best values in columns of the V10x3 matrix ⇒ A =

+
0,0867 0,0398 0,0000

The worst values in columns of the V10x3 matrix ⇒ A =

-
0,0372 0,2986 0,18091

0,0549 0.2826 0.8374

0,2855 0.0781 0.2147

0,0858 0.2357 0.7332

0,1606 0.2085 0.5649

Si+ = 0,2080 Si- = 0.1612 Gi = 0.4366

0,1597 0.1697 0.5152

0,0853 0.2364 0.7349

0,1553 0.2608 0.6268

0,1224 0.2295 0.6521

0.1841 0.5715
0,1380

Since it has the largest G value (0.8374), the decision-maker should select the Supplier 1 according to
the TOPSIS method.

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Learning Outcomes

3 To understand the tools and techniques in the supplier selection process

Self Review 3 Relate Tell/Share

Associate MCDM and Share an improvement

What are the basic principle
supplier selection with each that can be considered as
and advantages of TOPSIS?
other. MCDM in your life.

145
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Procurement and Supplier Selection

To understand the importance and steps

LO 1 of the procurement process

Companies must reduce their costs to maintain their competitive capabilities. Since purchasing costs have
an essential place in the total cost, nowadays, the importance of purchasing processes has increased. In
addition to achieving cost savings, an effective procurement process helps an organization improve supplier
performance, manage risk successfully, fulfill its contractual requirements, and shorten the lead time.
The procurement cycle includes the processes that must be carried out throughout the procurement process.
The procurement cycle steps may differ depending on the needs and goals of each company. The typical
Summary

supply cycle includes nine steps. These are listed below:

• Identifying need: The procurement cycle starts with identifying a need for a product or service
by the company. This need may be an existing product that simply needs to be reordered or the
introduction of a new product or service.
• Outline a procurement plan: A general strategy to supply the product or service is developed,
and documentation such as terms and conditions, product specifications, volumes, and service
agreements should be prepared in this step.
• Selecting suppliers: The objective of this step is to determine proper suppliers.
• Issue a Request for Quotation (RFQ): An RFQ is sent to selected suppliers, and it includes details
for the required products or services in this step.
• Tender evaluation process: A tender evaluation process includes price comparison, fulfillment
capabilities, quality of products or services, reference checking, credit, and financial checks,
supplier audit, products or services samples, or trials.
• Contract terms and conditions: The procurement contract will specify terms and conditions,
including agreed timescales, costs, and required stock levels to minimize risk.
• Supply chain management: In this step, the supply chain management policy of the firm should be
considered.
• Warehouse management: Essentials of warehouse management such as storage, product codes,
delivery times, and order processing should be considered in this step.
• Asset management: Assets should be monitored and reported against sales and marketing trends to
evaluate current and future company needs for the products and services offered.

To understand the criteria of supplier

LO 2 selection

Companies use some criteria to select their suppliers and monitor their performance. The criteria may
vary depending on the product or service to be supplied and the purpose should be defined accordingly.
Some of the criteria that can be used for supplier selection and monitoring are cost, quality, design
capability, manufacturing capability, technical capability, technological capability, performance history,
management capability, degree of cooperation, financial performance, and proximity degree. Supplier
selection is one of the most critical decisions for a company and the choice of a wrong supplier might
harm the supply chain significantly.

146
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Supply Chain Management

To understand the tools and techniques

LO 3 in the supplier selection process

The multi-criteria decision problem occurs if more than one criterion should be considered while
determining the more appropriate option among the limited number of options. In multi-criteria decision
problems, the ideal solution is defined as the hypothetical option with the best values that
​​ can be reached
in all criteria, and the anti-ideal solution is the hypothetical option with the worst values in
​​ all criteria.
TOPSIS, a technique used in the solution of multi-criteria decision problems, is based on the principle
choosing the option that is both the closest to the ideal solution and the farthest to the minus-ideal

Summary
solution. In this method, relative closeness to the ideal solution (Gi) value is calculated for each option.
As an option approaches the ideal solution, Gi value also approaches to 1. If Gi is equal to 1, the option
is equal to the ideal solution.

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Procurement and Supplier Selection

1 Which of the following about the benefits of 6 Which of the following is the name of the
an effective procurement process is false? hypothetical option with the best values that can
be reached in all criteria?
A. To design a new product
B. To save costs A. Ideal Solution
B. Anti-Ideal Solution
Test Yourself

C. To reduce risk
D.To reduce lead time C. Best Solution
E. To fulfill the requirements of the company D.Worst Solution
E. Expected Solution
2 Which of the following is not one of the steps
of the procurement cycle? 7 Which of the following is not one of the
steps of the TOPSIS?
A. Outline a procurement plan
B. Selecting suppliers A. Creating the standard decision matrix
C. Production management B. Creating the non-standard matrix
D.Tender evaluation process C. Determining ideal and anti-ideal solutions
E. Contract terms and conditions D.Calculating the separation measure
E. Calculating the relative closeness to the ideal
3 Which of the following is not a criterion that solution
can be used for supplier selection?
A. Cost
8 Which of the following is not one of the
advantages of the TOPSIS?
B. Quality
C. Technical capability A. Its simple process
D.The number of workers B. Ease of use
E. Performance history C. The number of steps does not increase regardless
of the number of criteria
4 Which of the following statements about D.Using the maximum distance
procurement and supplier selection processes is E. Using Euclidean Distance
true?
A. The steps of the procurement cycle are the same
9 The relative closeness to the ideal solution
(Gi) values of the suppliers A, B, C, D, and E
for all companies.
have been calculated as 0.76, 0.21, 0.39, 0.93, and
B. The supplier selection process ends with the 0.56, respectively by using TOPSIS. Which one
determination of suppliers. should be selected as the most proper supplier?
C. The criteria do not depend on the product or
service to be supplied and the purpose of the A. Supplier A B. Supplier B
company. They are the same for all companies. C. Supplier C D. Supplier D
D.If Gi = 1, the option is equal to the anti-ideal E. Supplier E
solution
E. The procurement process is to obtain some 10 The relative closeness to the ideal solution
needed products or services from suppliers (Gi) values of the suppliers A, B, C, D, and E
have been calculated as 0.76, 0.21, 0.39, 0.93, and
5 Which of the following is not an MCDM 0.56, respectively, by using TOPSIS. The company
method? wants to select two suppliers. Which two suppliers
should be selected?
A. AHP
B. ELECTRE A. Supplier B and C
C. RFQ B. Supplier B and E
D.PROMETHEE C. Supplier C and D
E. TOPSIS D.Supplier D and E
E. Supplier A and D

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Supply Chain Management
1. A If your answer is wrong, please review the
“Procurement Process” section.
2. C If your answer is wrong, please review the
“Procurement Process” section.
3. D If your answer is wrong, please review the
“Supplier Selection” section.
If your answer is wrong, please review
4. E
the “Procurement Process and Supplier
Selection” section.
If your answer is wrong, please review the
5. C “Tools and Techniques in the Supplier
Selection Process” section.
6
If your answer is wrong, please review the
6. A
“Tools and Techniques in the Supplier
Selection Process” section.
Answer Key for “Test Yourself”
If your answer is wrong, please review the
7. B
“Tools and Techniques in the Supplier
Selection Process” section.
If your answer is wrong, please review the
8. D
“Tools and Techniques in the Supplier
Selection Process” section.
If your answer is wrong, please review the
9. D
“Tools and Techniques in the Supplier
Selection Process” section.
If your answer is wrong, please review the
10. E
“Tools and Techniques in the Supplier
Selection Process” section.
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Procurement and Supplier Selection

What are the steps of a typical procurement cycle?

Suggested Answers for “Self Review”

The procurement cycle steps may differ depending on the needs and goals of
each company. The typical supply cycle includes nine steps; identify a need,
self review 1 outline a procurement plan, select suppliers, issue an RFQ, tender evaluation
process, contract terms and conditions, supply chain management, warehouse
management, and asset management.

What is the main aim of the supplier selection process?

Supplier selection is the process of selecting suppliers to purchase the necessary

products or services and evaluating the performance of existing suppliers.
Supplier selection and supplier management processes are of great importance
for companies to achieve their goals. A supply chain consists of interconnected
rings, and suppliers are one of these rings. This chain is as strong as its weakest
link. Therefore, no matter how well the businesses manage their processes,
self review 2 supplier-related disruptions affect all processes.
The main purpose of the supplier selection process is to identify suitable
suppliers that can meet the needs of a company. However, this process does
not end with the determination of suppliers, but rather it is a continuous
process that aims to monitor and develop existing suppliers and replace them
with new suppliers that can provide more benefits if they are not successful.

What are the basic principle and advantages of TOPSIS?

The ideal solution for multi-criteria decision problems is a hypothetical option

with the best values that can be reached in all criteria. The anti-ideal solution
is defined as the hypothetical option with the worst values in all criteria. The
self review 3 option chosen with TOPSIS is both the closest to the ideal solution and the
farthest to the anti-ideal solution. TOPSIS has a lot of advantages such as
its simplicity, its ability to maintain the same amount of steps regardless of
problem size, quick utilization to review other methods, or standing on its
own as a decision-making tool.

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Supply Chain Management

References
Chai, J. and Ngai, E. W. T. (2020). Decision-making techniques in supplier selection: Recent accomplishments
and what lies ahead. Expert Systems with Applications, 140, 112903.
Ic, Y. (2012). An experimental design approach using TOPSIS method for the selection of computer-integrated
manufacturing technologies. Robotics and Computer-Integrated Manufacturing, 28(2), 245-256.
Qin, X., Huang, G., Chakma, A., Nie, X. and Lin, Q. (2008). A MCDM-based expert system for climate-
change impact assessment and adaptation planning – A case study for the Georgia Basin, Canada. Expert
Systems with Applications, 34(3), 2164-2179.
Velasquez, M. and Hester, P. T. (2013). An Analysis of Multi-Criteria Decision Making Methods. International
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Online References
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Granger, E. (2018, August 9). Critical Factors when Selecting Your Suppliers. Retrieved from: https://www.
procurious.com/procurement-news/critical-factors-when-selecting-your-suppliers

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 Information Systems in Supply
Chapter 7 Chains
After completing this chapter, you will able to;
Learning Outcomes

1 Understand information and information

management in supply chains 2 Define the information systems and explain the
concepts of information systems

3 Explain the objectives and benefits of supply

chain information systems 4 Explain some of the information systems used
in supply chains

Chapter Outline Key Terms

Information Systems
Introduction
Supply Chain Management
Information and Information Management in
Radio Frequency Identification
Supply Chains
Barcode
Supply Chain Information Systems
Enterprise Resource Planning
Information Systems Used in Supply Chains
Internet of Things

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Supply Chain Management

INTRODUCTION
With the rapid growth in technology, information systems and technologies have become available in
all areas of life. Especially the widespread use of the internet and the fact that technological products are
more involved in our lives have enabled the use of information systems and technologies in every sector.
In systems with a large number of participants such as education, health, production, and transportation,
transactions and communication can be carried out easily through information systems.
Supply chain management is one of the areas that utilize information systems. The globalization of
supply chains and the spread of suppliers, manufacturers, and customers across large geographies make
supply chain management difficult. Besides, ever-increasing competition conditions between businesses
require an effective supply chain management. Therefore, the use of information systems technologies
in supply chain management is inevitable. Information systems provide numerous capabilities such as
agility, quick decision-making, and flexibility to supply chains. As a result of the recent developments in
technology, high data processing capacities enable using information systems through the whole supply
chain.

INFORMATION AND INFORMATION MANAGEMENT IN SUPPLY

CHAINS
The supply chain is defined as a system that includes the whole of the operations, information flow, and
physical distribution of the products or services from the raw material stage to the end customer. Supply
chain management is the optimization of all processes on the path of a product or service to the consumer
throughout the supply chain. The participants of a supply chain include suppliers, manufacturers,
distributors, retailers and vendors, transport companies, warehouses and distribution centers, service
providers, and customers. Flows arising from supply chain activities are formed among all of these
participants. These flows can be categorized mainly as material and product, money, and information
flows. The flows in a supply chain network are visualized in Figure 7.1.

Material/Product

Supplier ... Manufacturer ... Distributor ... Customer

Information

Money

Figure 7.1 The Flows in A Supply Chain

As can be seen in Figure 7.1, the flow of material and money is one-way while the information flow is
two-way. In other words, the information flow in the supply chain can be from suppliers to the end-users
and from the end-users to the suppliers. The information flow in the supply chain is also continuous. This
is an indication that information is indispensable in supply chain management.

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important
Besides product, information and money
flow, value and risk are also included in the
flows between supply chain participants.
Supply chain information flow provides a bi-
directional flow of information across the supply
chain participants at a variety of strategic, tactical,
and business levels. Some of this information
may include forecasts, planning decisions,
material lists, product data, pricing, stock levels,
customer and order information, delivery plans,
supplier and distributor information, delivery
status, performance measurements, commercial
documents, and financial information. Supply
chain participants are in constant communication
to transfer this information to each other and to
receive information.
The information in a supply chain must be
accurate, accessible, and available. Information
with these characteristics provides supply chain
managers making the best strategic, tactical,
and operational decisions. The availability of
information throughout the supply chain ensures
that the information is used at all levels by all
participants of the supply chain.
For successful supply chain management, the
communication of the supply chain participants
must be open and the participants must share
information. The information serves as a link
between the various stages of the supply chain,
allowing them to coordinate their operations and
provide many benefits to maximize total supply
chain efficiency.
important
For successful supply chain management,
the communication of the supply chain
participants must be open and the participants
must share information.
Information management in the supply chain
consists of information acquisition, classification,
collection, processing, presentation, dissemination,
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Information Systems in Supply Chains
and application system (Szymczak, et al., 2018). A
successful information management process forms
the basis of information sharing; and therefore,
information integration, which enables efficient
execution of supply chain processes and flows. Hsu
et al. (2008) define information sharing within
a supply chain as the integration of information
systems, decision systems, and business processes
used to conduct information searches, manage
business operations, monitor business details,
and perform other business activities. The need to
share information among the various participants
throughout the supply chain is crucial. Lotfi et
al. (2013) summarize the benefits of information
sharing in supply chains as given below:
• Inventory reduction and efficient inventory
management
• Cost reduction
• Increasing visibility
• Significant reduction or complete
elimination of bullwhip effect
• Improved resource utilization
• Increased productivity, organizational
efficiency, and improved services
• Building and strengthening social bonds
• Early problem detection
• Quick response
• Reduced cycle time from order to delivery
• Better tracing and tracking
• Earlier time to market
• Expanded network
• Optimized capacity utilization
important
The factors of information sharing are
information quality, information content,
and information sharing support technology.
The information sharing and collaboration
between supply chain participants provide
information integration. Information integration
aims to transmit and process the information to be
used in the supply chain decision making in real-
time. Information integration can be considered as
a dimension of supply chain integration.
Although it has many benefits, the supply
chain has some obstacles to ensure information
integration. Barriers such as information privacy,
 7
Supply Chain Management

lack of information, outdated information, and
integration costs can affect the performance of
the supply chain information integration. Supply
chain participants may need to bear high costs
for effective information integration. For this
reason, for the investments and initiatives to be
made for the integration of the information to be
made, the risks mentioned should be analyzed and
the obstacles should be tried to be eliminated.

Learning Outcomes

1 To understand information and information management in supply chain management

Self Review 1 Relate Tell/Share

What are the benefits of Associate the information Tell the importance of
information sharing for sharing by information information in supply
supply chains? integration in supply chains. chains.

SUPPLY CHAIN INFORMATION SYSTEMS

Information systems are defined as systems designed to store, process, and analyze the organizational
data. Information systems consist of hardware, software, database, network, and human components
to perform the mentioned functions. Generally, information systems aim to provide appropriate and
requested information to their users by processing the data they collect and store. Information systems
store and analyze data and information, support decision-making and management of business processes.
Information systems also provide time and cost savings in large quantities and prevent errors caused by
manual works are minimized. Besides, information systems reduce paper consumption in organizations.

Information systems are combinations of hardware, software, and telecommunications networks that
people build, and are used to collect, create, and distribute useful data, typically in organizational settings.

Information systems have a wide range of uses in daily life and business life. Supply chains are also
organizations where information systems benefit extensively. Supply chain management provides
integration and coordination through information systems. Information systems play an important role
in ensuring information integration that has an active role in supply chain efficiency. Furthermore, it
is not easy for the supply chain management to control all units, to ensure the flow of information, to
organize the units to work in harmony. For this reason, it is inevitable for supply chains to use information
systems to be successful in this highly competitive environment. It is also a requirement of today to use
information systems that standardize and automate business processes to save time and cost, reduce stocks
and product errors, and increase customer satisfaction, which is one of the main objectives of supply chain
management.
Ross (2010) emphasize that information technology has been, and continues to be, an essential enabler
for effective supply chain management. Efficient and real-time information systems add agility and
flexibility to the supply chain. Information systems with these characteristics increase the success rate of
the supply chain by providing fast communication and feedback between the supply chain participants
from the supplier to the end-user.

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Information Systems in Supply Chains

The main objectives of information systems and technologies in Supply Chain Management, which are
summarized by Simchi-Levi et al. (2003) are given as follows:
• Collecting information through the whole supply chain.
• Providing access to data from a single point of contact.
• Analyzing, planning, and decision-making using the information of the whole supply chain.
• Collaborating with all supply chain participants and operations.
Bowersox et al. (2002) emphasize that supply chain information systems, including logistics activities,
is built on four functions: strategic planning, decision analysis, management control, and transaction
system. They also visualized the activity and necessary information for these functions as a pyramid given
in Figure 7.2. They also state that management control, decision analysis, and strategic planning can be
developed on the basis of a strong transaction system.

• Strategic
alliance
Strategic formulation
Planning
• Development and
refinement of supply chain
capabilities and opportunities

• Focused/profit-based
customer relationship
management

Decision • Focused/profit-based
Analysis • Inventory levels and management
• Network/facility location and integration
• Vertical integration vs. third-party/outsourcing

Management • Financial cost, and asset measurement: • Customer service measurement

Control • Productive measurement
• Quality measurement

Transaction • Order management • Shipping

System • Inventory assigment • Pricing and invoicing
• Order selection • Customer inquiry

Figure 7.2 The Necessary Activity and Information on Functions of Supply Chain Information System
Source: Bowersox, Closs and Cooper (2002).

In the process of applying information systems in the supply chain, supply chain processes should
be restructured and unnecessary transactions should be eliminated. Thus, supply chain transactions are
simplified. Besides, some basic requirements for information technology solutions used to support supply
chain management are horizontal and vertical integration, security, reliability, and scalability (Chandra &
Grabis, 2007).

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Supply Chain Management

Some of the benefits provided by information • Decrease in transportation costs

systems and technologies can be listed as follows:
• Better monitoring of the supply chain
• Better forecasting
• Cost reduction by eliminating unnecessary
processes in the supply chain and increasing
the efficiency of the processes
• Shortening the lead time
• Better management of inventories and
consequently reduction of inventory costs
• The development of the relations between
the supply chain participants
• Effective monitoring of the supply chain
performance with real-time reports
• Quickly resolving customer dissatisfaction
• Ensuring sustainability and reducing
negative impacts on the environment
• Monitoring the purchasing behavior of
customers and responding quickly to
changes in customer expectations

Learning Outcomes

2 To define the information systems and explain the concepts of information systems
3 To explain the objectives and benefits of supply chain information systems

Self Review 2 Relate Tell/Share

What are the objectives and Associate the information Tell the objectives of the
functions of an information systems by the supply chain supply chain information
system? operations. systems.

INFORMATION SYSTEMS USED IN SUPPLY CHAINS

There are many information systems and technologies mostly used for information integration
in supply chain management. The information system and technologies used can generally change
according to the structure, size, need, and management understanding of the supply chain, etc. Some of
these information systems and technologies used extensively are Electronic Data Interchange, barcode,
Radio Frequency Identification, Enterprise Resource Planning, transportation management systems, and
inventory management systems. Besides, there are supply chain management applications of Internet of
Things technology, which has developed in recent years. Apart from these, the supply chain management
system, customer relationship management system, supplier relationship management system, e-supply
chain, e-business, etc. information systems and technologies are also information systems and technologies
used in supply chains.

Electronic Data Interchange

Electronic Data Interchange (EDI) is a standardized and automated method that enables electronic
transmission of information and documents between companies or departments with different information
management systems. There are many EDI standards used according to the structure and different needs
of the organizations.

IBM simply defines EDI as a standard electronic format that replaces paper-based documents like purchase
orders or invoices.

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Information Systems in Supply Chains

and speed up business processes. Barcodes can

be read using barcode scanners. A barcode and
barcode scanner is shown in Figure 7.3.
internet
Read more: https://www.edibasics.com/edi-
resources/document-standards/
A barcode is an image consisting of a series
of parallel black and white lines of various
The company at the location that sends the thicknesses that brings information about a
information with the EDI application generates product when scanned.
a transaction and sends it to the receiver. The
information transferred through the EDI system
must be in a standard format to be identified by important
the recipient. Therefore, participants who will
use EDI for a successful EDI implementation
There are different types of barcode scanning
must first agree on the content and format of the
tools. Some of these scanning tools are
transactions. Thus, when the information in the
handheld barcode scanners, fixed-mount
same format comes to the buyer as a result of the
scanners, pocket-sized scanners, mobile
agreement, it can directly activate the system of the
computers, and smartphones.
receiver without any conversion.
EDI plays three important roles in supply chain
management as given below (Min, 2000).
• Electronic integration;
• Information diffusion and sharing
• Electronic marketplaces.
Fundamentally, EDI provides working efficiently
in the supply chain. The information transmitted
through EDI throughout the supply chain can
be stock levels, customs certificates, delivery
documents, invoices, orders, etc. The usage of EDI
annihilates the errors due to manual operations and
increases efficiency. Operations performed quickly
and accurately with EDI ensure that costs are
Figure 7.3 Barcode and barcode scanner.
reduced and time-saving is provided. Besides, EDI
benefits the supply chain on issues such as effective
important
use of human resources, shorter order delivery
time, optimization of stock control, rapid decision
making, speeding up cash flow, and reduced paper The barcode was invented by Norman Joseph
usage. Even though there is a high implementation Woodland and Bernard in 1951. Barcode
cost of EDI at the beginning, the mentioned benefits technology was developed with inspiration
of EDI compensate for this cost. from the Morse Code.

Barcode There are numerous types of barcodes. The

most commonly used types of barcodes are one
A barcode is an image consisting of a series of
dimensional (1D) and two dimensional (2D)
parallel black and white lines of various thicknesses
barcodes. While Barcodes consisting of vertical
that brings information about a product when
lines and spaces of different thicknesses are called
scanned. In the simplest form, barcodes are labels
one-dimensional 1D barcodes; barcodes printed
on many products purchased in everyday life.
with square or rectangular shapes are called two-
Barcodes prevent errors that may arise during
dimensional 2D barcodes. Types of 1D barcodes
manual entry of product codes to the computer

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Supply Chain Management

such as UPC, EAN, COD39, ITF are widely used
in the application. Square codes, data matrices,
PDF417, and AZTEC are 2D barcode types. 2D
barcodes carry more information than 1D barcodes.
In recent years, 3D barcode applications have
started to become widespread. 3D barcodes, 1D,
and 2D barcodes are similarly used for inventory,
monitoring, and categorization. The only difference
of 3D barcodes is that they are somehow engraved
or applied to the product during production.
With its increasing use in the world, RFID
technology is widely used in many sectors such as
automotive, energy, textile, security, agriculture,
and logistics. The objectives of the usage of RFID
technologies in a business can be minimizing
human errors, speeding up operations and
processes, increasing security level, and so on.
important

Barcode technology is widely used in supply

chains because it provides an efficient integration RFID technologies reduce operational costs
process. Barcodes can be used to label semi and and speed up workflows, thereby increasing
finished products, stock items, and delivery, which operational efficiency and profitability.
must be tracked in the supply chain. Barcodes are
provided to identify the products accurately by
computer systems at the transition points as they The components of RFID technology are RFID
move through the entire supply chain. Thus, the label, reader, antenna, and a host computer. An
movement of the products along the supply chain example of an RFID label is given in Figure 7.4.
has been accelerated and the errors resulting from
data entry errors have been eliminated. Besides,
storage processes can be given as examples of other
usage areas of barcode technology in supply chain
management. Packages to be created during storage
such as pallets, boxes, and parcels are labeled with
barcodes. In this way, easy, accurate, and fast
identification is provided at the points passed
within the scope of logistics processes.

Radio Frequency Identification (RFID)

Radio Frequency Identification or RFID can
be defined as a technology in which digital data
encoded in RFID tags are met by a reader through
radio waves. RFID technology can be used to
identify and monitor all kinds of objects and living
creatures from a distance without touching them.
RFID can be defined as a technology in
which digital data encoded in RFID tags are
met by a reader through radio waves.
important
RFID was invented in 1948 by Harry
Stockman and took part in the literature with
his paper titled “Communications by Means
of Reflected Power”.
Figure 7.4 An RFID label.
RFID labels include an integrated circuit and
an antenna used to transmit data to the RFID
reader. The reader converts the radio waves, which
come from the RFID label into an available data
format. The information collected from the labels
is transferred to a computer system that can be
stored on the data computer via a communication
interface. These stored data can be analyzed and
used on the same computer.
Although the cost of RFID technology is higher,
it has many advantages over barcode technology.
While a person is scanning a visible barcode, there
is no need for people in RFID technology. Also,
the reading distance of RFID tags is high. RFID
technology allows many tags to be read at the same
time and the information can be stored. However,

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only the information reading function can be
performed with the barcode. While barcodes are
often damaged when exposed to environmental
influences; RFID tag life is quite long.
RFID can provide supply chains with a high
degree of efficiency, accuracy, visibility, and security.
Real-time inventory and logistics information is
shared by manufacturers, suppliers, distributors,
and retailers through RFID at every stage of the
chain. Besides, RFID technologies improve the
operations of supply chains such as production,
logistics, inventory management, and customer
services. Tajima (2007) demonstrated the benefits
of using RFID in supply chains in general based
on supply chain participants. The benefits of RFID
throughout the supply chain are listed as follows:
• Reduced shrinkage
• Reduced material handling
• Increased data accuracy
• Faster exception management
• Improved information sharing
important
RFID can provide supply chains with a high
degree of efficiency, accuracy, visibility, and
security.
The benefits of RFID technologies in terms of
manufacturer and supplier are stated as production
monitoring, quality control, and supply and
continuity of production. It is also emphasized
that RFID technology has material handling, land
use, and asset management benefits for distributors
and logistic providers. Lastly, the benefits of RFID
for retailers are specified as reduced stockouts,
customer service, aftersales service, and lower
inventory.
Enterprise Resource Planning
Enterprise Resource Planning (ERP) is
defined as an integrated management system
that enables the efficient use of resources such as
labor, machinery, and materials required for the
production of goods and services in enterprises. An
ERP system carries out a wide range of operations
such as planning, accounting, finance, purchasing,
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Information Systems in Supply Chains
inventory management, logistics, and human
resources in a holistic way.
Enterprise Resource Planning (ERP) is
defined as an integrated management system
that enables the efficient use of resources such
as labor, machinery, and materials required
for the production of goods and services in
enterprises.
With the spread of computers in businesses in
the 1960s, MRP (Material Requirements Planning)
software including production-related activities
has emerged. MRP-II was developed by adding
functions such as purchasing, production planning,
quality control, accounting, inventory management,
etc. to this software. Since the 1990s, these systems
have been transformed into ERP, which can be used
by the service industry and have more functions.
The use of ERP is inevitable for the business
to adapt itself to the constantly changing and
uncertain market conditions. ERP systems provide
decision-making and fast return to customers
thanks to the network that businesses currently
established between production and supply units
located in different geographies. Besides, ERP
software prevents manual processes and paper
consumption. Thus, the time loss caused by
manual errors and losses in the business processes
is almost non-existent. Some of the benefits that
ERPs provide to businesses can be listed as follows:
• Efficient use of resources and consequent
reduction in costs and time
• High traceability in the business/supply
chain
• Efficient inventory management
• Decrease in business processes
• Automatic preparation of accurate and
consistent reports
• Effective order tracking
• Annihilation of the limitations about
language and time
• Reaching the fastest and up-to-date
information in terms of market, customer,
and business
• Decrease in errors caused by manual works
and paper usage
 7
Supply Chain Management

An ERP software includes areas such as material management, production, production planning and
control, accounting, finance, cost accounting, financial control, purchasing/sales, marketing modules,
main management files, product data management, and document management. The main components
of an ERP system are illustrated in Figure 7.5.

Supply
Chain
Management
Quality Customer
Management Relationship
Management

Business
Purchasing
Intelligence

ERP
Inventory
Sales&
Management
Transportation
System

Production Financial
Planning and Management
Control
Project
Management

Figure 7.5 The Main Components of ERP Systems.

The function of the main components can be explained as below:

• The inventory management component includes warehouse processes from the introduction of
purchased materials to the warehouse and delivery to the customer as a product.
• The sales and distribution component ensures that the process from receipt of customer orders to
production and delivery is carried out.
• The purchasing component is related to the notification of material requirement requests to the
business, to the supplier, to the follow-up and delivery processes.
• The supply chain management component provides coordination and effective information flow
within and between businesses.
• The production planning and control component ensures that activities such as sales and operations
planning, material resource planning, demand management, production control, and capacity
planning are carried out.

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• The financial management component
is the component that covers all financial
operations including accounting, where
financial movements, debt, and receivable
tracking futures are tracked and recorded.
• The quality management component
includes monitoring and managing the
process steps of quality certification.
• The human resources component includes
all human resources functions, from
recruiting employees to career planning and
training scheduling.
• The project management component,
developed for project-type companies,
includes all activities, documents, purchases,
costs, and resources of the project.
• The Customer Relationship Management
(CRM) component works to minimize
customer dissatisfaction caused by planning
and organizational errors by enabling the
planning and organizing of activities related
to customer relations.
ERP provides integration across all supply
chain participants. Thus, it enables all participants
in different geographies to work through a
common system. ERP manages the supply chain
as a whole by ensuring coordination not only
within the company but also among businesses and
contributes to increasing its efficiency. Therefore,
ERP has a crucial role in the integration of
information among all of the suppliers.
important
ERP provides integration across all supply
chain participants.
When the supply chain management system
is integrated with ERP, basically all the chain
companies’ information about finance, sales, and
processes are easily transmitted. Thus, supply chain
management is ensured to take a broad and holistic
view of all supply chain operations. There are many
benefits to the participants of ERP use in supply
chain management, some of which are explained
below.
ERP ensures optimum inventory by making
accurate predictions for the supply chain. Thus, the
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Information Systems in Supply Chains
inventory cost is minimized. Besides, optimal stock
quantities prevent bottlenecks that may arise from
suppliers and manufacturers.
With ERP, all supply chain data is contained
in a single central database. Thus, the need for up-
to-date data can be achieved through ERP without
the need for extra communication or processing.
Thus, operations are simplified and possible errors
are prevented. Besides, the need to enter the same
type of information into the system many times is
eliminated and time is saved. ERP solutions, which
are end-to-end integrated systems, provide more
regular and error-free execution of supply chain
processes. Since ERP provides standardization in
all processes, it eliminates misunderstandings and
language problems between suppliers.
Offering a more efficient and effective supply
chain management, ERP provides products and
services to customers in a fast and high-quality
manner. This results in increased customer
satisfaction and preference for the supply chain.
Besides, ERP’s holistic perspective on supply chain
management enables managers to make more
accurate and informed decisions.
Transportation Management
Systems
A transportation management system (TMS)
can be defined as software for planning, executing,
and optimizing transportation activities. TMSs can
be a software application on their own or integrated
into ERP systems.
A transportation management system can be
defined as software for planning, executing,
and optimizing transportation activities.
Manufacturers, distributors, e-commerce
companies, and logistics service providers mostly
use TMS for planning, order management,
pricing, fleet management, routing, loading, etc.
TMS can also provide optimization of routing and
loading operations. In addition to these functions,
TMSs offer the ability to monitor the performance
of transportation operations with reporting and
dashboard functions. Thus, they can support

Supply Chain Management
the strategic decisions that managers will make
regarding transportation.
The use of TMS provides many advantages to
supply chains. Some of these advantages can be
listed as below:
• With the transportation system followed by
TMS, a reduction in transportation costs
can be achieved.
• TMSs provide route and load optimization.
It performs the optimization of the
mentioned issues in terms of warehouse,
order, customer, and supplier as integrated.
This opportunity provided by TMS saves
time and money.
• As with any information system, TMSs
minimize paper usage and increase supply
chain visibility.
• With a real-time TMS, planning and
forecasting work is more successful because
inventory levels are instantly correct.
• TMS provides a reliable transport system;
thus, it ensures that the shipment is made
accurately and almost without errors.
• TMS offers the opportunity to monitor
drivers and intervene in accident situations.
• TMS responds to the requests of the
customers quickly and enables to meet the
expectations of the customers.
• Supply chain success increases with
successful customer experience based on
TMS.
Inventory Management Systems
Inventory management systems are the
information systems that are basically used for
managing the inventory through a business or a
supply chain. An inventory management system
includes information such as all inventory items and
their locations, demands, safety stock quantities,
delivery times, and inventory error tracking. Like
TMS, inventory management systems can be a
module of ERP systems.
Inventory management systems are the
information systems that are basically used
for managing the inventory through a
business or a supply chain.
7
Inventory management systems usually detect
stock parts through a system such as a barcode.
Thus, human error is minimized through the
system. Through stock systems, the visibility
of inventories in the supply chain network
increases. Thus, stockout or overstock situations
can be prevented by inventory management
systems.
By applying automatic safety stocks with
inventory management systems, costs arising
from holding excess stock are eliminated. In this
way, inventory management systems that provide
inventory optimization increase supply chain
efficiency and cost savings.
As a result, inventory management systems
benefit supply chains in terms of keeping stock
levels in balance, preventing wrong records,
keeping stocks up-to-date, saving cost and time,
ensuring warehouse layout, etc. However, since
stock systems are an expensive solution, it is vital for
the supply chains to examine the feasibility of this
information system and to make the investment
decision according to the result.
important
Inventory management systems benefit
supply chains in terms of keeping stock
levels in balance, preventing wrong records,
keeping stocks up-to-date, and saving cost
and time.
Internet of Things
With the development of technology in recent
years, the Internet of Things (IoT) and cloud
computing technologies have quickly entered our
lives. There are numerous definitions of IoT in
the literature. As one of them, Gubbi et al. (2013)
define IoT as the interconnection of sensing and
actuating devices providing the ability to share
information across platforms through a unified
framework, developing a common operating
picture to enable innovative applications. They also
emphasized that this interconnection is provided
by seamless ubiquitous sensing, data analytics, and
information representation with Cloud computing
as the unifying framework. IoT is aimed at enabling
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the interconnection and integration of the physical
world and the cyberspace (Ma, 2011).
The Internet of Things is a network of
physical objects connected to each other and
systems. IoT enables objects and systems to
communicate with each other.
Lee and Lee (2015) specify five IoT technologies
that are widely used for the deployment of
successful IoT-based products and services. These
technologies are given below:
1. RFID
2. Wireless sensor networks
3. Middleware
4. Cloud computing
5. Applications
In the supply chain management context,
IoT expression was first used by Kevin Ashton in
2009 (Ashton, 2009). However, IoT supply chain
management practices are fairly new approaches
than the other information system applications
mentioned. In recent years, worldwide companies
such as Amazon, Nissan, Volvo, Decathlon, DHL,
and New Maersk Line have been managing their
supply chain with IoT.
IoT has an important role in sharing and
transferring information among the supply
chain members. IoT working on sensors and
interconnected systems provides flexibility
to supply chains. Besides, IoT technology
transforms the supply chain into digital and
intelligent systems. Supply chains become
stronger with IoT solutions powered by artificial
intelligence.
IoT technology can be used in all areas of
the supply chain. Below are examples of the
applicability of IoT in storage, transportation,
business processes, and retailing.
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Information Systems in Supply Chains
IoT can be used in storage and transportation
processes. Warehouses can be monitored in
real-time. Thus, storage costs can be reduced
by preventing overproduction and storage. In
addition, situations such as loss and theft of
products in the warehouse can be minimized with
real-time monitoring. The desired products can
be found quickly via the sensors on the shelves.
This saves workers’ physical workload and time
savings. In addition, ambient conditions such as
temperature and humidity can be continuously
monitored through sensors during the storage or
transportation processes of perishable products.
Autonomous orders can be created for products
that fall below the level by controlling the inventory
levels of the warehouse sensors. With real-time
monitoring of transport vehicles, information
such as transport information, road safety, vehicle
maintenance, urban mobility, traffic congestion,
fleet management, and carbon dioxide emissions
can be collected.
IoT solutions used in business process speed and
facilitate the detection of possible problems. For
example, possible downtime due to malfunctions
can be reduced with IoT solutions.
In retail stores, combining RFID-tagged
products with closed-circuit TV cameras can
monitor customer movement and behavior.
Thus, it helps the retailers to offer customer-
specific opportunities, plan dynamic pricing, and
streamline operations by learning the purchasing
behavior of the customer. In addition, customer
movement data can support inventory and
manpower regulation.
As mentioned, IoT can have many applications
in its supply chains. IoT generally adds speed,
flexibility, agility to supply chains, and makes
supply chains smart. With the rapid development
of technology, it is inevitable that IoT’s supply
chain applications will increase in the coming years.

Supply Chain Management
Further Reading
Delivering the Goods: 8 Examples of IoT
Transforming Supply Chain
Supply chains are increasingly complex in this
globalized world. Connecting people, processes,
data, and products is incredibly difficult, which
is why the Internet of Things (IoT) is tipped to
cause a big bang in how supply chains operate.
Amazon
For one of the world’s most recognised
brands, supply chain logistics are incredibly
important. Every one of Amazon’s orders is
unique, meaning it manages millions of different
products of various shapes, weights, and sizes.
Amazon employees used to roam warehouse
floors to scan for each product, now they use Wi-
Fi-connected robots provided by Kiva Systems
– which Amazon acquired in 2012 – to identify
products by reading QR codes using built-in
cameras. The AI system assesses which products
are to be prioritized for Amazon Prime orders,
for example, and the robots do the rest. While
this takes place, workers can focus on packaging
an order or restocking shelves. It has robots and
humans working side by side through IoT.
Maersk Line
Maersk is one of the biggest companies in the
sipping world. With operations delivering fresh
produce in 343 ports across 121 countries it also
has a hugely complex and crucial supply chain. To
tackle this, the Danish company partnered with
Ericsson in 2012 to install real-time monitoring
across its entire fleet with Ericsson’s mobile and
satellite communications technology. Since then,
the partnership has developed to include safety,
efficiency and cargo care. Ericsson’s tech now
allows Maersk’s 300,000 refrigerated containers to
transmit vital stats, such as temperature, location
and power supply via satellite. The information is
sent to the cloud and analyzed in a central office.
As well as offering real-time information as issues
develop, however, the collaboration has also led
to increased safety for port staff, as containers
now require less manual inspection.
7
Volvo
Swedish car manufacturer Volvo is not alone
for pushing for IoT technologies in cars, but
the Internet of Things is also impacting what
goes on behind the scenes to get these cars on
the road. Volvo is using cloud-based services
and IoT technologies to support the logistics
side of its supply chain in ordering components
from different countries to shipping vehicles to
suppliers across the world. The company told
V3 it was using cloud because these services give
them greater flexibility over on-premise setups.
Furthermore, the firm last year established a
relationship with Microsoft, which involved
trialing its mixed reality headset HoLoLens. The
firm believes the headset could transform car
design and the relationship between deals and
potential customers.
Nissan
Nissan, which deploys robots and machine-
learning techniques at its plants in Sunderland,
UK, has also automated a large part of its
supply chain. “The supply chain is massively
computerized,” Nissan’s VP of advanced
product strategy, Ponz Pandikuthira told
Internet of Business (IoB). “So, the key part
of it is Information Technology and the vast
improvement in software. It has dramatically
made the manufacturing process much more
efficient.”
Dallas Area Rapid Transit (DART)
Transportation and fleet management are an
important part of the supply chain and logistics
business, and IoT is already making waves in this
space. If you could have visibility over your entire
fleet, so that you know exactly where each truck
might be and when, and which is the best route
for it to take on any given day (and when it might
need servicing…) you’d probably do it. That’s
exactly how IoT technology has helped DART.
Based in Dallas, Texas, DART is one of the
largest public transport providers in the United
States; it transports over 100 million passengers a
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year. Using Cisco’s Internet of Things systems it
is monitoring and optimizing the performance of
its entire fleet.
New Jersey Transport Authority (NJTA)
While IoT is clearly an important cost
cutting tool long term, in New Jersey, USA, it
has also proved to be an effective safety measure.
The New Jersey Turnpike Authority is working
with IBM to 3,000 deploy sensors along the New
Jersey Turnpike– one of the busiest roadways in
the U.S. The data this generates is used by the
emergency services and traffic management
operators so that they can get to an accident
quicker, and reduce congestion build up.
Port of Hamburg
The Port of Hamburg, Germany, is one of
the busiest ports in Europe and, consequently, is
one of the main economic drivers for the region.
The number of container ships that pass through
the port is expected to rise from eight million in
2010 to 25 million by 2025, while the total cargo
it handles will reach 296 million tons versus 121
million in 2010. This rise in capacity puts huge
pressures on logistics at the port. To respond,
the Hamburg Port Authority (HPA) – which is
working with SAP and its HANA solution – is
embedding sensors and communicative capacities
in the port’s ‘main tangible assets.’ This includes
smart lighting based on motion detection to only
light up necessary areas. The main function of
the sensors is to identify recurring underused
Learning Outcomes
4 To explain some of the information systems used in supply chains
Self Review 3 Relate
What are the information
Associate the use of ERP by
systems used in supply
supply chain management.
chains?
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Information Systems in Supply Chains
capacity so it can be used properly. However,
there are numerous other connected elements
such as cameras, heat detection sensors and
alarm systems prevent theft and provide insight
for planning security updates. Carriers and
logistics providers are apparently already seeing
the benefits in operational efficiency delivered by
IoT. For the full case study see here.
Decathlon
Track and trace is the most common form of
IoT in the supply chain and a number of firms
are seeing real rewards from getting ahead with
this technology. Decathlon -a sports retailer
that owns 850 stores in 22 countries- is a prime
example of this. It’s using IoT technology,
such as radio frequency identification (RFID)
from Checkpoint Systems in more than 400 of
its stores, and plans to extend its use of RFID
tagging to millions of its products across the
globe. Supposedly, the tracking technology
ensures Decathlon’s products are delivered to
vendors with 100% accuracy every time, and
items arrive shelf-ready which saves employees
time by not manually checking each delivery.
A massive number of different brands are
deploying similar operations globally, from The
Bouqs Company to Nike and AeroScout to
Aarhus University Hospital.
Source: https://internetofbusiness.com/8-real-
life-examples-iot-supply-chain/
Tell/Share
Tell the advantages of using
RFID technology from the
barcode technology.
 7
Supply Chain Management

To understand information and

LO 1 information management in
supply chains

One of the flows between the supply chain participants is the flow of information. During the bi-
directional flow of information, from suppliers to end-users and from end-users to suppliers, information
is transferred at strategic, tactical, and business levels. In the supply chain, information is transmitted
through a combination of various information systems, business processes, and decision support systems.
Information sharing has many benefits to supply chain success and efficiency. Information integration,
realized through collaboration and sharing of information among the supply chain participants, is part of

Summary
the supply chain integration.

To define the information

LO 2 systems and explain the concepts
of information systems

Information systems are systems designed to store, process, and analyze corporate data consisting of
software, hardware, databases, networks, and people. While information systems used in many sectors
save time and cost they also eliminate errors caused by manual works.

To explain the objectives and

LO 3 advantages of supply chain
information systems

In a supply chain, information system aims to collect information through the whole supply chain, provide
access to data from a single point of contact, analyze, plan and make decisions using the information of
the whole supply chain, and collaborate all supply chain participants and operations.
It is known that the use of information systems in supply chains provides many advantages. Some of
these advantages are better monitoring of the supply chain, better forecasting, cost reduction, lead time
shortening, reductions in inventory and transportation costs, development of the relations between the
supply chain participants, real-time reporting, ensuring customer satisfaction, and sustainability.

To explain some of the information

LO 4 systems and technologies used in
supply chain management

With the development of technology, many types of information systems and technologies used in supply
chain management have been developed. Information technologies such as EDI, Barcode, RFID and
IoT and information systems such as ERP, TMS and inventory management systems are used in supply
chains. These information systems and technologies used provide many advantages to the supply chains
in a competitive environment.

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Information Systems in Supply Chains

1 I Material flow 6 Which of the following ERP components is

II Collaboration related to the notification of material requirement
III Information integration requests to the business, to the supplier, to the
Which of the above statements provide(s) follow-up and delivery processes?
information integration?
Test Yourself

A. Purchasing
A. Only I B. Supply chain management
B. Only III C. Sales and distribution
C. I and II D. Inventory management
D. II and III E. Production planning and control
E. I, II and III
7 Which of the following information systems
2 Which of the following is not one of the main is an image consisting of a series of parallel black
objectives of information systems used in supply chains? and white lines of various thicknesses that brings
A. Tracking transportation information about a product when scanned
B. Providing access to data from a single point A. EDI B. RFID
C. Collaborating with all participants and operations C. IoT D. TMS
D. Collecting information E. Barcode
E. Decision-making using the information
8 I. RFID
3 Which of the following information systems II EDI
are defined as integrated management systems III Cloud computing
that enable the efficient use of resources such as Which of the above statements is/are IoT
labor, machinery, and materials required for the technologies, which is/are widely used for the
production of goods and services in enterprises? deployment of successful IoT-based products and
A. TMS B. EDI services?
C. ERP D. IoT A. Only I B. Only II
E. RFID C. I and II D. I and III
E. II and III
4 Which of the following information
technology does not require human, visibility and 9 Which of the following is not one of the
close distance during scanning? information contained in inventory management
A. IoT B. RFID systems?
C. Barcode D. TMS A. Inventory items
E. EDI B. Demands
C. Error tracking
5 I Electronic marketplaces D. Pricing
II Electronic integration E. Safety stock quantities
III Information diffusion and sharing
Which of the above statements is/are EDI’s roles in 10 Which of the following is the information
supply chain management? system with optimization function in routing and
A Only II loading operations?
B. Only III A. TMS B. ERP
C. I and II C. EDI D. RFID
D. II and III E. IoT
E. I, II and III

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Supply Chain Management

If your answer is wrong, please review If your answer is wrong, please review the
1. D 6. A
the “Information and Information “Information Systems and Technologies
Management in Supply Chains” section. Used in Supply Chain Management” section.

Answer Key for “Test Yourself”

2. A If your answer is wrong, please review the
“Supply Chain Information Systems” section.
If your answer is wrong, please review the
7. E
“Information Systems and Technologies
Used in Supply Chain Management” section.

If your answer is wrong, please review the If your answer is wrong, please review the
3. C 8. D
“Information Systems and Technologies “Information Systems and Technologies
Used in Supply Chain Management” section. Used in Supply Chain Management” section.

If your answer is wrong, please review the If your answer is wrong, please review the
4. B 9. D
“Information Systems and Technologies “Information Systems and Technologies
Used in Supply Chain Management” section. Used in Supply Chain Management” section.

If your answer is wrong, please review the
5. E “Information Systems and Technologies
10. A
Used in Supply Chain Management” section.
If your answer is wrong, please review the
“Information Systems and Technologies
Used in Supply Chain Management” section.

What are the benefits of information sharing for

Suggested Answers for “Self Review”

supply chains?

The benefits of information sharing in supply chains can be listed as follows:

• Inventory reduction and efficient inventory management
• Cost reduction
• Increasing visibility
• Significant reduction or complete elimination of bullwhip effect
• Improved resource utilization
• Increased productivity, organizational efficiency, and improved
services
self review 1
• Building and strengthening social bonds
• Early problem detection
• Quick response
• Reduced cycle time from order to delivery
• Better tracing and tracking
• Earlier time to market
• Expanded network
• Optimized capacity utilization

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Information Systems in Supply Chains

What are the objectives and functions of an

information system?
Suggested Answers for “Self Review”

The objective of an information systems is providing appropriate and

requested information to their users by processing the data they collect and
self review 2
store. Information systems store and analyze data and information, support
decision-making and management of business processes.

What are the benefits of information sharing for

supply chains?

There are many information systems and technologies mostly used for
information integration in supply chain management. The information
system and technologies used can generally change according to the structure,
size, need, and management understanding of the supply chain, etc. Some of
these information systems and technologies used extensively are Electronic
Data Interchange, barcode, Radio Frequency Identification, Enterprise
self review 3 Resource Planning, transportation management systems, and inventory
management systems. In addition, there are supply chain management
applications of Internet of Things technology, which has developed in recent
years. Apart from these, the supply chain management system, customer
relationship management system, supplier relationship management system,
e-supply chain, e-business, etc. information systems and technologies are also
information systems and technologies used in supply chains.

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Supply Chain Management
References
Ashton, K. (2009). That ‘internet of things’ thing.
RFID journal, 22(7), 97-114.
Bowersox, D., Closs, D. and Cooper, M. B. (2002).
Supply Chain Logistics Management. Mcgraw-Hill
Education.
Chandra, C. and Grabis, J. (2007). Supply Chain
Configuration Concepts, Solutions and Applications.
Springer.
Gubbi, J., Buyya, R., Marusic, S. and Palaniswami,
M. (2013). Internet of Things (IoT): A vision,
architectural elements, and future directions.
Future Generation Computer Systems, 29 (7),
1645-1660.
Hsu, C.-C., Kannan, V. R., Tan, K.-C. and Leong, G.
K. (2008). Information sharing, buyer‐supplier
relationships, and firm performance. International
Journal of Physical Distribution & Logistics
Management, 38(4), 296-310.
Huang, Y.-Y. and Handfield, R. B. (2015). Measuring
the benefits of ERP on supply management
maturity model: a “big data” method. International
Journal of Operations & Production Management,
35(1), 2-25.
Lee, I. and Lee, K. (2015). The Internet of Things
(IoT): Applications, investments, and challenges
for enterprises. Business Horizons, 58(4), 431-440.
Lotfi, Z., Mukhtar, M., Sahran, S. and Zadeh, A. T.
(2013). Information Sharing in Supply Chain
Management. Procedia Technology, 11, 298-304.
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Ma, H.-D. (2011). Internet of Things: Objectives and
Scientific Challenges. Journal of Computer Science
and Technology, 26(6), 919-924.
Min, H. (2000). “Electronic Data Interchange in
Supply Chain Management”, P. Swamidass (Ed.),
in Encyclopedia of Production and Manufacturing
Management. Boston, MA: Springer.
Ross, D. F. (2010). Introduction to Supply Chain
Management Technologies. CRC Press.
Simchi-Levi, D., Kaminsky, P. and Simchi-Levi, E.
(2003). Managing the Supply Chain: Definitive
Guide for the Bussiness Professional. McGraw-Hill.
Szymczak, M., Ryciuk, U., Leończuk, D., Piotrowicz,
W., Witkowski, K., Nazarko, J. and Jakuszewicz,
J. (2018). Key factors for information integration
in the supply chain–measurement, technology
and information characteristics. Journal of Business
Economics and Management, 19(5), 759-776.
Tajima, M. (2007). Strategic value of RFID in supply
chain management. Journal of Purchasing & Supply
Management, 13, 261-273.
Valacich, J. and Schneider, C. (2010). Information
Systems Today: Managing the Digital World.
Prentice-Hall.
Zhou, H. and Benton Jr., W. C. (2007). Supply
chain practice and information sharing. Journal of
Operations Management, 25, 1348-1365.
171
 Chapter 8 Sustainability in Supply Chains

After completing this chapter, you will able to;

Learning Outcomes

1 Understand the concept of sustainability and

climate change 2 Use measures for sustainability

3 Understand operational aspects of sustainable

supply chains 4 Relate closed-loop supply chains with
sustainability

Key Terms
Triple bottom-line accounting
Chapter Outline Climate change
Introduction
Life cycle assessment
Sustainability and Climate Change
Carbon footprinting
Measuring Sustainability in Supply Chains
Green logistics
Operational Aspects of Sustainable Supply Chains
Green inventory management
Closed-loop Supply Chains and Sustainability
Recycle
Remanufacture

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Supply Chain Management
INTRODUCTION
Sustainability is a term that was first introduced
by the United Nations World Commission
(Brundtland Commission) Report in 1987.
The report describes sustainable development as
“development that meets the needs of the present
without compromising the ability of future
generations to meet their own needs.” It basically
urges the economic and social activities of today to
preserve the environmental resources for the future;
and thus not deplete, destroy or distort them.
The definition of sustainability may not be
as precise as one would prefer. From a strong
sustainability perspective, natural capital (resources)
should not be replaced by manufactured capital
to achieve true sustainability. However, any
supply chain today converts natural capital into a
manufactured good; and hence, is unsustainable.
From a weak sustainability perspective, it is acceptable
to deplete natural resources as long as there is a
corresponding increase in manufactured capital. So,
a supply chain may be sustainable if its net impact
is neutral; e.g., water pollution is acceptable as long
as decontamination technology advances and is
used in parallel. With the limitations of the current
technology, social organization and economic activity,
a supply chain cannot declare itself “sustainable” even
in the weak sense. Thus, sustainability can be taken
as a direction, and it makes more sense to refer to
“a more sustainable business” as one that is better at
identifying its environmental and social impacts and
finding ways to mitigate those.
SUSTAINABILITY AND CLIMATE
CHANGE
Sustainability definition not only covers the
environmental (or green) aspects of a business
but also its social impacts. The social aspect
still lies in the original definition: the future
generations should not be deprived of the
ability or means to meet their own needs. Thus,
sustainability urges businesses to be mindful of
the effects of its activities on all its stakeholders;
not merely shareholders. Stakeholders of a firm
include its customers, employees, partner firms
and their employees, regulatory authorities, non-
governmental organizations, and basically society
at large. Thus, sustainability definition not only
covers environmental or “green” issues regarding a
business, but also its social impact.
8
internet
Read more at https://www.un.org/
s u s t a i n a b l e d e ve l o p m e n t / s u s t a i n a b l e -
development-goals/ for the 17 sustainable
development goals set by United Nations to
achieve by 2030.
important
Sustainability covers both environmental and
social aspects regarding an organization or a
business.
Companies, to become a more sustainable
business, should first measure their environmental
and social performance. Only upon observing
their impact they can take action to alleviate
their negative effect, or improve their positive
contribution. Organizations, just as they publish
annual financial reports to publicly announce their
economic performance, are encouraged to publish
an annual corporate social responsibility report to
share their environmental and social performance.
As opposed to a traditional firm that only
focuses on its economic performance, a firm
that strives to be sustainable also considers its
environmental and social impact when making
decisions. This perspective is referred to as Triple
Bottom-Line accounting (TBL, 3BL). This system
urges businesses to track “gains & losses” along
the three dimensions: economic impact (profit),
environmental impact (planet), and social impact
(people), and jointly maximizes them. This
accounting system is also referred to as PPP (short
for profit-planet-people).
Note that the three criteria above do not
necessarily conflict with each other. Though not
all environmentally-focused initiative is profitable,
there may be opportunities that could be win-win-
win across the three dimensions for a firm. Major
reasons for a firm to seek to be more sustainable
due to financial reasons can be referred to as
economic drivers of sustainability. We can classify
these economic drivers into two groups: (1) market
forces or opportunities, and (2) risk of regulation
and exposure. The first group refers to cases where
173
8
businesses pursue sustainable practices to improve
or sustain their economic performance under
changing market conditions. In the second group
of cases, companies proactively improve their
environmental or social performances to avoid
regulation or exposure risk, which may result in
significant costs financially.
When Unilever discovered that the supply for
its frozen fish sticks was at risk because the global
fish supply was declining, it set up the Maritime
Stewardship Council in collaboration with
World Wildlife Fund that promotes and certifies
sustainable fisheries around the world. According to
Co-CEO Anthony Burgmans, “As one of the largest
purchasers of fish, it is in Unilever’s commercial
interest to protect the aquatic environment from
fishing methods that will ultimately destroy stocks”
(Etsy 2006, p. 31). Thus, Unilever embraced better
environmental standards to sustain economic
performance under changing market forces.
In Christmas 2001, right before the peak
selling season, Sony’s shipment of 1.3 million
Playstation boxes was blocked by the Netherlands
customs department and could not get on store
shelves because of a legally unacceptable toxic
element (Cadmium) found in its game controls.
The company’s neglect in tracking environmental
regulations and maintain its own standards
accordingly resulted in a total loss over $130
million (Etsy 2006, p. 1-2).
When an eight-story Rana Plaza factory
collapsed in Bangladesh in 2013, more than
1000 workers were killed with an additional
2500 injured. It was a crowded building, full of
apparel workers. In Rana Plaza, building safety
codes were overlooked and lives were lost due to
negligence. The workers killed or injured were
making clothes for global brands such as Loblaw,
Primark, Benetton, Mango, Bonmarche, and the
Children’s Place. Such an unfortunate incident has
consequences for all associated global brands since
they are the ultimate customers. In 1990s, Nike
was under intense pressure due to poor working
conditions exposed in its contract manufacturers
in Asia. All these incidents generally tarnish the
reputation of the associated brands and harm the
sales. Thus, poor labor practices in the extended
supply chain; and hence, poor social performance
of a company poses a significant risk for its
economic performance as well.
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Sustainability in Supply Chains
important
Environmental and social performance of a
company may or may not conflict with its
economic performance.
Triple bottom-line accounting is a framework
where firms evaluate their performance
and make their decisions according to
three criteria: economic impact (profit),
environmental impact (planet), and social
impact (people).
We have discussed sustainability from a
general business perspective up to now. However,
a supply chain perspective is key to understand
and evaluate the sustainability practices of a firm.
In today’s competitive marketplace, a company
has to be associated with a vast supply network
to be successful; it has multiple echelons of
suppliers upstream, each with its own supply chain
network, and multiple echelons of intermediaries
or buyers downstream until it reaches the end-
customer. Thus, it is a challenge to evaluate a firm’s
responsibility for the environmental consequences
(e.g., greenhouse gas emissions, air pollution, water
use, and etc.) associated with a final product or
service. Additionally, all supply chain activities are
interrelated; when an upstream supplier develops
a component design with less material use, it will
both drive down the downstream manufacturer’s
cost (including transportation and storage) in
addition to reducing its environmental burden.
As observed in the examples of Unilever, Sony,
and Nike, a company’s sustainability performance
and motivation for sustainable practices cannot
be decoupled from its supply chain. Thus,
sustainability must be discussed in a supply chain
context.
important
A company’s sustainability performance
cannot be decoupled from its supply chain.

Supply Chain Management
A business (or a supply chain) may have its own
incentives to measure environmental performance.
The evaluated performance may be communicated
internally. These performance measures may be
utilized in making critical decisions regarding the
supply chain, such as supplier selection, sourcing/
process decisions (e.g., whether to outsource a
component production or not), and design of the
supply chain/product (e.g., product components,
the supplier network to be utilized, warehouses and
stocking points). In some cases, businesses measure
their environmental impact to communicate
externally, due to government regulations, corporate
reporting requirements or investor pressure.
Through communication with the stakeholders, a
business may also use these measures for marketing
purposes and to enhance its reputation.
Environmental performance of a supply chain
may be analyzed and communicated in different
ways depending on the environmental issue of
concern. Climate change, water use, land use, use
and depletion of natural material resources, toxicity
(toxic waste accumulated in the human body or
the nature), air pollution (acidification) and ozone
layer depletion are the most widely discussed
environmental issues of concern. Currently, the
“most urgent” environmental issue that requires
efforts at individual, corporation, and national levels
is the climate change. Thus, in the rest of the chapter,
climate change will be the focal environmental
impact area as well. Below, some background
information on the issue is provided first.
Climate Change
This issue is also referred to as “global
warming.” However, it is not a mere increase
in the temperature, it entails the change and/
Figure 8.1 Global CO2, CH4, and N2O Concentration Over Time
Source: Synthesis Report of Intergovernmental Panel of Climate Change (IPCC) (2014).
8
or disruption of climate globally. It involves
phenomena such as melting of ice caps, rising sea
levels, change in rainfall patterns, severe droughts,
floods, hurricanes, and new pathways of disease
(Etsy, 2006). In a nutshell, it is the biggest threat
to the habitability of the planet.
The main reason for climate change is the rising
concentration levels of greenhouse gases (GHG)
in the atmosphere. These gases (carbon dioxide,
methane, nitrous oxide, water vapor, ozone,
chlorofluorocarbons, perfluorocarbons, and sulfur
hexafluoride) trap the heat that would otherwise
bounce off the surface of the Earth. This effect, also
referred to as the greenhouse gas effect, is the primary
reason for Earth to be habitable (reach reasonable
temperatures). However, global GHG emissions
have been increasing due to industrialization and
changes in agriculture and land use. Thus, the
greenhouse gas concentration has been increasing
gradually, with the capability to trap more heat,
and has started to distort the climate balance on
Earth. According to the Environmental Protection
Agency (www.epa.gov), the primary greenhouse gas
carbon dioxide (CO2) has a rising concentration
from an annual average of 280 parts-per-million
(ppm) in the late 1700s to 401 ppm as measured in
2015; methane (CH4) concentration has more than
doubled since preindustrial times, and nitrous oxide
(N2O) concentration has risen from a baseline of
280 parts-per-billion (ppb) to 328 ppb as measured
in 2015. The increase in CO2 emissions is due to
human activities; mainly the combustion of fossil
fuels such as coal, oil, and gas. CH4 emissions mainly
come from agriculture, fossil fuel use, livestock,
and landfills (waste), N2O emissions source from
agriculture and chemical processes. Figure 8.1
below provides the change in the concentration of
CO2, CH4, and N2O over time.
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8
Sustainability in Supply Chains

More than 70% of the GHG concentration in the atmosphere is CO2, and it has risen substantially
along with other primary gases like CH4 and N2O, due to human activities that involve fossil fuel use,
agriculture, livestock, and landfills. In fact, according to IPCC (2014), the share of economic sectors in
anthropogenic (i.e., due to human activity) GHG emissions are as in Table 8.1.

Table 8.1 Global Anthropogenic Greenhouse Gas Emissions by Economic Sector

Economic Sector Activities Share (%)

Electricity and heat production Burning of coal, natural gas, and oil for electricity and 25%
heat
AFOLU (Agriculture, forestry, and Cultivation of crops and livestock; deforestation 24%
other land use)
Industry Fossil fuels burned on site at facilities for energy; 21%
emissions from chemical, metallurgical, and mineral
transformation processes
Transportation Fossil fuels burned for road, rail, air, and marine 14%
transportation
Buildings Onsite energy generation and burning fuels for heat in 6.4%
buildings, or cooking in homes
Other energy Emissions from the energy sector which are not directly 9.6%
associated with electricity or heat production, such as
fuel extraction, refining, processing and transportation
Source: Adapted from IPCC 2014 and www.epa.gov

Environmental performance of a supply chain may

be analyzed with respect to various environmental
issues of concern such as climate change, water use, land
use, use and depletion of natural material resources,
toxicity, air pollution, ozone layer depletion, and etc.
To fight climate change, there is a rising global effort
coordinated by the United Nations. As a consequence,
local and national authorities enforce certain regulations
to reduce the emission rates of greenhouse gases. The
most commonly used types of regulations are (1) carbon
tax, (2) carbon cap, (3) cap-and-trade systems. Carbon
tax is a type of tax charged per unit GHG emissions
produced. This tax may be enforced on the individual
consumer (e.g., carbon tax per lt/gallon of gasoline
purchased); or may be enforced on businesses based
on their organizational GHG emissions. Carbon tax
is a monetary instrument to restrain activities that are
involved with GHG emissions, and hence reduce the
total GHG emissions. Some regulations do not involve
a monetary penalty but only enforce a cap (i.e., a strict
internet
Learn more about climate change from http://
www.ted.com/talks/al_gore_the_case_for_
optimism_on_climate_change.
important
The climate change is the consequence
of increasing GHG concentration in the
atmosphere. This increase is mainly attributed
to human activity and industrialization.
important
Climate change is currently the most
imminent threat to the habitability of the
planet.

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Supply Chain Management
limit) on the GHG emissions of a company.
In cap-and-trade systems, firms are subject to
carbon caps but are rewarded (penalized) for
emitting less (more) than their caps through
selling (purchasing) carbon credits. Availability
and pricing of emission credits in these markets
are determined by a carbon exchange market. In
some cap-and-trade systems, firms are allowed
to offset emissions in excess of their caps by
purchasing carbon offsets. A carbon offset is the
realized (or estimated) GHG emission reduction
due to a carbon-reducing project undertaken
elsewhere, typically offered by a third party.
Cap-and-trade systems are the most commonly
used mechanisms to control and reduce GHG
emissions. These systems are generally set up for
certain industries only.
Further Reading
UN Climate Change Summit – COP 21
(Conference of Parties) – Also known as “Paris
Climate Conference” – Remarks by President
Obama at the First Session
Nov 30, 2015, Paris
“President Hollande, Mr. Secretary General,
fellow leaders. We have come to Paris to show
our resolve.
… keeps changing faster than our efforts to address
Nearly 200 nations have assembled here this
week -- a declaration that for all the challenges
we face, the growing threat of climate change
could define the contours of this century more
dramatically than any other. What should give
us hope that this is a turning point, that this is
the moment we finally determined we would
save our planet, is the fact that our nations share
a sense of urgency about this challenge and a
growing realization that it is within our power to
do something about it.
Our understanding of the ways human
beings disrupt the climate advances by the day.
Fourteen of the fifteen warmest years on record
have occurred since the year 2000 -- and 2015 is
on pace to be the warmest year of all. No nation
8
A cap-and-trade system enforces a certain cap
(limit) on member firms, but they are rewarded
(penalized) for emitting less (more) than their caps
through selling (purchasing) carbon credits.
Carbon tax is a type of tax charged per unit GHG
emissions generated for a product or by a firm.
A carbon offset is the realized (or estimated) GHG
emission reduction due to a carbon-reducing
project undertaken elsewhere, typically offered by
a third party.
-- large or small, wealthy or poor -- is immune to
what this means.
This summer, I saw the effects of climate
change firsthand in our northernmost state,
Alaska, where the sea is already swallowing
villages and eroding shorelines; where permafrost
thaws and the tundra burns; where glaciers are
melting at a pace unprecedented in modern
times. And it was a preview of one possible future
-- a glimpse of our children’s fate if the climate
it. Submerged countries. Abandoned cities.
Fields that no longer grow. Political disruptions
that trigger new conflict, and even more floods
of desperate peoples seeking the sanctuary of
nations not their own.
That future is not one of strong economies,
nor is it one where fragile states can find their
footing. That future is one that we have the
power to change. Right here. Right now. But only
if we rise to this moment. As one of America’s
governors has said, “We are the first generation
to feel the impact of climate change, and the last
generation that can do something about it.”
I’ve come here personally, as the leader of
the world’s largest economy and the second-
largest emitter, to say that the United States of
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America not only recognizes our role in creating
this problem, we embrace our responsibility to
do something about it.
Over the last seven years, we’ve made
ambitious investments in clean energy, and
ambitious reductions in our carbon emissions.
We’ve multiplied wind power threefold, and solar
power more than twentyfold, helping create parts
of America where these clean power sources are
finally cheaper than dirtier, conventional power.
We’ve invested in energy efficiency in every way
imaginable. We’ve said no to infrastructure that
would pull high-carbon fossil fuels from the
ground, and we’ve said yes to the first-ever set of
national standards limiting the amount of carbon
pollution our power plants can release into the sky.
The advances we’ve made have helped drive
our economic output to all-time highs, and drive
our carbon pollution to its lowest levels in nearly
two decades.
But the good news is this is not an American
trend alone. Last year, the global economy grew
while global carbon emissions from burning fossil
fuels stayed flat. And what this means can’t be
overstated. We have broken the old arguments for
inaction. We have proved that strong economic
growth and a safer environment no longer have
to conflict with one another; they can work in
concert with one another.
And that should give us hope. One of the
enemies that we’ll be fighting at this conference is
cynicism, the notion we can’t do anything about
climate change. Our progress should give us hope
during these two weeks -- hope that is rooted in
collective action.
Earlier this month in Dubai, after years of
delay, the world agreed to work together to cut
the super-pollutants known as HFCs. That’s
progress. Already, prior to Paris, more than 180
countries representing nearly 95 percent of global
emissions have put forward their own climate
targets. That is progress. For our part, America
is on track to reach the emissions targets that I
set six years ago in Copenhagen -- we will reduce
our carbon emissions in the range of 17 percent
below 2005 levels by 2020. And that’s why, last
year, I set a new target: America will reduce our
emissions 26 to 28 percent below 2005 levels
within 10 years from now.
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Sustainability in Supply Chains
So our task here in Paris is to turn these
achievements into an enduring framework
for human progress -- not a stopgap solution,
but a long-term strategy that gives the world
confidence in a low-carbon future.
Here, in Paris, let’s secure an agreement that
builds in ambition, where progress paves the way
for regularly updated targets -- targets that are
not set for each of us but by each of us, taking
into account the differences that each nation is
facing.
Here in Paris, let’s agree to a strong system of
transparency that gives each of us the confidence
that all of us are meeting our commitments. And
let’s make sure that the countries who don’t yet
have the full capacity to report on their targets
receive the support that they need.
Here in Paris, let’s reaffirm our commitment
that resources will be there for countries willing
to do their part to skip the dirty phase of
development. And I recognize this will not be
easy. It will take a commitment to innovation
and the capital to continue driving down the cost
of clean energy. And that’s why, this afternoon,
I’ll join many of you to announce an historic
joint effort to accelerate public and private clean
energy innovation on a global scale.
Here in Paris, let’s also make sure that these
resources flow to the countries that need help
preparing for the impacts of climate change that
we can no longer avoid. We know the truth that
many nations have contributed little to climate
change but will be the first to feel its most
destructive effects. For some, particularly island
nations -- whose leaders I’ll meet with tomorrow
-- climate change is a threat to their very
existence. And that’s why today, in concert with
other nations, America confirms our strong and
ongoing commitment to the Least Developed
Countries Fund. And tomorrow, we’ll pledge
new contributions to risk insurance initiatives
that help vulnerable populations rebuild stronger
after climate-related disasters.
And finally, here in Paris, let’s show businesses
and investors that the global economy is on a
firm path towards a low-carbon future. If we
put the right rules and incentives in place, we’ll
unleash the creative power of our best scientists
and engineers and entrepreneurs to deploy clean

Supply Chain Management
energy technologies and the new jobs and new
opportunities that they create all around the
world. There are hundreds of billions of dollars
ready to deploy to countries around the world
if they get the signal that we mean business this
time. Let’s send that signal.
That’s what we seek in these next two
weeks. Not simply an agreement to roll back the
pollution we put into our skies, but an agreement
that helps us lift people from poverty without
condemning the next generation to a planet
that’s beyond its capacity to repair. Here, in Paris,
we can show the world what is possible when we
come together, united in common effort and by
a common purpose.
And let there be no doubt, the next
generation is watching what we do. Just over a
week ago, I was in Malaysia, where I held a town
hall with young people, and the first question I
received was from a young Indonesian woman.
And it wasn’t about terrorism, it wasn’t about the
economy, it wasn’t about human rights. It was
about climate change. And she asked whether I
was optimistic about what we can achieve here
in Paris, and what young people like her could
do to help.
I want our actions to show her that we’re
listening. I want our actions to be big enough
to draw on the talents of all our people -- men
and women, rich and poor -- I want to show her
passionate, idealistic young generation that we
care about their future.
For I believe, in the words of Dr. Martin
Luther King, Jr., that there is such a thing as being
Learning Outcomes
1 To understand the concept of sustainability and climate change
Self Review 1 Relate
How can triple bottom-line
Associate environmental and
accounting help a firm become
social impact of a firm.
more sustainable?
8
too late. And when it comes to climate change,
that hour is almost upon us. But if we act here,
if we act now, if we place our own short-term
interests behind the air that our young people
will breathe, and the food that they will eat, and
the water that they will drink, and the hopes and
dreams that sustain their lives, then we won’t be
too late for them.
And, my fellow leaders, accepting this
challenge will not reward us with moments of
victory that are clear or quick. Our progress will
be measured differently -- in the suffering that is
averted, and a planet that’s preserved. And that’s
what’s always made this so hard. Our generation
may not even live to see the full realization of
what we do here. But the knowledge that the
next generation will be better off for what we do
here -- can we imagine a more worthy reward
than that? Passing that on to our children and
our grandchildren, so that when they look back
and they see what we did here in Paris, they can
take pride in our achievement.
Let that be the common purpose here in
Paris. A world that is worthy of our children.
A world that is marked not by conflict, but by
cooperation; and not by human suffering, but by
human progress. A world that’s safer, and more
prosperous, and more secure, and more free than
the one that we inherited.
Let’s get to work. Thank you very much.”
(Applause.)
Source: Retrieved from: https://obamawhitehouse.
archives.gov/the-press-office/2015/11/30/
remarks-president-obama-first-session-cop21
Tell/Share
Find an example where an
environmental initiative/
project results in an economic
burden for a firm.
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Sustainability in Supply Chains

MEASURING SUSTAINABILITY IN SUPPLY CHAINS

Environmental issues of concern for a supply chain may encompass a range of areas such as climate
change, water use, land use, use and depletion of natural material resources, toxicity and waste, air
pollution, and ozone layer depletion. In one or a subset of these impact areas, a supply chain may be
interested in measuring and reporting its performance. Though the main focus in this chapter will be on
climate change, we first introduce a general methodology called life cycle assessment (LCA) that may be
utilized to estimate impact at any environmental issue of concern.

Life Cycle Assessment

ISO 14040 defines Life Cycle Assessment (LCA) as a “technique for assessing the environmental aspects
and potential impacts associated with a product by compiling an inventory of relevant inputs and outputs
of a product system; evaluating the potential environmental impacts associated with those inputs and
outputs; interpreting the results of the inventory analysis and impact assessment phases in relation to the
objectives of the study.” The environmental impact area(s) of concern should be specified at the beginning
of the study. If the goal of the study is to estimate the total water use (water footprint) for a certain product
or service, then LCA covers the entire life cycle of the product in focus, and estimates the total water use
from the extraction of natural resources to the final waste management of the disposed product. This
complete life cycle approach is also referred to as cradle to grave.
LCA is the basic methodology used to answer questions such as “Is a paper bag better than a plastic
bag?” or “Is an electric car better than a gasoline car?” Thus, LCA may be used to compare multiple product
system(s) as well as for evaluating the environmental impact of one product system. Though not common
practice, for comparison purposes, the scope of an LCA study may only cover the range from extraction of
natural resources to the shipment to the customer. This life cycle approach is referred to as cradle to gate.
Note that LCA is used to estimate the environmental impact of a certain category, and not utilized
in estimation of a social impact of a product or service. The example process of a typical LCA study is
available in Figure 8.2 below.

Recycled Materials

Energy Energy Energy Energy

Raw Disposal
Production Transportation Use
Materials Recycle

Waste Waste Waste Waste Waste

Emissions to air and Emissions to air and Emissions to air and Emissions to air and
water water water water

Figure 8.2 Example LCA Process

LCA has four steps.

1. Goal and scope definition: In this phase, the purpose of the study is clearly specified. The
environmental impact areas of concern are listed. The scope of the study is determined (in terms of the
extent of the processes in the life cycle to be considered). Most importantly, a unit of analysis that will

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Supply Chain Management

facilitate an objective comparison of multiple product systems is defined. If the purpose of the study is to
compare an incandescent bulb with an LED counterpart, then an objective comparison of them is harder
than it looks. Life spans as well as lighting performances of the two bulbs differ considerably. That’s why
the unit of analysis needs to be defined in terms of the “function” that both products supply, which is
giving a light of a certain quality. Thus, in this study, the functional unit may be defined as “lighting a
standard room of 15 m2 with 1000 lm (lumen) for 1h.” Similarly, to compare a paper towel dispenser with
a warm air hand dryer, the functional unit of analysis may be “one pair of dried hands.”
2. Inventory analysis: ISO defines this step as “phase of life cycle assessment involving the compilation
and quantification of inputs and outputs for a product throughout its life cycle.” Basically, all the relevant
inputs and outputs (emissions) throughout the life cycle of the product system (based on the scope
determined in step 1) are quantified and listed. In this step, one needs to make sure that all quantities are
consistent in terms of the output quantity needed. For example, if a process consumes 1 lt of water but
produces 3 units of a component where only 1 of them is needed in the production of the final product,
one needs to inventory only 1/3 units of water use from that process.
3. Impact Assessment: ISO defines this step as “phase of life cycle assessment aimed at understanding
and evaluating the magnitude and significance of the potential environmental impacts for a product system
throughout the life cycle of the product.” In this step, one basically converts the quantified input/output
data from the previous step to relevant environmental category impact assessments. First, one sorts/groups
the inventory parameters based on the environmental impact they contribute to (one emission may be
relevant for more than one impact category), and then at the second step, one estimates the contribution
of the emissions and resources consumed for each type of environmental impact. This characterization step
is a simple aggregation as follows:

(Indicator result for category c) Ic= ∑sCFc, s x ms

where CFc,s is the characterization factor that links substance s to impact category c, and ms is the emitted
amount of substance s in kg (or relevant unit). The sum is over all substances that contribute to that
indicated impact category c. Note that the characterization factors are taken from the scientific estimates
in the literature regarding that substance and impact category; i.e., they are just parameters from the
perspective of LCA.
Suppose we want to calculate the category indicator measure for climate change. Climate change
impact category is usually reported in CO2-equivalent emitted (kg), and the characterization factor for
each greenhouse gas is referred to as global warming potential (GWP). These factors represent the heat-
trapping capacity of each type of gas. Then, GWP of CO2 is 1 by definition (since we standardize all
greenhouse gases based on CO2) and GWP for CH4 is 25. Suppose now that the inventory table lists the
emissions of CO2 as 100kg and CH4 as 10 kg. Then, we get

Icc = GW = ∑sGWPs x ms = 1x100 + 25x10 = 350 kg CO2-equivalent

4. Interpretation: In this step, the findings from the previous phase are evaluated with respect to the
specified goal of the study in order to reach conclusions and deliver recommendations. This step also
involves sensitivity and uncertainty analysis to check the robustness of the results arrived.
Life cycle assessment facilitates evaluation of services such as management of municipal waste, or
compare modes of freight transport according to selected environmental impact categories. When we
evaluate the climate change impact category using a complete life cycle approach for a product or service,
we find the carbon footprint of that product/service.

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Life cycle assessment is a technique for
assessing the environmental impact
associated with a product by compiling all
relevant inputs and emissions of a product
system, and interpreting the results in
relation to the objectives of the study.
important
Life cycle assessment analyzes the entire
life cycle of the product in focus and this
approach is referred to as cradle to grave.
Carbon Footprinting in Supply
Chains
Carbon footprinting is the activity of measuring
greenhouse gas emissions. There are three types of
carbon footprinting that differ by scope.
Organizational: Emissions from all activities
across an organization (including building energy
use, industrial processes, and the company’s
vehicles) are taken into account.
Value chain: It is not limited to an organization’s
own operations; it includes the whole supply chain
(i.e., emissions from both suppliers and consumers,
including product use and end-of-life emissions).
Product footprint: It entails the emissions over
the whole life cycle of a given unit of product or
service, from the extraction of raw materials and
manufacturing to its use and final reuse, recycling,
or disposal.
Organizational and value chain footprinting
produces the total GHG emissions over a time
window (e.g. a year), whereas product footprint
calculation is timeless; it is an estimate of the total
greenhouse gases emitted over the whole life cycle
of a unit of a product/service.
Organizational carbon footprinting reports
GHG emissions from all activities across an
organization over a time window.
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Sustainability in Supply Chains
important
Carbon footprinting reports GHG emission
levels in CO2-eq kg’s.
A business may do carbon footprinting due to
various reasons:
a. Managing GHG risks and identifying
reduction opportunities: A business may do
carbon footprinting to identify cost effective
reduction opportunities, and be prepared
for GHG limitations or regulations in the
future.
b. Public reporting and participation in
voluntary GHG programs: A business
may voluntarily share its GHG emission
performance with stakeholders such as the
government and various non-governmental
organizations (NGOs). It may publicly
declare and register these measures for
eco-labeling its products/services, GHG
certification, and for recognition of early
voluntary action.
c. Participating in mandatory reporting
programs: A business may face a regulation
regarding GHG emissions, and may need
to report and reduce its GHG emission
performance accordingly. The regulation
may be at international, national, or
regional level.
To do organizational carbon footprinting, a
business needs to first define its organizational
boundary. Business operations today vary in their
legal and organizational structures. They may
have wholly owned operations, incorporated and
non-incorporated ventures, subsidiaries, and etc.
Thus, it is essential to set the boundary of the
organization so that all activities and their related
GHG emissions inside that boundary becomes
the organization’s responsibility. To determine the
organizational boundary, three different approaches
may be used:
(1) Equity share approach: In this approach,
a business is liable for the GHG emissions
from operations in proportion of its share
of equity in the operation. The equity
share reflects economic interest; i.e., extent

Supply Chain Management
of rights a company has to the risks and
rewards from an operation.
(2) Control approach: Based on this framework,
all operations the firm has control over
lies inside the organizational boundary,
and 100% of GHG emissions from these
operations are accounted for. If a firm
owns an interest but has no control over a
certain operation or entity, that operation
is not accounted for in organizational
footprinting. Two different criteria may
be used to determine whether the firm has
“control.”
a. Financial control: If the company has
the ability to direct the financial and
operating policies of the operation (e.g.
the right to majority of the benefits
of the operation, or if it retains the
majority risks and rewards of ownership
of the operation’s assets), then that
operation is inside the organizational
boundary according to this approach.
This framework is generally consistent
with the financial accounting standards;
if the operation is considered as a group
company or subsidiary for the purpose
of financial consolidation, then the
firm has financial control over the
operation.
b. Operational control: If a firm has full
authority to introduce and implement
its operating policies at an operation,
then that operation lies inside the
organizational boundary according to
this criteria.
If a company wholly owns all its operations,
its organizational boundary will be the same
whichever approach is used. Firms are free to
choose the appropriate approach in defining their
organizational boundaries in carbon footprinting.
Note that, a firm may naturally be held accountable
for all GHG emissions from operations inside its
organizational boundary. From this perspective, a
control approach may be more appropriate since
an operation will be included only if the firm has
some kind of authority over the related operation.
Also notice that, when two or more companies
hold interests in the same joint operation and use
different consolidation approaches, then there may
8
be double-counting or underrepresented GHG
emissions in their reports. Thus, linked businesses
are recommended to coordinate their approach
selections.
important
In organizational carbon footprinting, a firm
needs to select one of the three approaches
to define its organizational boundary: equity
share, financial control, or operational
control.
After determining the organizational boundary,
a firm needs to classify its GHG emissions with
respect to operational boundaries in its reports. A
firm classifies its GHG emissions in three groups:
Scope 1: These are direct GHG emissions from
sources that are owned or controlled by the company.
Some examples to activities that produce scope 1
emissions are:
i. Generation of electricity, heat, or steam
from combustion of fuels in stationary
sources (boilers, furnaces, turbines)
ii. From manufacture or processing of
chemicals and materials (cement,
aluminum, waste processing, and etc.)
iii. Transportation of materials, products,
waste, and employees by company-owned/
controlled mobile combustion sources
(trucks, trains, ships, airplanes, buses, and
cars)
iv. Fugitive emissions such as methane
emissions from coal mines and venting;
HFC emissions from refrigeration and air
conditioning equipment
Scope 2: These are the emissions from the
generation of purchased electricity or heat
consumed by the company. Scope 2 emissions
physically occur at the facility where electricity/
heat is generated but the consuming firm is
indirectly responsible for those emissions. For
many companies, purchased electricity represents
one of the largest sources of GHG emissions, and
there exists a significant opportunity to reduce
these emissions through upgrading to energy-
efficient technologies or switching to renewable
energy sources.
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Scope 3: These are indirect emissions related
with the activities of the company. These emissions
are consequences of the activities of the focal firm,
but occur at sources not owned or controlled by
the company. Since a firm cannot fully account
for all its scope 3 emissions, reporting them is
optional, and regulations are not involved with
this group of emissions. Note that, organizational
boundaries should also have a role in identifying
scope 3 emissions. Some examples to activities that
produce these types of emissions are:
i. Extraction and production of purchased
raw materials and fuels
ii. Transport-related activities such as
transportation of purchased materials
or goods, transportation of purchased
fuels, employee business travel,
employees commuting to and from work,
transportation of sold products, and
transportation of waste
iii. Electricity-related activities not included in
scope 2
iv. Leased assets, franchises, and outsourced
activities
v. Use of sold products and services
vi. Waste disposal
Figure 8.3 Emission Scope Categories in a Manufacturer’s Value Chain
GHG emissions may be calculated with two different methods depending on the activity that produces
the emissions and availability of data.
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Sustainability in Supply Chains
Figure 8.3 categorizes emissions that may be
observed in a manufacturer’s value chain with
respect to its scope definition.
Notice that if a firm manages an operation
with its owned or controlled equipment, then the
related emissions are reported as scope 1. However,
if the same operation or service is outsourced to
another company, the related emissions should be
reported as scope 3. For example, GHG emissions
from transportation with a firm’s own truck fleet, or
from shuttle services for employee commute with
its own bus fleet should be reported as scope 1. If
the logistics or commute services are provided by
a third-party company, then the related emissions
become scope 3.
Reporting scope 3 emissions may be critical
for some firms to fully assess their GHG emission
performances. For example, 98% DHL Nordic’s
emissions in Sweden is generated by the transport
of goods via outsourced partner transportation
firms (GHG Protocol, 2004). Similarly, 66% of
IKEA’s emissions is attributed to consumer travel,
which is linked to IKEA’s choice of store location
and warehouse shopping concept (GHG Protocol,
2004).
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Supply Chain Management

Energy-based calculations: These calculations
determine GHG emissions based on mass balance
or theoretical combustion specific to a facility or
process. This method may be preferred when there
is fuel consumption, either at production sites or
in transportation. The general formula used in this
calculation is
GHG Emissions = Fuel Consumed (gallon or LT)
* Fuel Emission Factor (kg CO2-eq per gallon or LT)
Activity-based calculations: These calculations
determine GHG emissions from standardized
activity information by using conversion factors.
These factors are calculated ratios relating GHG
emissions to a proxy measure of activity at an
emissions source. This method makes use of
calculation parameters readily available from sources
like GHG Protocol, EPA, and etc. It is a commonly
used method since it does not require highly detailed
data as energy-based calculation does. This method
is mainly utilized to calculate electricity-related
emissions and transportation emissions.
For electricity, we use the formula
GHG Emissions = Energy Consumption (kWh) *
Electricity Factor (kg CO2-eq per kWh).
In the formula above, the electricity factor is an
average value based on how electricity in that area
(city, region or country) is generated. This factor
will be high if electricity is produced by burning
fossil fuels such as coal and natural gas, and will be
as low as zero if it is predominantly produced from
renewable resources.
For transportation, we use the formula
GHG Emissions = Number of Shipments * Avg
Distance (km or mile) * Avg Weight (tonne) * Mode
Emission Factor (kg CO2-eq per tonne-km or tonne-
mile).
Here, transportation emissions change with
respect to the mode of transportation used (rail,
ocean, road, air, and etc.), and increase by the
weight and the distance of the trip. The mode
emission factor is a mode-specific parameter that
gives the average CO2-eq emission per tonne-km
(or tonne-mile) transported. So, it needs to be
multiplied by the average distance travelled by a
shipment of an average weight. Thus, if a total of
40 tonnes were transported to a distance of 1000
km in 2 shipments, we need to multiply the mode
emission factor by 2*20*1000 or 40*1000.

Learning Outcomes

2 To use measures for sustainability

Self Review 2 Relate Tell/Share

Suppose you want to compare

How can a product carbon
footprint analysis facilitate
GHG emission reduction?
two firms in GHG emission
performance. The firms
produce two substitutable
products, but one of them
Develop a high-level plan
is very close to vertically-
to do organizational carbon
integrated whereas the latter
footprinting at your school or
outsources almost all supply
at a business you can observe.
chain operations. Evaluate the
organizational, value chain, or
product carbon footprinting
approaches to compare the
two firms.

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OPERATIONAL ASPECTS OF
SUSTAINABLE SUPPLY CHAINS
A supply chain’s operations are driven with
financial objectives; i.e., cost minimization or profit
maximization. A supply chain incorporates its
environmental performance in its decision-making
and operations in a number of ways: (1) translate
the environmental performance into economic
costs and minimize the total costs, (2) minimize
the costs while restricting the environmental impact
(e.g., total GHG emissions) to not exceed a given
maximum value or to participate in a mechanism
like a cap-and-trade system, and (3) combine the
environmental impact and cost perspectives and use
a multiple criteria approach in decision making. The
first two ways may be used when there are regulations
enforced on the company; i.e., a carbon tax or a
carbon cap. Firms with voluntary commitments to
reduce their environmental impact generally adopt
the second or the third approach.
Supply chain operations revolve around logistics
and inventory management. These activities are
mainly driven by the supply network of the firm.
Supply network design determines the nodes
(locations for storage, distribution, manufacturing,
and retail points) and flows of goods in between.
Other than these, suppliers of the supply chain
affect the chain’s logistics and inventory decisions.
In this chapter, we will discuss green logistics and
green inventory management.
Green Logistics
Logistics encompasses the operations/decisions
in management of the flow of goods from points
of origin to demand points. Green logistics refers
to the measurement, analysis, and consequently
mitigation of the environmental impact of logistics
activities (Blanco & Sheffi, 2017). In some
cases, logistics activities also include managing
the reverse flow of (used) products to recover,
reuse and/or recycle; and hence, are measured
accordingly. The environmental issue of concern
may be consumption of nonrenewable sources, air
emissions, noise, GHG emissions, waste, and etc.
Environmental impact of logistics activities may be
improved in two distinct ways: (1) With technological
changes such as upgrade of the vehicle fleet with energy-
efficient counterparts, or replace packaging with
reusable alternatives, or (2) With operational changes;
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Sustainability in Supply Chains
i.e., better ways to plan and execute the movement of
goods. The first method targets an improvement with
no need to change operational or tactical decisions.
For example, new and fuel-efficient trucks may have
substantially lower GHG emission factors compared
to the old fleet. The second method, however, utilizes
the environmental performance tradeoff to make
operational changes and consequently reduce the
environmental impact. For example, with the same
vehicle fleet, a supply chain may revert to less-frequent
shipments with higher vehicle utilizations to reduce
the total GHG emissions.
In case of a change to improve environmentally,
whether it is technological or operational, the firm
has to incur additional costs associated with the
change. The first requires some kind of technology
or equipment upgrade; and hence, requires an
additional upfront cost. The second pushes the
supply chain to change its operational practices from
the previously cost-optimal levels to alternatives
that are environmentally more preferable. This
new set of decisions will have consequences such
as higher transportation or inventory-related costs.
A supply chain can always adopt both types of
changes, to have a compounded improvement on
its environmental performance.
The contribution of transportation to global
GHG emissions is significant (see Table 8.1).
According to numbers reported by World
Economic Forum in 2009, 2800 megatonnes of
CO2-eq were emitted due to logistics activities in
a year: 1500 megatonnes from road transportation,
500 megatonnes from ocean freight, about 300
megatonnes from air freight, about 200 megatonnes
from rail freight, and only about 300 megatonnes
due to logistics buildings (World Economic
Forum, 2009). Thus, with climate change as
the environmental impact category in focus,
transportation is the activity with a significantly
bigger burden compared with warehousing.
From the climate change perspective, there
are five drivers that determine the environmental
impact of a transportation activity:
(1) Distance: As the total distance covered in
transportation increases, associated GHG
emissions increase as well. To restrain this
factor and the consequent GHG emissions,
a firm may prefer “local” sourcing; i.e.,
working with suppliers closer in distance.

Supply Chain Management
(2) Mode: The mode of transportation is a
critical factor that affects the emissions
per tonne-km. A firm may opt for greener
transportation modes (e.g., rail and ocean)
as opposed to road or air freight to reduce
its transportation-related GHG emissions.
(3) Equipment: The type of vehicle/equipment
used in transportation affects the emission
load as well. The energy-efficiency level
and the type of fuel/energy used by the
vehicle greatly affects the GHG emission
per tonne-km. Thus, a firm may upgrade
to high-technology equipment to reduce its
total carbon emissions in transportation.
(4) Load: The emissions generated per km
increases with the load of a vehicle. However,
emissions per unit product decreases as the
utilization of the vehicle increases. Thus, a
firm that does transportation by truck may
reduce its GHG emissions if it avoids less-
than-truckload (LTL) shipping and does
full truckload shipping.
(5) Operation: The logistics plan itself makes a
big difference. The route taken in visiting the
location(s) in terms of sequence and traffic
congestion on-route and the vehicle speed
affect the environmental performance.
GHG emissions per unit distance increase
with high speeds.
important
Transportation-related emissions are driven
by five factors: distance covered, mode of
transportation, type of equipment used, load
of the vehicle, and operation.
Any change implemented to reduce
transportation-related emissions may induce
changes at other operations in the supply chain. For
example, local sourcing or redesigning the supply
chain network to reduce the total transportation
distance may entail higher procurement costs
or may require structural changes in the supply
network. Additionally, the “local” supplier may
be worse in production-related emissions, and a
switch to local sourcing may end up raising the
total GHG emissions in the supply chain. When
a firm switches from road to ocean freight, lead
times will change requiring the firm to adjust its
8
inventory levels in its warehouses, retail points,
even at storage points of supply chain partners,
and maybe even to reposition its supply network.
Similarly, less frequent transportation will require
higher inventory levels across the supply chain.
Equipment upgrades may promise reduction
in transportation emissions but will require
investment upfront. Full truckload shipping will
reduce the transportation emissions per unit.
However, it may require changes in loading
practices and may delay shipments between stages
in a supply chain. Thus, a complete supply chain
perspective is essential in evaluating a scheme to
reduce the overall environmental impact.
important
Any initiative undertaken to reduce GHG
emissions at a certain activity or stage should
be evaluated from a complete supply chain
perspective with all the triggered changes
and their environmental and economic
consequences.
Green Inventory Management
Traditional inventory management deals with
determining the order quantity of products and
timing of the order to the right location(s) of
storage so that customer demand is fulfilled at a
certain service level, at minimum cost. Green
inventory management deals with these decisions
not only from an economic perspective, but with
consideration of the environmental impacts as
well. Most common environmental issues of
concern in green inventory management are
emissions of greenhouse gases, other harmful gases,
and particles. Out of the three types of emissions,
greenhouse gases (i.e., climate change) comprise
the prevalent environmental impact category
considered.
GHG emissions associated with operating
an inventory system may be classified into three
groups: (1) emissions associated with holding/
storing items, (2) emissions associated with not
satisfying customer demand on time, and (3)
emissions associated with ordering (i.e., producing
and transporting) items. The extent of these
emissions depend on the characteristics of the
supply chain and the inventory system.
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Holding items may have emissions associated
with operating the storage facility, handling the
items, discarding any leftover or perished items in
stock. The first two will involve energy consumption
such as electricity for lighting purposes and
temperature-controlled environments, and
electricity or fuel for the handling equipment.
Fugitive emissions from refrigeration equipment
may also contribute to this factor. If the leftover
or perished items have to be discarded, there may
be emissions associated with waste-processing or
landfill. Overall, emissions associated with holding
items may or may not be proportionally increasing
with the number of units kept in stock.
Not satisfying customer demand on time (or a
stock-out occasion) may involve emissions that vary
with the system characteristics. If there is a delay in
production (and hence customer demand is not met
on time) due to a machine breakdown, there may
be emissions associated with the waste of work-in-
process inventory, and energy consumed in cleaning
and other related processes. If the inventory is not
available at a storage or retail point, the customer
may need to make a second visit to the location or the
item may be sent to the customer’s site in expedited
shipping. Thus, these types of emissions are system-
specific and need to be estimated carefully.
Ordering items mainly produce emissions
related with producing and transporting the items.
If production is triggerred with an order, that may
produce a fixed amount of emissions in addition
to a variable component that increases with the
number of units. Similarly, emissions associated
with transporting the items may have a fixed
and a variable component that increases with the
shipment size. Capacity of the vehicle and the
utilization achieved will be important factors in
determining total emissions as well.
GHG emissions associated with operating an
inventory system may source from (1) holding/
storing items, (2) not satisfying customer
demand on time, and (3) ordering items.
Note that, transportation-related emissions
should be evaluated together with inventory-
related emissions. Emissions for producing and
transporting items tend to be much larger than
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Sustainability in Supply Chains
those for holding items in stock. That’s why supply
chains are recommended to focus on reducing
production and transportation-related emissions
and sacrifice from inventory-related emissions if
necessary. This may translate into less-frequent
shipments with higher utilization rates at the
expense of higher inventory levels.
important
Transportation-related emissions should be
evaluated together with inventory-related
emissions in supply chains.
Decarbonizing Supply Chains
Up to now, various factors that need to be
considered in efforts towards making a supply chain
more sustainable have been discussed. The emphasis
has been that each factor’s effectiveness will change
with the characteristics of the supply chain in
focus. In terms of generalized recommendations,
World Economic Forum (2009) highlighted three
opportunities that offer the highest potential for
GHG emission reduction in supply chains:
(1) Clean vehicle technologies: Upgrade to high-
efficiency vehicles, switch to vehicles with
alternative of hybrid fuel technology sources
(2) Despeeding the supply chain: Decrease the
speed in road vehicles and ships, opt for
high vehicle utilization with less-responsive
replenishment (relaxed time windows)
(3) Optimized (supply chain) networks: Update
the supply network nodes (production
sources and distribution/storage points)
and the transport flows between them.
In addition to these, the other major initiatives
discussed include low-carbon sourcing (sourcing
from a low-carbon manufacturer or supplier),
switching to greener modes of transportation,
converting to energy-efficient buildings, and
reducing the weight and volume of packaging.
internet
Read more at http://www3.weforum.org/docs/
WEF_LT_SupplyChainDecarbonization_
Report_2009.pdf
 8
Supply Chain Management

Learning Outcomes

3 To understand operational aspects of sustainable supply chains

Self Review 3 Relate Tell/Share

Read the corporate social

What are the environmental Compare the idea of responsibility (CSR) report
consequences of operating an despeeding supply chains with of a global corporation and
inventory system? the lean philosophy. summarize its reports on
supply chain operations.

CLOSED-LOOP SUPPLY CHAINS AND SUSTAINABILITY

A closed-loop supply chain (CLSC) represents a series of processes and flows aimed at some form of
reuse and recovery of products and materials (Abbey & Guide Jr, 2017). By definition, a closed-loop
supply chain includes a reverse/reuse chain in addition to the typical forward supply chain. Figure 8.4
contains the diagram of a typical closed-loop supply chain.

Figure 8.4 Diagram of A Typical Closed-loop Supply Chain

Source: Adapted from Bouchery et al. (Eds.) (2017).

In a closed-loop supply chain, products are collected at

end-of-use and routed back to the forward supply chain
to be re-used in some form. Though 100% recovery is
not feasible with the current technology, a closed-loop
supply chain converts what was previously a stream of
waste into profitable reuse. Thus, a CLSC perspective aims
to maximize value creation over the entire life cycle of a
product. This means the decisions such as product design,
raw material selection, and manufacturing process design
are made with also the consideration of recovery of the
product and materials in the reverse chain.
important
In a closed-loop supply chain, products are
collected at end-of-use and routed back to
the forward supply chain to be re-used in
some form. However, 100% recovery is still
not feasible; a certain portion of collected
items still go to the waste stream.

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In a closed-loop supply chain, for the reverse
supply chain to recover and reuse items, a first life
cycle must occur and the item must be returned/
collected. Different types of returns represent different
recovery options. Items may be returned when they
reach end-of-use or may be just convenience returns
from customers. The latter group represents a higher
value since they can be easily converted into a like-
new condition and get resold.
Products collected at a closed-loop supply chain
offer different opportunities for recovery and reuse.
One of them is recycling, which recovers value at the
materials reprocessing phase and contributes value to
earlier stages in the forward supply chain. In other
words, recycling recovers value at the raw material
level from a collected product. Examples for this
are plastics recycling or aluminum recycling. Thus,
a recycling facility may process different types of
products with the same raw material composition.
The other opportunity is remanufacturing (or
refurbishing), which recovers value at the component
or product reprocessing phases. Remanufacturing is a
comprehensive industrial process where a previously
used, worn, or non-functional product or component
is returned to a “like-new” condition to be resold. It
entails disassembling the collected product, replacing
any broken or unusable component and remaining
defects, and repackaging the product for resale. The
unused parts or components may still be routed to
recycling. Remanufacturing captures more value
from a collected item compared to recycling. As a
remanufactured item goes through fewer stages until
reaching the end consumer compared to a recycled
counterpart, it requires far less energy intensity. Thus,
remanufacturing tends to be both commercially and
environmentally preferable.
important
Products collected at a closed-loop supply
chain offer different opportunities for
recovery and reuse.
Remanufacturing is a comprehensive industrial
process where a previously used, worn, or non-
functional product or component is returned
to a “like-new” condition to be resold.
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Sustainability in Supply Chains
Closed-loop supply chains present new
operations and decisions compared to a typical
forward supply chain. Collection of end-of-use
or returned items, sorting of incoming items for
remanufacturing, recycling, or for direct resale,
sales of remanufactured products to the end
consumer along with brand new products, and
market cannibalization are all issues that need
to be managed in CLSCs. Forward supply chain
decisions such as raw material sourcing, product
design, and manufacturing processes may greatly
affect the performance in the reuse supply chain.
Traditional forward supply chains turn into
to closed-loop supply chains due to economic
and environmental reasons. Consumer returns
may represent a significant value for a firm. For
example, in the fiscal year 1999, 5.7% of HP
printers sold in North America were returned (Van
Wassenhove et al., 2002). Thus, recovering value
from these returned products may be essential
for the economic performance of a firm. In
some other cases, collecting end-of-use products
may be a requirement because of government
regulations. WEEE (Waste of Electrical and
Electronic Equipment) directive was put into
force in European Union in 2003, and requires
manufacturers to collect and recycle electronics
at end of life. This regulation aims to recover
nonrenewable natural materials (e.g., gold) used
in electronic products, and divert hazardous
substances contained in the products (e.g., lead,
mercury, chromium) from going into the landfills
to avoid damaging environmental and human
health.
important
Traditional forward supply chains turn into
to closed-loop supply chains due to economic
and environmental reasons.
internet
Read more about the WEEE directive at
https://ec.europa.eu/environment/waste/
weee/index_en.htm
 8
Supply Chain Management

Primary environmental motivations behind
the transition to closed-loop supply chains are (1)
preservation of natural material resources, and (2)
removal of hazardous substances from landfills that
may damage the environmental and human health
(i.e., reduce toxicity). These are also followed by the
goal of reducing the energy intensity in the chain;
i.e., reduce the total energy consumed over the life
cycle of a product. Based on this, one would expect
closed-loop supply chains to perform better from a
climate change perspective as well. However, this
conclusion is not so straightforward, and CLSC
operations need to be analyzed in detail. From a
complete life cycle perspective, the carbon load
(i.e., GHG emissions) of the collection, recycling,
remanufacturing, and waste-processing activities
should be carefully evaluated and compared with
the production of an item in the forward supply
chain. Depending on the product characteristics,
especially recycling may produce significant GHG
emissions, disassembly and remanufacturing may
be energy-intensive; and hence, the product carbon
footprint in a closed-loop supply chain may be
higher than its counterpart in a typical forward
supply chain. Thus, a closed-loop supply chain
may have varying performances with respect to the
environmental impact category in focus, and the
tradeoff between these performances needs to be
studied.
important
Though closed-loop supply chains are
preferable to traditional forward supply
chains from preservation of natural material
resources and toxicity perspective, they may
not be superior across all environmental
impact categories.

Learning Outcomes

4 Relate closed-loop supply chains with sustainability

Self Review 4 Relate Tell/Share

Explain how you would use

How can a traditional forward Research the role of
the life cycle assessment (LCA)
supply chain become “more municipalities in product
technique to analyze a product
sustainable” by turning into a acquisition and value recovery
that is manufactured in a
closed-loop supply chain? for closed-loop supply chains.
closed-loop supply chain.

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Sustainability in Supply Chains

To understand the concept of

LO 1 sustainability and climate change

Sustainable development is defined as “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.” It urges the economic and social
activities of today to preserve the environmental resources for the future; and thus not deplete, destroy or
distort them. Under current technological, social and economic conditions, a supply chain cannot declare
itself “sustainable.” Thus, it makes more sense to refer to “a more sustainable business” as one that is better
Summary

at identifying its environmental and social impacts and finding ways to mitigate those.
Sustainability definition not only covers the environmental (or green) aspects of a business but also its social
impacts. Companies, to become a more sustainable business, should first measure their environmental
and social performance, and also take those into account in its decision-making processes. This perspective
is referred to as Triple Bottom-Line accounting (TBL, 3BL).
A supply chain perspective is key to understand and evaluate the sustainability practices of a firm. A
company is associated with a vast supply network. Thus, it is a challenge to evaluate a firm’s responsibility
for the environmental consequences associated with a final product or service. Additionally, all supply
chain activities are interrelated.
Environmental performance of a supply chain may be analyzed and communicated in different ways
depending on the environmental issue of concern. Climate change, water use, land use, use and depletion
of natural material resources, toxicity (toxic waste accumulated in the human body or the nature), air
pollution (acidification), and ozone layer depletion are the most widely discussed environmental issues
of concern. Currently, the “most urgent” environmental issue that requires efforts at the global level is
climate change. The main reason for climate change is the rising concentration levels of greenhouse gases
(GHG) in the atmosphere. GHG emissions have been increasing due to industrialization and changes in
agriculture and land use. Thus, the greenhouse gas concentration has been increasing gradually, with the
capability to trap more heat, and has started to distort the climate balance on Earth. The increase in GHG
emissions is due to human activities; mainly the combustion of fossil fuels, agriculture, livestock, landfills
(waste), and chemical processes. To fight climate change, local, national or international authorities
enforce certain regulations to reduce the emission rates of greenhouse gases. The most commonly used
types of regulations are carbon tax, carbon cap, and cap-and-trade systems.

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Supply Chain Management

LO 2 To use measures for sustainability

Life Cycle Assessment (LCA) is a “technique for assessing the environmental aspects and potential impacts
associated with a product by compiling an inventory of relevant inputs and outputs of a product system.”
LCA covers the entire life cycle of the product in focus; it is used to estimate the environmental impact of
a certain category, and not utilized in estimation of a social impact of a product or service.
Carbon footprinting is the activity of measuring greenhouse gas emissions. There are three types of carbon

Summary
footprinting that differ by scope: organizational, value chain, or product footprint. Organizational and
value chain footprinting produces the total GHG emissions over a time window (e.g. a year), whereas
product footprint calculation is an estimate of the total greenhouse gases emitted over the whole life cycle
of a unit of a product/service.
To do organizational carbon footprinting, a business needs to first define its organizational boundary by
selecting one of the three approaches: equity share, financial control, or operational control. If a company
wholly owns all its operations, its organizational boundary will be the same whichever approach is used.
After determining the organizational boundary, a firm needs to classify its GHG emissions with respect to
operational boundaries. A firm classifies its GHG emissions in three groups. Scope 1 emissions are direct
emissions from sources that are owned or controlled by the company. Scope 2 emissions are the emissions
from the generation of electricity or heat purchased by the company. Scope 3 emissions are indirect
emissions related with the activities of the company; they occur at sources not owned or controlled by the
company. Since a firm cannot fully account for all its scope 3 emissions, reporting them is optional, and
regulations are not involved with this group of emissions.
GHG emissions may be calculated with two different methods depending on the activity that produces the
emissions and availability of data. Energy-based calculations may be used when there is fuel consumption,
either at production sites or in transportation, and if the organization has access to detailed data on
fuel consumption. Activity-based calculations utilizes standardized activity information and makes use
of calculation parameters from non-governmental organizations (e.g., GHG Protocol, Environmental
Protection Agency (EPA)). This method is mainly utilized to calculate electricity-related emissions and
transportation emissions.

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Sustainability in Supply Chains

To understand operational
LO 3 aspects of sustainable supply
chains

Supply chain operations revolve around logistics and inventory management. These activities are mainly
driven by the supply network of the firm. Supply network design determines the nodes (locations for
storage, distribution, manufacturing, and retail points) and flows of goods in between. Other than these,
suppliers of the supply chain affect the chain’s logistics and inventory decisions.
Green logistics refers to the measurement, analysis, and consequently mitigation of the environmental
Summary

impact of logistics activities. The environmental issue of concern may be consumption of nonrenewable
sources, air emissions, noise, GHG emissions, waste and etc. Green inventory management deals
determining the order quantity of products and timing of the order to the right location(s) of storage so
that customer demand is fulfilled at a certain service level, not only from an economic perspective, but
with consideration of the environmental impacts as well. Most common environmental issues of concern
in green inventory management are emissions of greenhouse gases, other harmful gases, and particles.
World Economic Forum (2009) highlights three opportunities that offer the highest potential for GHG
emission reduction in supply chains: Clean vehicle Technologies, despeeding the supply chain, and
optimized (supply chain) networks.

To relate closed-loop supply

LO 4 chains with sustainability

A closed-loop supply chain (CLSC) represents a series of processes and flows aimed at some form of reuse
and recovery of products and materials. In a closed-loop supply chain, products are collected at end-of-use
and routed back to the forward supply chain to be re-used in some form. However, 100% recovery is still
not feasible; a certain portion of collected items still go to the waste stream.
Products collected at a closed-loop supply chain offer different opportunities for recovery and reuse. One
of them is recycling, which recovers value at the materials reprocessing phase and contributes value to earlier
stages in the forward supply chain. The other opportunity is remanufacturing (or refurbishing), which
recovers value at the component or product reprocessing phases. Remanufacturing is a comprehensive
industrial process where a previously used, worn, or non-functional product or component is returned to
a “like-new” condition to be resold. Remanufacturing tends to be both commercially and environmentally
preferable to recycling.
Closed-loop supply chains are environmentally better because they preserve natural material resources,
and remove hazardous substances from landfills that may damage the environmental and human health
(i.e., reduce toxicity). They also tend to have a lower energy intensity than a typical forward supply chain.
From the climate change perspective, comparison of closed-loop supply chains with traditional forward
supply chains warrants a detailed analysis. GHG emissions associated with the collection, recycling,
remanufacturing, and waste-processing activities should be carefully evaluated and used in the comparison
to the production of an item in the forward supply chain.

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Supply Chain Management

1 Which of the following is not a phase in life 5 Which of the following statements about
cycle assessment (LCA)? GHG emission reporting is correct?

Test Yourself
A. Interpretation A. Direct onsite emissions should be reported as
B. Environmental impact scope 1.
C. Inventory analysis B. Emissions related with consumer and employee
D. Impact assessment travel should be reported as scope 2.
E. Goal and scope definition C. Onsite heat production should be reported as
scope 2.
D. Emissions of the third-party logistics provider
2 Which of the following statements about life should be reported as scope 2.
cycle assessment (LCA) is false?
E. Emissions associated with purchased electricity
A. It utilizes data about consumer use as well as should be reported as scope 3.
upstream and downstream stages in a product
life cycle. 6 Which of the following does not affect the
B. It may be used to assess the water waste sustainability of a supply chain?
emissions of a product system.
C. Defining the functional unit is important. A. Carbon tax
D. It may be used for comparison of a plastic bag B. Supply chain network
with a paper bag on the social impact category. C. Mode of transportation
E. It may be used for comparison of an electric car D. Inventory levels
with a gasoline car on the toxicity or climate E. Perishability of inventory
change category.
7 Which of the following is a form of value
3 Which of the following statements about recovery in closed-loop supply chains?
carbon footprinting is false? A. Product acquisition
A. Characterization factor of CO2 is 1. B. Remanufacture
B. For value chain carbon footprinting, supply C. Reassign
chain perspective is necessary. D. Relevel
C. For organizational carbon footprinting, E. Disassemble
organizational boundary is necessary.
D. For organizational carbon footprinting, scope 3 8 Which of the following factors does not
are the most critical type of emissions. affect transportation emissions?
E. Product carbon footprinting takes a complete
A. Efficiency of the vehicle
life cycle approach.
B. Load
4 Which of the following is not a GHG C. Speed
emission regulation term? D. Distance
E. Perishability
A. Carbon tax
B. Carbon cap
C. Carbon credit
D. Carbon return
E. Carbon offset

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Sustainability in Supply Chains

9 Which of the following terms is not related 10 Which of the following does not contribute
with the concept of sustainability? to global GHG emissions?
Test Yourself

A. Meeting the needs of the present without A. Livestock

compromising the ability of future generations B. Transportation
to meet their own needs
C. Agriculture
B. Social impact
D. Sunlight
C. Flow of goods from points of origin to demand
E. Fossil fuel use
points
D. Ozone layer depletion
E. Recycling

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Supply Chain Management

If your answer is wrong, please review the If your answer is wrong, please review the
1. B 6. A
“Measuring Sustainability in Supply Chains” “Operational Aspects of Sustainable Supply
section. Chains” section.

Answer Key for “Test Yourself”

If your answer is wrong, please review the If your answer is wrong, please review
2. D 7. B
“Measuring Sustainability in Supply Chains” the “Closed-loop Supply Chains and
section. Sustainability” section.

If your answer is wrong, please review the If your answer is wrong, please review the
3. D 8. E
“Measuring Sustainability in Supply Chains” “Operational Aspects of Sustainable Supply
section. Chains” section.

If your answer is wrong, please review the

4. D If your answer is wrong, please review the 9. C
“Introduction” and “Closed-loop Supply
“Introduction” section.
Chains and Sustainability” section.

If your answer is wrong, please review the

5. A “Measuring Sustainability in Supply Chains”
10. D If your answer is wrong, please review the
“Introduction” section.
section.

Suggested Answers for “Self Review”

How can triple bottom-line accounting help a
firm become more sustainable?

Sustainable development is defined as “development that meets the needs

of the present without compromising the ability of future generations to
meet their own needs.” Though sustainability is not a status that can be
achieved by a business under current economic and technological conditions,
it can be taken as a direction. Thus, a firm’s main goal may be becoming
“a more sustainable business”; i.e., a business that is better at identifying its
environmental and social impacts and finding ways to mitigate those. To
self review 1 be more sustainable; a firm must be tracking its environmental and social
impact, seek to reduce them, and take those impacts into consideration in
making fundamental decisions. Triple bottom-line accounting is a framework
where firms evaluate their performance and make their decisions according to
three criteria: economic impact (profit), environmental impact (planet), and
social impact (people). Thus, it provides a structure in management for firms
to be successful in their goal of becoming more sustainable.

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Sustainability in Supply Chains

How can a product carbon footprint analysis

facilitate GHG emission reduction?
Suggested Answers for “Self Review”

Life cycle assessment (LCA) technique is used in calculating the carbon

footprint of a product. LCA takes into account all GHG emissions from
the extraction and processing of raw materials to distribution, retail, use and
disposal and waste processing phases. Thus, it will be easy to identify the steps
with the highest carbon load. In an electronics product, it may be the use
phase. For a metal composite product, it may be the raw materials processing,
self review 2 manufacturing or disposal/recycling phases. For the former case, the firm
may focus on increasing the energy efficiency of the product; for the latter
there may be options to change the material composition and design of the
product to reduce the emission in the high-load phases. Thus, with LCA, the
whole life cycle will be under focus, the stages with high carbon load will be
underlined, and the reasons will be revealed. Thus, a firm may target those
stages and initiate changes to reduce their GHG emissions.

What are the environmental consequences of

operating an inventory system?

Operating an inventory system affects the environment through the emission

of greenhouse gases, other harmful gases, and particles. GHG emissions may
be associated with (1) ordering a batch of items, (2) holding items in storage,
and (3) not meeting customer demand on time. All these components and
the extent of the related emissions depend on the specific characteristics of the
inventory system. Ordering may involve production and transportation-related
emissions. A fixed amount of emissions in addition to a variable component that
self review 3 increases with the order quantity may be incurred at each order. Holding items
may have emissions associated with electricity and fuel consumption, from
fugitive emissions from refrigeration equipment, and emissions from perished
and discarded items. The emissions associated with not meeting demand
on time very much depend on the system characteristics. It may involve an
extra customer trip to the store, expedited shipping to the customer’s address,
expedited production, or delay-related processes in production.

How can a traditional forward supply chain

become “more sustainable” by turning into a
closed-loop supply chain?

In a traditional forward supply chain, the product that reaches end-of-use is

expected to join the waste stream and end up in the landfills. Thus, each item
is produced from scratch (i.e., from virgin materials) and eventually becomes
waste. This contributes to the depletion of natural material resources, and
endangers the environmental and human health due to hazardous materials in
the disposed products. By closing the loop, a supply chain diverts products/
value from the waste stream to reuse in the forward supply chain. Thus, a part of
self review 4 the collected products/components will be used for remanufacturing, a portion
will be recycled, and hazardous materials will be collected and safely stored
or reused. This way, waste and toxic emissions of the chain will be reduced,
natural material sources will be preserved, recycled materials will be used in
the manufacturing of the product or in other supply chains, and overall energy
intensity will be reduced. Thus, the supply chain is expected to improve in
categories of waste, depletion of natural material resources, energy, and toxicity.

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Supply Chain Management

References
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ISO 14040 (2006). Environmental management
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Online References
Banjo, S. and Kapner, S. (2013, Aug 20). “U.S. Retailers to Implement Bangladesh Factory Plan,” Wall Street
Journal. Retrieved from https://www.wsj.com/articles/us-retailers-to-implement-bangladesh-factory-
plan-1376971609
Envrionmental Protection Agency (www.epa.gov)
Nielsen, M (2013, May 10). “How Nike Solved its Sweatshop Problem,” Business Insider. Retrieved from
https://www.businessinsider.com/how-nike-solved-its-sweatshop-problem-2013-5
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what-is-remanufacturing)
Staff (2013, May 10). “Bangladesh Factory Collapse Toll Passes 1,000,” BBC. Retrieved from http://www.bbc.
co.uk/news/world-asia-22476774
Staff (2013, May 10). “Dhaka Building Collapse: Factories and Buyers,” BBC. Retrieved from http://www.bbc.
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