SUPPLY CHAIN MANAGEMENT

Chapter 4: Supply Chain Integration

 Reference
Prescribed textbook:
• Simchi-Levi, D., Kaminsky, P. & Simchi-Levi, E. 2003, Designing and Managing the Supply
Chain, 3rd edition, McGraw-Hill, USA.
Reference textbook:
• Bloomberg, D.J., Murray, A. and Hanna, J.B. 1998, The Management of Integrated Logistics: A
Pacific Rim Perspective, 2nd edn, Sprint Print, Prentice-Hall.
• Bowersox, D.J. Closs, D.J. and Cooper, M.B. 2002, Supply Chain Logistics Management,
McGraw-Hill/Irwin, New York.
• Christopher, M. 1998, Logistics & Supply Chain Management, 2nd edn, Pearson Education.
Essex.
• Cooper, J. 1994, Logistics & Distribution Planning, Kogan Page, London.
• Coyle, J. J., Langley, C. J. & Bardi, E. J. 2003, The Management of Business Logistics: A
Supply Chain Perspective, 7th edn, Thomson Learning, Canada.
• Coyle, J.J., Bardi, E.J. and Langley, C.J. 2003, The Management of Business Logistics, West
Publishing Company, New York.
• Greasley, A. 2006, Operations Management, John Wiley & Sons Ltd, Chichester, England.
• Johnson, J.C. 1999, Contemporary Logistics, Prentice Hall, Upper Saddle River, N.J.
 Reference textbook:
• Lambert, D. M., Stock, J. R. and Ellram, L. M. 1998, Fundamentals of Logistics Management, McGraw
Hill, USA.
• Rushton, A., Croucher, P. and Baker, P. 2006, The Handbook of Logistics and distribution
Management, 3rd edn, Kogan Page, UK.
• Stock, J.R. and Lambert D.M. 2001, Strategic Logistics Management, 4th Edn, Irwin/McGraw-
Hill, Boston.
• Mentzer, J. T., DeWitt, W., Min, S., Nix, N. W., Smith, C. D. and Zacharia, Z. G. 2001,
‘Defining supply chain management’, Journal of Business Logistics, Vool. 22, No. 2, pp. 1 –
25.
List of additional readings
• Giard, V. and Sali, M. 2013, ‘The bullwhip effect in supply chains: a study of contingent and
incomplete literature’, International Journal of Production Research, Vol. 51, No. 13, pp. 3880
– 3893.
 Content

4.1 Information and supply chain integration

4.2 Effective forecasts and supply chain integration
4.3 Information for the coordination of systems
4.4 Lead time reduction
4.5 Information and the synchronised supply chain
4.1 Information and supply chain integration

• The bullwhip effect

• The reasons for bullwhip effect
• Quantifying the bullwhip effect
• Information centralisation and the bullwhip effect
• Bullwhip effect: Managerial insight
• Reducing bullwhip effects
 Food for Thoughts

• “In modern supply chains, information replaces

inventory”
– Why is this true?
– Why is this false?
• Information is always better than no information. Why?
• Information
– Helps reduce variability
– Helps improve forecasts
– Enables coordination of systems and strategies
– Improves customer service
– Facilitates lead time reductions
– Enables firms to react more quickly to changing market
conditions
 Food for Thought

• Recall that SCM is built on the notion of

integration
• It is competition between supply chains that
matters
• An integrated approach of managing critical
supply chain functions is needed, thus

• Information is KEY to supply chain

integration
 The Bullwhip Effect

• Consider a simple supply chain with a

manufacturer, a distributor and a retailer
• The retailer keeps inventory to serve its
customers and initiates a replenishment order
according to inventory policy
• The distributor receives the orders from the
retailer and initiates its own replenishment order
to the manufacturer
• Bullwhip effect occurs as demand information
gets distorted as it travels upstream
The Bullwhip Effect (C)

Source: Mason-Jones & Towill (2000)

 The Bullwhip Effect (C)

• As the Effect occurs, order variability is

amplified up the supply chain; upstream
echelons face higher variability

• Consequences of the Effect:

– Increased safety stock
– Inefficient allocation of resources
– Increased transportation costs
– Increased warehousing and inventory carrying costs
 Bullwhip Effect: The Reasons

• Demand forecasting:
– Standard forecasting techniques often used for
production scheduling, capacity planning, inventory
control and materials requirement planning
– Order history often used as a proxy for demand from
the firm’s immediate customers
– Forecasting can be subjective and possesses errors;
order information can be subjectively biased &
projected
– As more data are observed, Mean (M) & Standard
deviation (STD) of demand in forecasting model are
modified more, leading to higher variability in order
quantity
 Bullwhip Effect: The Reasons (C)

• Lead time:
– Safety stock level & reorder point are functions of M,
STD, and lead time. Thus,
– With longer lead time, small change in demand
implies significant change in safety stock & reorder
level, thus a significant higher variability of order
quantity
• Batch ordering:
– Firms in SC often order periodically in batches when
reorder point is reached → upstream firms see larger
order variability
– Other reasons can be for volume and transport
discounts
 Bullwhip Effect: The Reasons (C)

• Price fluctuation due to promotional sales:

– If price fluctuates (due to special promotions and
price discounts from manufacturers or suppliers),
retailers & wholesalers buy & stock in large
quantities

• Inflated order:
– If customers, wholesalers and retailers suspect that a
product will be in short supply, they may order in
large quantities with the expectation that they will
receive a greater allocation of products
 Quantifying the Bullwhip Effect

• Consider a two-stage SC: single retailer, single

manufacturer
– Retailer observes customer demand, Dt
– Retailer orders qt from manufacturer

Dt qt
Retailer Manufacturer
L
 Quantifying the Bullwhip Effect (C)

• Retailer reviews inventory level every period and

places order to bring it up to a target level – The
order-up-to point (Re-order Point):

ROP = ( AVG  L) + ( z  STD L )

– AVG & STD are average & standard deviation of
customer demand
– L is the lead time
– Z: safety factor, to ensure that probability of
stockouts during lead time is equal to specified
service level (100% - service level)
 Quantifying the Bullwhip Effect (C)

• Retailer and other chain members may employ

the moving average forecasting technique
• Bullwhip effect is given as the ratio between
variances in retailer orders to manufacturer (q)
and retailer demands (D)
Var (q) 2 L 2 L2
 1+ + 2
Var ( D) P P
– Where: P is the number of recent most periods used
in the forecasting (moving average) to determine the
order quantity
 Quantifying the Bullwhip Effect (C)

• Moving Average method: Example 3-Month

Moving Average Forecasting
Total demand 3-month
Demand for during past 3 moving
Month, i month, i months average
. . . .
. . . .
. . . .
20 120 . .
21 130 360/3 120
22 110 380/3 126.67
23 140 360/3 120
24 110 380/3 126.67
25 130
26 ?
Source: Ballou (1999)
 Quantifying the Bullwhip Effect (C)

• Bullwhip effect is magnified as we increase lead time

and/or decrease P
14
L=5
12

10

8 L=3
6

4 L=1
L=1
2

0
0 5 10 15 20 25 30
Information Centralisation and Bullwhip Effect

• Bullwhip effect causes distortion in demand

information, amplified as it travels upstream
• Frequently suggested solution to reduce this
effect is to centralise demand information
(Simchi-Levi et al. 2003):
– Provide each stage of SC with complete info. on
actual customer demand
– Each stage of SC can use this info. to create more
accurate forecast
 Bullwhip Effect with Decentralised Demand
Information

• SC members act independently without sharing

information: retailer does not pass along actual
demand data to wholesaler; wholesaler estimate
demand based on past orders from retailer, etc.
 Bullwhip Effect with Decentralised Demand
Information (C)

• Suppose that due to bullwhip effect demand

variation amplified by 1.2 at wholesaler, 1.4 at
distributor and 1.5 at manufacturer
• If order variation at retailer as Var(D), then:
– Var(Q1)/Var(D) = 1.2 or Var(Q1) = 1.2 Var(D)
– Var(Q2)/Var(Q1) = 1.4 or Var(Q2)/Var(D) = 1.4 x 1.2 =1.68
– Similarly, Var(Q3)/Var(D) = 1.68 x 1.5 = 2.52
k 
2 Li 2 Li 
2
Var (q k )
  1 + + 2 
Var ( D) i =1  P P 
 Bullwhip Effect with Centralised Demand
Information

• Firms share demand information across the

supply chain:
– Retailer transmits order his forecast mean demand to
wholesaler
– Wholesaler uses this forecast mean demand
information to calculate his inventory position and
order up to level
– Distributor receives order from wholesaler, but his
order to next level is again based on retailer’s
forecast demand
 Bullwhip Effect with Centralised Demand
Information (C)

• The order at any stage of the SC, when compared

with the retailer demand, has incidence of total
lead time up to that stage

2
k
 k

k 2 Li 2  Li 
 1 + i =1 +  i =1 2 
Var (q )
Var ( D) P P
• The effect is additive
Information Centralisation and Bullwhip Effect (C)

Dec, k=5

Cen, k=5

Dec, k=3
Cen, k=3

k=1

Source: Simchi-Levi et al. (2003)

Managerial Insights on the Value of Centralised
Information

• Bullwhip effect exists, in part, due to the retailer’s

need to estimate the mean and variance of demand
• The increase in variability is an increasing
function of the lead time, and a decreasing
function of the number of observations used in
demand forecasting
• The more complicated the demand models and the
forecasting techniques, the greater the increase
• Centralized demand information can significantly
reduce the bullwhip effect, but will not eliminate it
 Reducing Bullwhip Effects

• Reducing uncertainty by information visibility

across the supply chain
– POS
– Sharing information, using IT i.e. EDI, XML
– Sharing forecasts and policies
• Reducing variability in customer demand: if
variability seen by retailer is reduced, variability
seen by wholesaler also reduced despite of
bullwhip effects
– Eliminate promotions
– Everyday Low Pricing (EDLP)
 Reducing Bullwhip Effects (C)

• Reducing lead times results in reduced bullwhip

effect
– EDI: for information lead time (time it takes to
process an order)
– Cross-docking: for order lead time (time it takes to
produce and ship the physical product)
• Eliminating echelons in the supply chain to
reduce time delays and information distortion
• Strategic partnerships
– Vendor Managed Inventory (VMI): making the
supplier responsible for inventory levels at customer
locations
– Data sharing
– Quick Response (QR)
 Example of Quick Response: Benetton

• Benetton, the Italian sportswear manufacturer,

was founded in 1964. In 1975 Benetton had 200
stores across Italy

• Ten years later, the company expanded to the

U.S., Japan and Eastern Europe. Sales in 1991
reached 2 trillion
• Many attribute Benetton’s success to successful
use of communication and information
technologies
 Example of Quick Response: Benetton (C)

• Benetton uses an effective strategy, referred to as

Quick Response, in which manufacturing,
warehousing, sales and retailers are linked
together. In this strategy a Benetton retailer
reorders a product through a direct link with
Benetton’s mainframe computer in Italy.
• Using this strategy, Benetton is capable of
shipping a new order in only four weeks, several
week earlier than most of its competitors
 Example of Benetton: How it work?

1. Integrated Information Systems

▪ Global EDI network that links agents with
production and inventory information
▪ EDI order transmission to HQ
▪ EDI linkage with air carriers
▪ Data linked to manufacturing
2. Coordinated Planning
▪ Frequent review allows fast reaction
▪ Integrated distribution strategy
 4.2 Effective Forecast and Supply Chain
Integration
• One of the main causes of uncertainty is
forecasting error inherent in any forecasting
system
• Information leads to more effective forecast
• Effective forecasting has been found to be
strongly co-related with information sharing &
collaboration among partners
– Issues i.e. pricing, promotion, new products, etc.
affecting customer demand are controlled by
retailers, distributors, manufacturers
– If info. about these issues are available to all partners,
forecasting will be more accurate
– CPFR addresses these issues: sharing & using same
forecasting tool
4.3 Infomation for the Coordination of Systems

• A SC system is made up of many independent

subsystems: manufacturing, storage, transport,
distribution, retail systems
• As different subsystems have different
operational objectives, managing any one of
them involves complex trade-offs
• As these systems are connected, e.g. outputs of
one are inputs for the other, it’s important to
have a holistic view of the supply chain and a
mechanism by which the integration process can
become a win-win situation for all participants
Infomation for the Coordination of Systems (C)

• Ex: cheaper freight rate for truck load quantities

might encourage a retailer to order in truck load
quantities even when the inventory level built up
as a result would be too high for the retailer
under normal circumstances
• This will tend to hide real demand information
and will create uncertainty in the supply chain,
pushing upstream members to keep additional
inventory
• It is thus not sufficient to find trade-offs for any
one stage, which is true whether or not there is a
common owner of systems in SC
Infomation for the Coordination of Systems (C)

Source: Kim (2005)

Infomation for the Coordination of Systems (C)

• Questions:
– Who will optimize?
– How will savings be split?

• Information is needed:
– Production status and costs
– Transportation availability and costs
– Inventory information
– Capacity information
– Demand information
 4.4 Lead Time Reduction

• Why?
– Customer orders are filled quickly
– Bullwhip effect is reduced
– Forecasts are more accurate
– Inventory levels are reduced
• How?
– EDI
– POS data leading to anticipating incoming orders
– Etc.
Information and the Synchronised Supply Chain

• A winning supply chain is an integrated system:

– each stage of SC has different business processes and
operational economics
– their immediate goals and operational objectives are
different
• System approach requires that the supply chain
is optimised at the integrated system level where
all stages are considered together
• What about the conflicting goals and objectives?
Information and the Synchronised Supply Chain
(C)
• Lot Size – Inventory trade-off:
– Advanced manufacturing systems, i.e. Kanban
– POS data for advance warnings:
• If info. is available, manufacturer has time to react to need
of downstream SC members
• If retailer or distributor can observe factory status &
inventory, they can quote lead time to customers more
accurately
• Inventory – Transportation trade-off:
– Advanced production control systems to manufacture
items as late as possible
– Information systems for combining shipments
– Cross-docking
– Advanced DSS
4.5 Information and the Synchronised Supply
Chain (C)
• Lead Time – Transportation trade-off:
– Lea time can be reduced if items are transported
immediately instead of waiting for accumulation
– Methods used can be:
• Use of advanced production control system to manufacture as
late as possible
• Improved forecasting to lower other order lead time components
• Product Variety – Inventory trade-off:
– Delayed differentiation/postponement
• Cost – Customer Service trade-off:
– Direct shipping from warehouse to home of retail
customer requires information about warehouse
inventory available at the store, &order info. rapidly
transmitted to warehouse
 Some final Notes

• Overall, why does information matter?

• Do you think it is easy to quantify the bullwhip

effects? Why or why not?

• What do you think as the key issues of supply

chain excellence in future: managing
information or inventory, or both?