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Summer 2017・CTL.SC3x – Supply Chain Dynamics Key Concepts・MITx MicroMasters in Supply Chain Management MIT Center for Transportation & Logistics・Cambridge, MA 02142 USA ・[email protected] This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.

CTL.SC3x-SupplyChainDynamics

KeyConceptsDocument

ThisdocumentcontainstheKeyConceptsfortheSC3xcourse.ThisisaDRAFTversion.

Additionalmaterialwillbeaddedthroughoutthiscourse–theversionwillbeupdated

whennewmaterialhasbeenadded.Wewillupdatethroughcourseupdateswhenita

newversionhasbeenupdated.

Thesearemeanttocomplement,notreplace,thelessonvideosandslides.Theyareintendedtobereferencesforyoutousegoingforwardandarebasedontheassumptionthatyouhavelearnedtheconceptsandcompletedthepracticeproblems.ThisdraftwasrevisedandupdatedbyDr.AlexisBatemanintheSummerof2017.Thisisadraftofthematerial,sopleasepostanysuggestions,corrections,orrecommendationstotheDiscussionForumunderthetopicthread“KeyConceptDocumentsImprovements.Thanks,ChrisCaplice,EvaPonceandtheSC3xTeachingCommunitySummer2017v6


TableofContentsIntroductiontoSupplyChainDynamics...................................................................................3

Complexity..................................................................................................................................3ProcessAnalysisinPractice.........................................................................................................6

SystemDynamics...................................................................................................................15SupplyChainsasComplexSystems...........................................................................................15FeedbackorCausalLoopDiagrams..........................................................................................16StockandFlowDiagrams..........................................................................................................17ModelingSystemDynamics......................................................................................................19

Dealingwithpartners:CollaborationandSupplyContracts....................................................26Collaboration............................................................................................................................26SupplyContracts.......................................................................................................................28

SupplyChainStrategy.............................................................................................................32Supplychainstrategy................................................................................................................32Strategictools...........................................................................................................................34RethinkingyourSupplyChainStrategy.....................................................................................38

GlobalSupplyChainManagement..........................................................................................42GlobalSupplyChainManagementConcepts............................................................................42InternationalTransportation....................................................................................................47CurrencyIssuesandFinancing..................................................................................................51SourcingandShoring................................................................................................................57

EnterpriseResilience..............................................................................................................62RisksandDisruptions................................................................................................................62DetectabilityandPreparation...................................................................................................65

ExogenousFactors..................................................................................................................69SourcesofExogenousFactors(STEEPFramework)...................................................................69Regulations...............................................................................................................................69ImpactsontheSupplyChain.....................................................................................................70FirmResponseandApproach....................................................................................................76

PalmOilCaseStudy................................................................................................................78TheRiseofPalmOil..................................................................................................................78PalmOilEndtoEnd..................................................................................................................80TheProblemwithPalmOil........................................................................................................80CorporateResponses................................................................................................................82


3

IntroductiontoSupplyChainDynamics

SummarySupplychaindynamicsillustrateshowrealitycanimpactsupplychains.Weintroducetheideaofcomplexityandweidentifyfivemaindriversofsupplychaincomplexity.Supplychainsarecomplexsystems.However,asystemismorethanjustthesumofitscomponents,butratheralsoinvolvestheproductoftheirinteractionsandtheneedfortheiralignment.

ComplexitySupplychainsarecomplex,areonlygettingmorecomplex,complexityaddcoststothesupplychain!Thereforeweneedtomitigateorminimizecomplexity.Firstweneedtounderstandwhatcomplexityis!

Productcomplexity CustomercomplexitySmallbatchsizes CustomizedproductsLongset-uptimes ShortleadtimesUniquecomponents UnpredictableordersSpecialtests/inspections ExtensivetechnicalsupportExtensivematerialhandling Extensivepost-salessupportSpecialvendors Specialtestsorrequirements

Table1-1.Sourceofcomplexity

Figure:Traditionalcostsestimationunderestimatedadditionalcomplexity

Twotypesofcomplexity(Senge,1990):

• Detailcomplexity:Distinctnumberofprocessesorpartswithinthesystem• Dynamiccomplexity:Unpredictabilityofresponseofthesystemduetointeractions

AccordingtoHerbetSimon(1962):“Asystemiscomplexif it ismadeupofalargenumberofpartsthatinteractinanon-simpleway”.

overcosted

undercosted

volume

complexity

low

high

low high

traditional5costs


4

DriversofComplexityDriversofSCcomplexity(complexityincreasesaccordingtothesedrivers):

• Numerousness-numberofsuppliers,products,customers…• Variety/diversityofthedifferententitiesorcomponents• Interconnections/interactionsbetweenthoseentities• Opacityofinteractions• Dynamiceffects

Whydowecarewhatthediversofcomplexityare?Driversofcomplexity=thedriversofprofitability.Driversofprofitability:

• Increaserevenueperunit• Increasethenumberofcustomers• Increasenumberofunitssold• Decreasecostperunit

SourceofComplexityMostcomplexityentersfromtheends!

Figure:ComplexityenterstheSCthroughnewproductsorthroughmarketingandsales

Startbymappingthecomplexityfingerprint:identifyingwherecomplexityliesbyidentifyingthepotentialcomplexitydriversandcounttotalnumberused.AnyinitiativetoreducecomplexityintheSCneedstoinvolvepeoplefrommarketingandsalesaswellasfromnewproductdevelopmentundertheR&Dprocess.Complexity-adjustedmargin

𝐶𝑜𝑚𝑝𝑙𝑒𝑥𝑖𝑡𝑦𝑅𝑂𝐼 =𝐼𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙𝑀𝑎𝑟𝑔𝑖𝑛 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝐶𝑜𝑚𝑝𝑙𝑒𝑥𝑖𝑡𝑦𝐶𝑜𝑠𝑡

𝐹𝑖𝑥𝑒𝑑𝐶𝑜𝑚𝑝𝑙𝑒𝑥𝑖𝑡𝑦𝐶𝑜𝑠𝑡

VariableComplexityCostLowvolumeofaSKUdrivescosts

source make deliverresearch'&development

customers'and'market'

marketing'&'sales


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• Volumediscountsforprocurement• Excesscosts(obsolescence,storage,etc.)• Shortagecosts(expedite,lostsales,etc.)

FixedComplexityCostHighSKUvarietydrivescosts

• Resourcecosts(R&D,testing,etc.)• Externalcashoutlays(tooling,etc.)• Indirectimpacts(manufacturingswitching,returns,etc.)

LearningObjectives• Learnwhatcomplexityisandhowtorecognizeit• Understandhowtomanagecomplexityinsupplychains• Identifyhowtoassesscomplexityandmitigationoptions• Helpunderstandthedynamicswithinasystem

ReferencesForSupplyChainSystems

• Bozarth,C.C.,Warsing,D.P.,Flynn,B.B.,&Flynn,E.J.(2009).Theimpactofsupplychaincomplexityonmanufacturingplantperformance.JournalofOperationsManagement,27(1),78-93.

• Kaplan,R.S.(2001)“IntroductiontoActivity-BasedCosting”,HarvardBusinessSchoolPublishing,(ProductNumber:197076)

• Mitchell,M.(2009)“Complexity–AGuidedTour”,OxfordPress.• Senge,P.M.(1990)“TheFifthDiscipline:TheArt&PracticeoftheLearning

Organization”.CurrencyDoubleDay.• Simon,H.A.(1962)“TheArchitectureofComplexity”.ProceedingsoftheAmerican

PhilosophicalSociety,Vol.106,Nº6,December.• Sterman,J.D.(2000).Businessdynamics:systemsthinkingandmodelingforacomplex

world.McGraw-Hill.ForSupplyChainsasComplexSystems

• Morecroft,J.(2015),StrategicModellingandBusinessDynamics:AFeedbackSystemsApproach.Willey.

• Senge,P.M.(2006)“TheFifthDiscipline:TheArt&PracticeoftheLearningOrganization”.CurrencyDoubleDay.

• Sterman,J.D.(2000).Businessdynamics:systemsthinkingandmodelingforacomplexworld.McGraw-Hill.

• http://www.systemdynamics.org/


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ProcessAnalysisinPracticeProcessanalysisisanimportantperspectiveinsupplychainmanagement.AccordingtoWallaceHopp(2011),“asupplychainisagoal-orientednetworkofprocessesandstockpointsusedtodelivergoodsandservicestocustomers.”

ImpactofvariabilityVariabilitywithinaprocessoccursduetoeitherarrivaland/orprocessvariability.Sourcesofinputorarrivalvariabilityinclude:

• Scheduling• Transportationdelays• Qualityissues• Upstreamprocessing• Randomdemand

Sourcesofprocessvariabilityinclude:• Varietyofitems• Operatorspeed• Failures• Setups• Qualityproblems.

SupplychainprocessvariabilityOneofthekeyproblemsinSupplyChainsisdealingwithvariability.Therearetwomainsourcesofvariability:interarrivalvariabilityandprocessvariability.

Figure:Supplychainprocessvariability

ReducingvariabilityThereareseveralapproachesforreducingvariability:

• Identify&measuresourcesofvariabilityanddefects• Developplansandcoursesofaction• Segmentcustomers,SKUs,suppliers,etc.

outputsarrivals processqueueCVa CVp


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Inaddition,theapproachesforbufferingagainstvariabilityare:• Inventory–traditionalapproach,implieshighinventorylevelsORflexibleinventory–

moduleparts,commonplatforms,genericstock• Capacity–maintainexcesscapacityatfacilitiestohandlepeaksORflexiblecapacity–

crosstrainerpersonnel,multi-useequipment/facilities• Time–plantimeforsystemtorecoverORflexibletimedynamicallyallocatewaiting

timeacrosscustomersegments

CoreSupplyChainProcessesMainactorsandprocessesinasupplychain:

Figure:Mainactorsandprocessesinasupplychain

ProcessesfollowtheworkflowsocoordinationacrossfunctionsisthekeytoSCM.

Figure:CoordinationacrossthefunctionsinaSCM

According toLambert (2014) therearesevencoresupplychainprocesses.Wecancategorizethemininternalandexternalprocesses.Internalfacingprocesses:

• Demandmanagement• Orderfulfillment• Manufacturingflowmanagement• Newproductdevelopment• Returnsmanagement

Internal(Supply(Chain(Management(Processes

ISCM“make,(move,(store”

Customer(Management(Processes

CRM“sell”

Supp

lier

Custom

er

Firm

SRM“source”

Supplier(Management(Processes

Finance

Procurement

Production/M

anufacturing

Research5&Developm

ent

Logistics

Marketing5&5Sales


8

Externalfacingprocesses:• Customermanagement• Supplierrelationshipmanagement

• Thesearecriticallinksinthesupplychain,theymirrorprocess–toalargedegree.Aroughprocesstoassess:

1. Review/alignfirmstrategy2. Identifysegmentationcriteria3. Establishproductandserviceagreement(PSA)guidelinesfordifferentsegments4. Developmetrics–primarilyprofitability5. Createguidelinesforsharingimprovementbenefits

ToworkonCRMandSRM–youcanalsosegmentbasedondifferentcriteria.Forcustomersitcouldbeprofitability,growth,stability,volume,competitivepositioning,buyingbehavior,sophistication,andlocation.Forsuppliers,theycanbesegmentedonprofitability,growth,volumepurchased,criticality,innovation,quality,sophistication,andpotentialtoco-createvalue.

InternalFacingProcessesInternalFacingProcessesincluding:demandmanagement,orderfulfillment,manufacturing,newproduct,management.


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DemandManagement–potentialvariabilitydriversSource Potentialproblems PossiblesolutionsPromotions Createslumpydemand;

Cannibalizesfuturedemand;Misdirectsscarceresources

Planandcoordinatetiming,duration,andlevelwithoperationsandcustomersinadvance

Salesmetrics

Createshockeystickeffectatendofperiods;Createssurgesandlumpydemand

Designsalesmetricstolessenendofquartereffect

Minimumorderquantities

Createslumpydemand;Increasespotentialforobsolescenceandspoilage

IncorporateallcostswhendeterminingMOQ;WorktominimizetheMOQinordertospeedupinventoryvelocity

Table:Mainsourcesofvariabilityfordemandmanagement

OrderFulfillmentStrategicTasks

1. Review/alignfirmstrategy–coordinatewithCRMteams2. Definerequirements–specificleadteamandcustomerservicerequirements3. Evaluatenetwork–how/wherecustomerswillbeservice4. DefinePlan–establishrulesforallocatingscarceproduct,informationalflow5. Developmetricstomonitor–cash-to-cashcycletime,orderfillrates,perfectorder

OperationalTasks


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ManufacturingflowmanagementStrategicTasks

1. Review/alignfirmstrategy2. Determinelevelofflexibility3. DeterminePush/Pullboundaries4. Identifymanufacturingconstraints&capabilities5. Developmetricstomonitor

Figure:Typeofmanufacturingprocesses

Order%to%Delivery-Lead-Time

Order Deliver Assy Mfg Procure Design

Ship-to-Stock

Make-to-Stock

Assemble-to-Order

Make-to-Order

Buy-to-Order

Engineer-to-Order


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NewProductDevelopment

ReturnsManagementStrategicTasks

1. Review/alignfirmstrategy2. Defineavoidance,gatekeeping,anddisposition3. Createnetworkforreturnflows4. Definecredit/refundrules5. Developmetricstomonitor

OperationalTasks

ProcessmapA processmap is amodel that is a symbolic representation of theworkflow used to betterunderstand,communicate, level-set,codify,andconvergeonhowaprocessworks.Therearedifferenttypes:flowcharts,relationshipmaps,cross-functional(swimlane)maps,valuestreammaps,etc.


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Mainstepstocreateaprocessmap:• Determinethescopeandlevelofdetail• Basedonscope,identifyandlistthepeopleorfunctionsinvolved• Usingstickypads,brainstormthestepsinvolved• Workthroughtheprocesschronologically,placingthestickypadsintheappropriate

swimlanes• Discussanddebatethedraftprocessmapandadjustaccordingly• Dofunctionstouchthesameitemsmultipletimes?• Arethererepeatedandredundanthandoffs?• Arestepsmissingorextraneous?• Transferthediagramtopaper;addadateandversion

ExampleSwimLaneDiagram

ProcessimprovementtoolsToolsforcheckingvariability

• Histograms:helpunderstandoutliers• Timeseriescharts:helpunderstandwheretofocus


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ExampleHistogram

Toolsforidentifyingcausesofvariability

• 5Whyso toolforencouragingbrainstormingo forcesteamtolookbeyondsuperficialsolutionso goodexcusetoactlikea5yearold

• Causeandeffectdiagrams(fishbone/Ishiwaka):o Toolthatprovidesstructureforunderstandingrootcuasedso Ensuresthatabalancelistofideashavebeenconsidered

LearningObjectives• UnderstandtheSupplyChainasaprocess• Learnhowtomeasuretheperformanceofaprocess• Identifysourcesofprocessvariability• Quantifyhowprocessvariabilityimpactstheperformanceofaqueue• Understandsupplychainprocessesandvariability• Identifystrategiestoreducevariability• Describethesevencoreprocessesinasupplychain• Learntoolsandtechniquestohelpwithprocessanalysis


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References

• Lambert,D.etal.(2014)SupplyChainManagement:Processes,Partnerships,andPerformance,SCMI.

• Damelio,R.(2011)TheBasicsofProcessMapping,CRCPress.• George,M.L.,Maxey,J.,Rowlands,D.,Price,M.(2004).TheLeanSixSigmaPocket

Toolbook:AQuickReferenceGuideto100ToolsforImprovingQualityandSpeed.McGraw-HillEducation.

• Goldratt,E.M.(1990).Theoryofconstraints.Croton-on-Hudson:NorthRiver.• Swink,M.,Melnyk,S.(2013).ManagingOperationsAcrosstheSupplyChain.McGraw-

Hill/Irwin.ForInPractice

• Hopp,W.J.(2011).Supplychainscience.WavelandPress.• Hopp,W.J.,&Spearman,M.L.(2000).Factoryphysics.FoundationsofManufacturing

Management.SecondEdition.McGraw-Hill.• Anupindi,R.,Chopra,S.,Deshmukh,S.D.,VanMieghem,J.A.,&Zemel,E.

(2011).Managingbusinessprocessflows:principlesofoperationsmanagement.PearsonHigherEd.

• Taha,H.A.(2010).OperationsResearch.Anintroduction.9thedition.PearsonPrenticeHall.Chapter15.


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SystemDynamics

SupplyChainsasComplexSystemsInthislessonwereviewthebasiccomponentsofsystemdynamics,whatitis,howtoapplyit,andhowtousemodelstounderstandit.Wegooverfeedbackloops,causalloopdiagrams,timelags&delays,andstock&flowdiagrams.Allapproachestovisualizesystemcomplexity.Wethenmoveintoadiscussiononmodelingthesystems.Throughoutthecourseofthelesson,webuilda“toolbox”forsystemdynamicswhichincludescausalloopdiagrams,behaviorovertimecharts,stock&flowdiagrams,andmodels.“Asystemisnotthesumofitsparts,itistheproductoftheirinteractions.”RussellAckoff

Figure:Event-orientedapproachtosolveproblems

EventOrientedThinkingEvent-orientedthinkingisproblematicbecause:

• Assumesproblemisanisolatedeventtobesolvedinisolation• Linearthinking-doesnotconsiderfeedbackfromothers• “pragmatic,actionoriented,alluringlysimple,andoftenmyopic”• Sometimesthesolutionisworsethantheoriginalproblem!!!

MovingfromlineartocircularthinkingMoveawayfromlinearthinkingtobeabletoincorporateoureffectsonothersaswellastheactionsofothers.

Goals/Objective

Situation/Environment

Problem Decision Action/Result


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Figure:Circularthinkingand“side”effects

FeedbackorCausalLoopDiagrams• Causallink(arrows):capturescausalrelationshipbetweentwovariablesalongwith

polarity,toindicatehowthedependentvariablechangeswhentheindependentvariablechanges

• Positivelink(+):thecauseincreases,thentheeffectincreasesabovewhatitwouldhaveotherwisebeen

• Reinforcingloop:acollectionoflinksthatformaloopthatispositive• Negativelink(-):thecauseincreases,thentheeffectdecreasesbelowwhatitwouldhave

otherwisebeen• Balancingloop:acollectionoflinksthatformaloopthatisnegative

Figure:CausalLoopDiagramnotation

Goals/Objective

Environment3/3State3of3 the3System

Decisions

“Side”3Effects

Actions3of3Others

Goals3of3Other3Agents “Side”3Effects

chickenseggs+

+R road/crossings

+

0B


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TimeLags&DelaysThelongerthedelaythemore“aggressive”theresponseandthelongertoreachsteadystate.Delaysbetweenactionsandconsequencesareeverywhere...suchasthebullwhipeffect!Anexampleofatimelagintheshower:

“informationtransferredintheformoforderstendstobedistortedandcanmisguideupstreammembersintheirinventoryandproductiondecisions…thevarianceofordersmaybelargerthanthatofsales,andthedistortiontendstoincreaseasonemovesupstream”Lee,PadmanabhanandWhang(1997)CommonlyRecognizedPatternsinSupplyChains: Oscillation–fluctuationinordersincreaseaswemoveupstream Amplification–thesizeofthefluctuationsincreaseaswemoveupstream PhaseLag–theimpactisdelayedlongeraswemoveupstream

StockandFlowDiagramsStocks FlowsDefinethe“state”ofthesystem DefinetherateofchangeofsystemstatesExamples:

• Balancesheet• Wealth• Waterinabathtub• InventoryinaDC• Integrals

Examples:• Cashflowstatement• Income–Expenses• Flowsinthroughfaucetandoutdrain• Throughput(replenishment–shipments)• Derivatives

Table:StocksandFlows


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Stocks:

• Definethe“state”ofthesystem• Stockshavememory• Stockschangethetimepathofflows• Stocksdecoupleflows• Stockscreatedelays• Examples:

o BalanceSheeto Wealtho Waterinabathtubo InventoryinaDCo Integrals

Flows:

• Definetherateofchangesystemstates• Examples:

o CashFlowStatemento Income–Expenseso Flowsinthroughfaucetandoutdraino Throughput(replenishment-shipments)o Derivatives

Figure:StockandFlowsDiagrams

eggsegg$laying$rate hatching$rate

chickensexpiring$rate

road$crossings

RB+

+

++


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Stock&FlowDiagram–Chicken&Eggs

ModelingSystemDynamicsSofarinthislessonwehavereviewedCausalLoopDiagramsandStock&FlowDiagrams,wewillnowaddtwomoreapproachestoyoursystemdynamicstoolboxincludingBehaviorOverTimeChartsandModels.


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Behaviorovertimecharts• BOTchartsarisefromtherelationshipsdescribedintheCLD• BOTstrackaprimaryattributeofthesystem(#customers,profit,sales,#eggs,etc.)• ABOTchartisNOTapointforecast,insteadthecriticalaspectisitsshape

ExaminingtheBehaviorovertimecanpreventunintendedconsequencesforthefuture.Forinstances,focusingmyopicallycanleadtoapooroutcome.BOTchartsinformthisprogressionovertimetoassessthisoutcome.Seeexamplebelowregardinghighrawmaterialscosts,theBOTchartwasabletovisualizetheunintendedconsequenceofashortsightedfix.


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ConvertingStock&FlowDiagramsintoaModelIntheexamplediscussedinthelecture,ofegglayingandhatching,wewanttosimulatethebehaviorofthesystem:

• ArrowsinCLDthatarenotconnectedtoanythingareconstantsorinputs!


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SimulationModelExample

Notes:• Thisisadeterministicsimulation–thereisnorandomnessorstochasticity• Allbehaviorresultsfromtheinteractionsoftheratesofegghatchingandlaying• Noneedtoconverttointegers–remember–thisisNOTanexactforecast


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VLOOKUP• VLOOKUPFunctionletsyou“lookup”avaluefromatable.Thefirstcolumnofthelookup

tablemustbeinascendingorder.Itreturnsthecorrespondingvalueinthecolumnspecified

• VLOOKUPhascommonstructureinExcel,GoogleSheets&LibreOfficeforthefirst3parametersofthefunction:

• VLOOKUP(criteria,array,column)• Optional4thparametersdoslightlydifferentthingsthatarenotimportantforouruse

here.


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IncludingaDecisionMatrix

Includingadecisionmatrixallowsyoutoexamineactionsandresults.Allowformoreinformeddecision-making.

LearningObjectives

• Introductiontotheconceptsandtoolsofsystemdynamics• ReviewFeedbackLoopsandtheirrolesystemdynamics• RecognizeTimeLagsandDelays• LearnToolstoCaptureandModelSystems,CausalLoopDiagrams,andStockandFlow

Diagrams• Reviewthetoolsofsystemdynamicsincludingbehaviorovertimechartsandmodeling• Learnhowtomodelsystemdynamicsstocksandflowsincludingmanagementpractices


25

ReferencesSterman, John, (2000), Business Dynamics: Systems Thinking and Modeling for a Complex World, McGraw-Hill. Morecroft, John, (2015), Strategic Modelling and Business Dynamics: A Feedback Systems Approach, Wiley. Senge, Peter, (2006), The Fifth Discipline, Doubleday. http://www.systemdynamics.org/ Don Woodlock’s videos on System Dynamics https://www.youtube.com/playlist?list=PL7490F4FA4B45DA26


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Dealingwithpartners:CollaborationandSupplyContracts

CollaborationThislessonfocusesoncoordinatingtheinterfacebetweenafirmanditsimmediatedownstreampartner–orcustomer.Thecoordinationrequiresexchanginginformationandunderstandingtheimpactofonefirm’sactionsontheother.

TheBullwhipEffectwasintroduced.EssentiallytheBullwhipEffectiswhentheupstreamvariabilityofdemandisgreaterthanthedownstreamvariability.Thiscanoccurformanyreasonstoinclude:orderbatching,demandforecastingupdates,rationingandshortagegaming,andpricefluctuations.TheconceptwaspioneeredinitiallybyJayForresterandwasobservedinpracticeinthesupplychainbyP&Ginitsdisposablediaperline.TheeffectinsupplychainswasfirstdescribedandquantifiedbyLee,Padmanabhan,andWhangin1997.

TheBullwhipEffectisessentiallyasignalthatasupplychainisnotcoordinated.Thecostsofthislackofcoordinationincludes:

• Increasedmanufacturingcosts• Higherinventorylevels&costs• Longerreplenishmentleadtimes• Highertransportationcosts• Lowerproductavailability• Deterioratestradingpartnerrelationships• Lowerssupplychainprofitability

ThelessondiscussesapproachestocounteractingtheBullwhipEffecttoinclude:Improveforecastingmethodology,Designsingle-stagereplenishmentcontrol,Shortenleadandreviewperiodtimes,Reducebatchingoforders,Reducetheincentiveofforwardbuying,andBettersharingofinformation.

TheBullwhipEffectTheBullwhipEffectisthesituationwherethevariabilityofdemandinthesupplychainincreasesasonemovesupstreamfromtheconsumertosuppliers.Itisprimarilycausedbyfourfactorsandisexacerbatedbytheobservationthatsupplychainsconsistofmultipleindependentfirmsandthatindividualfirmswilltendtooperateinordertomaximizetheirownprofits.:

• DemandForecasting–whereforecastingreliesonthedemandeachfirmseesfromits

immediatedownstreampartnerorcustomerandnottheenddownstreamdemand


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• RationingandShortageGaming–wheresuppliersrationsupplyandcustomers,knowingthis,inflateordersorsubmitphantomordershowever,ordersevaporatewhensupplyismadeavailable.Theneteffectisfalsedemandsignalsthatrippleandareamplifiedupstream

• OrderBatching–wherecustomersbunchorbatchordersformanydifferentreasonstoinclude:o Orderingsetupcostso Optimallot-sizingo Periodicreviewpolicies

• PriceFluctuations–wheretheretailerincentivizesbehaviorfromitsconsumersbychangingpricesthatinturncausesbatchingoforders.Theseinclude:

o Volumediscountso Minimumorderquantitieso Limitedtransportationmodeoptionso Forwardbuying

QuantifyingtheBullwhipEffectWecanmeasuretheroughimpactoftheBullwhipEffectundercertainconditions:

• OneretailersellingoneitemreplenishedbyonewholesalerDCo Dailydemandatstoreis~N(100,10)o Dailyreviewperiodwith(R,S)inventorypolicy(orderupto)o St=µtL+kσt√Lo μt=expecteddailydemandestimatedattimeto σt=standarddeviationofdailydemandestimatedattimeto L=leadtimeindayso k=Safetyfactor

• ForecastingusessimplemovingaverageofthelastMtimeperiodswhichimpliesthatμandσwillchangeeachperiodbasedonnewforecastandimpacttheorderuptolevelandsafetystock.

Then,wecanseethat:

CounteractingTheBullwhipEffectThereareseveralmethodsorapproachestocounteractingtheBullwhipEffect.Theseinclude:

• Improveforecastingmethodology

o Eliminatemultipleforecaststhatonlyuseimmediatepartnerorderdatao Employpoint-of-saleorendconsumerdata,ifpossibleo Avoid“nervous”forecastingtechniques


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• Designsingle-stagereplenishmentcontrolo Haveupstreampartnermanageitsdownstreampartner’sinventoryo ReferredtoasVendorManagedInventory(VMI)orContinuousReplenishment

Programs(CRP)o Bypassthedownstreamstages–consumerdirectpolicies

• Shortenleadandreviewperiodtimeso Morefrequentreviewandfasterdeliveryreducesimpacto Lesstimeforuncertaintytobuildo Incentorderstobebetterdistributedovertime

• Reducebatchingoforderso Reducethefixedcostofordersetupanddelivery(lowerfriction)o Shiftfromminimumorderquantity(MOQ)ofindividualSKUs(orfamilies)tominimum

volumequantityofawiderassortmentofproductso Reducetransportationcostsbyusing:milk-runs,multi-zonetrucks(ambient,

refrigerated,andfrozen),3PLsolutions...• Reducetheincentiveofforwardbuying

o Beselectiveontheuseofpricepromotionso AnalyzethetruecostsofapromotionusingABCaccountingo Shiftsalesincentivesfrom“Sell-To”to“Sell-Through”o Usesupplychainriskandothercontractstocoordinatesales

• Bettersharingofinformationo AllowingvisibilityintoPOSorendcustomerdemando Sharingofplansandintentions–sometimescalledCollaborativePlanning,Forecasting,

andReplenishment(CPFR)

SupplyContractsInthislesson,wecoveradifferentaspectofthebuyer-sellerrelationship.Ratherthanlookingatanauction,welookedatthetypeofcontract,orthetypeofrelationshipwiththebuyersandseller.Thatis,oncetheprocurementdepartment,orthebuyer,decideshowmuchtheyaregoingtobuyfromthesupplier,thequestionishowthecontractshouldbedesigned,andwhattypeofcontracttohave.

Asitturnsout,therearequiteafewtypesofcontracts.Sointhislesson,wefirstwentthroughcontractsingeneral.Wediscussedsupplycontractsandwhattheproblemiswiththem.Thiswasmainlycoveredthroughwhatiscalledwholesalepricecontracts.Then,wecontinuedthisdiscussionbyintroducingbuybackcontracts,revenuecontracts,andoptioncontracts,whicharecontractsthataredesignedtoalleviatesomeoftheproblemsresultingfromstraightforwardwholesalepricecontracts.

Throughoutthelesson,wefocusedonaparticularscenario.Wehadonesuppliersellingtooneretailer,andtheretailerwassellingintosomeuncertainmarket.


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WholesalepricecontractsThisisacontractwherethebuyerpaysapriceperunitforeveryunitordered.Normally,thispriceislowerthantheretailprice(hencethetermwholesaleprice).

OveragecostandunderagecostOveragecost:Thecostperunitoforderingmorethanneededinasalesperiod.Whenproductsaresoldinasinglesalesperiod(likenewspapers,whicharesoldonlyforoneday),thecostofhavingtoomanyproductsattheretaileristhepurchasepriceminusanysalvagevalue.

Underagecost:thecostperunitoforderinglessthanneededinasalesperiod.Whentherearefewerproductsthanthereisdemand,thecostofnothavingenoughproductsfortheretaileristheproductmargin–thisistheamounttheretailerwouldhavereceivediftherewasenoughgoods.

OptimalorderquantityinasingleperiodmodelConsideraretailersellingproductsoverasinglesalesperiod.TheforecasteddemandhascdfF(x).Insuchasituation,theretailer’soptimalorderquantityisfoundfrombalancingexpectedunderageandexpectedoveragecosts.

The(informal)explanationisthefollowing:consideranarbitrarypotentialorderquantityQ.GiventhisQthereisaprobabilityF(Q)thatdemandislessthanQandaprobability(1-F(Q))thatdemandisgreaterthanQ.IfdemandislessthanQ,theretailerwillincuroveragecosts.IfQislow,thereisaverylowprobabilityofthis,sotheexpectedoveragecostislow.IfinsteaddemandisgreaterthanQ,theretailerwillincurunderagecosts.IfagainQislow,thereishighprobabilityforthis,sotheexpectedunderagecostishigh.Clearly,byincreasingQ,theexpectedoverageincreaseswhiletheexpectedunderagedecreases.Ifexpectedoverageincreaseslessthanexpectedunderagedecreases,thenincreasingQleadstohigherexpectedprofits.Atsomepoint,thetwoexpectedcostsareequal.ThisistheoptimalorderquantityQ*.Thatis,

coF(Q)=cu(1-F(Q))Withawholesalepricew,aretailpricer,andasalvagevalues,wecansolveforF(Q):

F(Q)=cu/(cu+co)=(r-w)/(r-s).

Thisisoftenreferredtoasthecriticalfractileorthecriticalratio.Takingtheinverseofthecdfyieldstheoptimalorderquantity.

Channel(supplychain)coordinationAchannelorsupplychainissaidtobecoordinatedwhentheindividuallyoptimalorderquantityisthesameasthechanneloptimalorderquantity.Foranormalwholesalepricecontract,thismeansthatthe


30

criticalfractilefortheretailermustbethesameasthecriticalfractilefortheintegratedchannel.Itiseasilyseenthatthisisonlythecaseifthewholesalepriceisequaltothemarginalcostofthesupplier–inthatcasethesuppliermakesnoprofit.

BuybackcontractWithabuybackcontract,thesupplierofferstheretailertobuybackallunsolditems.Thisreducestheretailer’sriskofoverage–ifthereareunsolditemsattheendoftheseasontheycanbesoldbacktothesupplier.Theretailer’soptimalorderquantityisthusgivenbythesolutionto

F(Q)=(r-w)/(r-b),wherewisthewholesalepriceandbisthebuybackrate.Thechanneliscoordinatedwhentheretailer’scriticalfarctileisequaltotheintegratedchannel’scriticalfractile,whichmeansthatthechanneliscoordinatedwhen

b=((r-s)/(r-c))w-(r(c-s)/r-c))wherecisthemarginalcostofthesupplier.Notethatthismeansthatthechanneliscoordinatedformanydifferentcombinationofwandb.However,ahigherwholesalepricerequiresahigherbuybackrateforthechanneltostaycoordinated.Notealsothatasthewholesaleprice(andthebuybackrate)grows,thesupplier’sshareoftheprofitincreases.

RevenuesharingcontractRevenuesharingisanothertypeofcontractthatcanreducetheretailer’sriskofoverage.Withthiscontractualsetup,thesupplierlowersthewholesalepricebuttakesapercentage(1-p)oftherevenue.Withthis,theretailer’soptimalorderquantityisgivenasthesolutionto

F(Q)=(pr-w)/(pr-s),

wherepisthepercentagerevenuekeptbytheretailer.Aswiththebuybackcontract,thechanneliscoordinatedwhentheretailer’scriticalfarctileisequaltotheintegratedchannel’scriticalfractile,

p=w(r-s)/(r(c-s))-s(r-c)/(r(c-s))

Inpractice,thesecontractsmaybedifficulttoimplementinmanyindustriessincethesuppliermustkeeptrackofretailerrevenues.

RealoptionsWitharealoptionscontract,theretailerbuysQcalloptionsatpricew,givingtheretailertherighttobuynomorethanQunits.Exercisinganoption,oncedemandisknown,comesatanextrafeeofE.Aswiththeotherbuybackandtherevenuesharingcontracts,thisreducestheretailer’sriskofoveragesothatthechannelcanbecoordinated.


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LearningObjectives• Understandhowfirmsshouldcollaboratetoimproveoverallefficiency• UnderstandtheBullwhipEffect,howitiscaused,theimpact,andhowtomitigateit• FamiliaritywithdifferentinitiativesoncollaborationtoincludeVendorManaged

Inventory,ContinuousReplenishment,andCollaborativePlanning,Forecasting,andReplenishmentprograms.

• Introductiontosupplycontracts• Theproblemsofnormalwholesalesupplycontracts• Howtodesigncontractparametersofcertaincontractstocoordinateachannel(supply

chain)• Understandthebenefitsofbuybackcontracts,revenuesharingcontracts,andreal

options

Additionalreferences:Cachon,G.P.(2003).Supplychaincoordinationwithcontracts.Handbooksinoperationsresearchandmanagementscience,11,227-339.

LeeHL,PadmanabhanV,WhangS(1997a)Informationdistortioninasupplychain:Thebullwhipeffect.ManagementSci43(4):546–558LeeHL,PadmanabhanV,WhangS(1997b)Thebullwhipeffectinsupplychains.SloanManagementReview38(4):93–102ChenYF,DreznerZ,RyanJK,Simchi-LeviD(2000a)Quantifyingthebullwhipeffectinasimplesupplychain:Theimpactofforecasting,leadtimesandinformation.ManagementSci46(3):436–443FransooJC,WoutersMJF(2000)Measuringthebullwhipeffectinthesupplychain.SupplyChainManagement5(2):78–89


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SupplyChainStrategy

SummaryStrategyiskeytoaneffectivesupplychain.Tounderstandthis,wereviewthemostcommonbusinessstrategyframeworksandmethodologies.Weprovidesomeexamplesthathelptounderstandhowsupplychainsneedtoaligntotheselectedcompany’sstrategyinordertoenableit.Thereisnotasinglebestsupplychainforeveryfirm.Typically,eachcompanyshoulddevelopandutilizeaportfolioofdifferentsupplychains.Wealsointroduceanovelwayofthinkingaboutsupplychainstrategy.Itdemonstratesawayoftacklingtheproblemofsupplychainstrategizing.OurprimaryresourceforthislessonisthematerialdevelopedbytheMITCTLSupplyChainStrategyLabledbyDr.RobertoPerezFranco.Wediscussthenatureoftheproblemthatsupplychainstrategizingpresentstosupplychainpractitionersandpresenttensupplychainstrategyevaluationcriteria.

KeyConceptsStrategy isan“art”,notexactlya science, thismeans focusingon thebigpictureandoverallresultsofaneffort.Herearesomedefinitions:According to the Oxford English Dictionary: “The art of a commander-in-chief; the art ofprojecting and directing the larger military movements and operations of a campaign.”Perspectivesandchallengesofthegeneralandsoldierareverydifferent.According toMerriam-Webster: “Thescienceandartofmilitarycommandexercised tomeettheenemyincombatunderadvantageousconditions.”

SupplychainstrategyTheimportanceofstrategyforsupplychainmanagementhasbeenrecognizedforalongtime.ShapiroandHeskett(1985)highlightedthat“logistics’mostimportantroleisstrategic”.Theyrecommendedthatlogisticsmanagersapplyavarietyofperspectiveswhilerunningtheirlogisticssystems:

• Internalperspective:understandstructure,economicsandrequirementsofthelogisticssystemsaswellasconstraintsandcomponents

• Interfunctionalperspective:interactconstantlywithotherfunctionalmanagersinareassuchasmarketing,production,andfinance

• Channelperspective:thinkintermsofmaximizingthetotalchannelbenefit,consideringthatthefirm’sdecisionsaffectandisaffectedbychannelpartners


33

• Strategicperspective:welldesignedlogisticsmanagementcaninfluencecompany’sstrategyandhasthepotentialto“advanceacompany’sstrategicgoals”

Adichotomy:Thetwofacesoflogistics(supplychainmanagement)Successful supply chainmanagement requires attention to detail, to day-to-day control andcoordination,and to the tacticalandanalytic.However,managers shouldalsobeable to see“thebigpicture,”andbecognizantofthebroad,qualitative,long-termaspectsofsupplychainmanagement.Thisawarenesswillensurethatthefirm’ssupplychainfunction,combinedwiththeotherfunctionalareas,canfurthertheoverallobjectivesoftheorganization.

Figure:“Adifficult,yetfundamentaldichotomy”.BasedonShapiroandHeskett(1985)

ShapiroandHeskett(1985)pointoutthatthis“ever-presenttensionbetweenthestrategicandthe tactical, the broad and the detailed”, “all conspire to make the job of a supply chainmanagerachallengingone.”

TwostrategicrolesforthesupplychainAsinputtoformulatenewoverallstrategySupplychainmustbeaninputwhenformulatinganewoverallstrategy.Organizationsusuallyhave–andshouldhave–anoverallstrategythatgivesthemdirectionandhelpsthemsucceed.Thisoverall strategy is calledbymanynames,dependingon the typeoforganizationwearereferringto.Inthecaseoforganizationsthatcompeteagainstothers,thisisoftencalledtheircompetitivestrategy.Inthecaseofbusinessunits,itisoftencalledtheirbusinessstrategy.Butinall cases, theoverall strategyseeks toprovide theorganizationwithapathordirection tosuccess.Asenablerofanexistingoverallstrategy

Tactical

Short+term

Quantitative

Detailed

Strategic

Long+term

Qualitative

Broad


34

Implementinganoverallstrategymeanstranslatingobjectivesintodecisions,goalsintoaction.Anoverallstrategythatprovidesasetofhigh-levelstrategicobjectivehastobeelaboratedintomorespecificobjectives,policiesandchoicesacrossawiderangeofareasofactivity.Thismayinclude many diverse functions that are relevant to the supply chain, such as purchasing,logistics,operationsandsales.Themeansthatthestrategyexecutedhastobeinlinewiththeprinciples and values the organization embraces, across a series of areas of interest such asquality,sustainability,service level,safety,etc.There isagapbetweentheoverallstrategyofanorganizationand theexecutionof this strategy. Supply chain strategyhelps tobridge thisgap.

Strategictools

Porter’sFiveForcesPorter argues that a company’s ability to increase profit is affected not only by rivalry ofimmediate competitors but also by four other forces, which determine the intensity ofcompetitionandtheattractivenessofanindustry.Thesefiveforcesare:

1. Internalrivalryamongexistingcompetitors,whichisinfluencedbydifferentfactorssuchasnumberofexistingcompetitors,rateofmarketgrowth,balancebetweensupplyanddemand,amongothers.

2. Threatofnewentrants,whichreferstohowdifficultitistobecomeacompetitorinagivenmarketandisinfluencedbyaccesstospecifictechnology,brandcredibilityandrecognition,lawsandregulations,etc.

3. Easeofsubstitution,whichdependsonalternativeproductsorservicesavailablethatcustomerscouldchoosetobuyinstead.

4. Relativepowerofsuppliers,whichisinfluencedbythenumberofsuppliersavailable,availabilityofsubstitutesforthematerialorcomponentyouareprocuring,numberofcustomersthesupplierhas,costofswitchingtoanothersupplier,amongothers.

5. Relativepowerofcustomers,whichisdeterminedbythequantityboughtbyeachcustomer,availabilityofsimilarproductsfromcompetitors,costofswitchingfromonesellertoanother,amountofinformationthatisavailabletocustomers,customers’profitmargin,etc.


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Figure1-2.Porter'sFiveForces

Growth-ShareMatrixTheGrowth-ShareMatrix isatoolthatwasdevelopedbytheBostonConsultingGroupinthe70’s,usedtomanageaportfolioofbusinesseswithinafirm.Itisimportanttounderstandthecategorizationsforeachbusinesslinebecausethesupplychainrequiredforeachcategorywillbeverydifferent.Accordingtothemarketshareandthebusinesspotentialgrowthrate,wecanclassifythelinesofbusinessesina2x2matrix.Thefourtypesofbusinessesare:

• Stars:arelinesofbusinesswithhighgrowthrateandhighmarketshare,whichgeneratealotofcashandrequireinvestmentstomaintainthemarketshare.

• CashCows:arelinesofbusinesswithhighmarketsharebutlowgrowthrate.Likethestars,cashcowsgeneratealotofcashbut,becauseofthelowgrowthrate,investmentsdonotmakesense.

• Dogs:arelinesofbusinesswithlowmarketshareandlowgrowthrate,whichdonotgenerateanyprofit;thestrategyfortheseistodivest.

• Questionmarks:arelinesofbusinesswithhighgrowthrateandlowmarketshare,therearetwopotentialstrategiesfortheselinesofbusinesses:investtoincreasemarketshareordivestandreallocateyourresources.

MIT Center for Transportation & Logistics

Porter’s5Forces

AdaptedfromPorter(1980),Assen etal(2009),Weiss(2011),Evans(2013)

Relativepowerofcustomers

Relativepowerofsuppliers

Easeofsubstitution

Threatofnewentrants

Internalrivalryamongexistingcompetitors

21


36

Figure:Growthsharematrix.Source:adaptedfromHedley(1977)

SWOTAnalysisTheSWOTanalysis,developedbyKennethAndrews,isusedtocategorizeinternalandexternalfactors that influence strategic decisions. SWOT is an easy way to have a structuredbrainstormingsessionwithateamtobetterunderstandthe layofthe land.SWOTstandsforStrengths,Weaknesses,OpportunitiesandThreats.

Figure:SWOTAnalysis

lowBu

siness*Grow

th*Rate

Relative*Competitive*Position*(Market*Share)

high

high

low

Stars• High*growth,*High*share• Should*generate*large*

amounts*of*cash• Requires*investment*to*

maintain*leadership*position• Best*opportunities* for*firm• Secure*share*for*when*the*

market*matures• Strategy:) Invest)for)growth

Cash*Cows• Low*growth,*High*share• Entrenched*and*superior*

market*position• High*profit*and*revenue*

generation*with* low*costs• Limited*investment*needs• Funds* investments* in*other*

areas*and*businesses• Strategy:) )Invest)to)maintain)

or)harvest

?

Question*Marks• High*growth,*Low*share• Cash*needs*are*high*due*to*

growth• Cash*generation*is*small*due*

to*low*share• Two)Potential)Strategies

• Invest)&)move)to)star• Divest)(sell)or)shut)down)

Dogs• Low*growth,*Low*share*• Poor*competitive*position• Low*profits*and*low*growth*

potential• Often*a*“cash*trap”*for*a*firm• Strategy:) )Divest


SWOTAnalysis

Strengths• Whatdoestheorganizationdowell?• Whatareasofexpertisedoesithave?• Examples:lowcostmanufacturing,

productdesign,technicalcapabilities

25

Weaknesses• Whatdoestheorganizationnotdo

well?• Whatdoesitlack?• Examples:weakbrandidentity,

ineffectivesalesgroup,customization

Opportunities• Whatfutureopportunitiesarethere

fortheorganization?• Examples:expansiontonewregion,

extendproductlinetonewpurposes

Threats• Whatfuturethreatsareloomingfor

theorganization?• Examples:changesinregulations,new

competingtechnology,shiftingconsumertastes

InternalFactors ExternalFactors


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StrategicFitPorter introduces the concept of “fit”, whichmeans that activities are consistent with eachotherandreinforceeachothertocreateacompetitiveadvantageandsuperiorprofitability.Porteridentifiesthreetypesof“fit”,which“arenotmutuallyexclusive”:

• Firstorderfitensuresthat“competitiveadvantageofactivitiescumulateanddonoterode”

• SecondOrderfit“occurswhenactivitiesarereinforcing”• Thirdorderfitis“optimizationeffort”

WhatisStrategy?AccordingtoPorter’sfamouspaper:

• Strategyiscreatingfitamongacompany’sactivities• Successfulstrategyisaresultofdoingmanythingswell,andintegratingthem• Ifthere’snofitamongactivities,there’snodistinctivestrategyandthestrategywillbe

unsustainable

SupplyChainStrategyAccordingtoNarasimhanetal.(2008):“supplychainstrategycanbeviewedasthepatternofdecisionsrelatedtosourcingproducts,capacityplanning,conversionofrawmaterials,demandmanagement,communicationacrossthesupplychain,anddeliveryofproductsandservices.”AccordingtoCiglonietal.(2004):“whatcompaniesactuallydid,ratherthanwhattheyclaimedtheir strategic intent to be, is the best clue to reveal their very supply chain managementstrategies.”

MatchandMismatchinSupplyChainStrategiesMarshall Fisher introduced the concept ofmatch andmismatchof supply chain strategies in1997.Figure3-5includeshis2x2matrix.

Figure:Fisher’s2*2matrix.Source:Fisher,1997

Match Mismatch

Mismatch Match

FunctionalProducts

InnovativeProducts

EfficientSupply9Chain

ResponsiveSupply9Chain


38

Lee’sMatchedStrategiesLee (2002)uses theuncertainty frameworkasaway toclassify risks.Figure3-6presents this2x2matrix.

Figure:Lee’smatchedstrategies.Source:Lee,2002

RethinkingyourSupplyChainStrategy

TheBasicChallengesSupplychainstrategypresentsasetofinterrelatedchallenges:

Figure:Thebasicchallenges

TensupplychainstrategyevaluationcriteriaThefirstchallenge is toassess thecurrentsupplychainstrategy,whichmeansunderstandingwhatyouhave inplace today.Tounderstand thestrategy,youmustmap thecurrent supply

Demand'UncertaintySupp

ly'Uncertainty

Low'(Functional'Products)

High'(Innovative'Products)

Low

(Stable'P

rocess)

High

(Evolving'P

rocess)

EfficientSupply'Chains

ResponsiveSupply'Chains

RiskEhedgingSupply'Chains

AgileSupply'Chains

Challenge(1Assess$your$current$supply$chain$strategy

Challenge(2Anticipate$future$$$supply$chain$needs

Challenge(3Craft$an$improved$

supply$chain$strategy


39

chainstrategyandevaluate it.Toevaluatewhetherthecurrentsupplychainstrategy isgoodenoughthereare10evaluationcriteria.First criterion is coverage. A good supply chain strategy must be comprehensive and covereveryareathatmattersforacompany’ssupplychain.Itmusthaveclarity–policiesandchoicesinasupplychainstrategymustbeunambiguousandunderstoodbyallofthedecisionmakers.Itmustbefeasible,realisticandabletobeachieved.Internalconsistencyiskeytosupplychainstrategywithdifferent objectives, policies and choices and canbe thought in threedifferentlevels:compatibility,coherence,andsynergy.Eachcomponentofagoodsupplychainstrategymustsupport,enable,advanceorhelprealizesomeelementoftheoverallorganization’sstrategy.Supply chain strategy must also have: sufficiency, external consistency, advantageousness,parsimony,andriskiness.

1 Coverage2 Clarity3 Feasibility4 InternalConsistency5 Support6 Sufficiency7 ExternalConsistency8 Advantageousness9 Parsimony10 Riskiness

Table:SupplychainstrategyevaluationcriteriaEvaluation criteria can be summarized as: “a good supply chain strategy should becomprehensive,clear,feasible,consistentbothinternallyandexternally,sufficientlysupportive,competitively advantageous, not wasteful, and not riskier than is acceptable to theorganization.”

ScenarioPlanningThesecondchallengeisanticipatingfuturesupplychainneeds,whichinashort-termtimelineareidentifiedusingforecastingtechniques.However,foralongertimelineweusethescenarioplanning technique. Scenario planning is a method that shifts from predicting events topreparing for multiple potential futures. It is defined as: “a structured brainstormingmethodology that immerses decisionmakers of an organization in different potential futurescenarios inorder tobetterunderstandpotential risks,blind spots,opportunities,and futureneeds.”Creatingscenarios


40

Ascenarioisessentiallyastoryaboutafuturebasedonasetofdrivingforces.Theyhavehighimpactandhighuncertaintyforyourselectedtimeframe.Somecriteriaforcreatingagoodsetofscenariosare:

• Avoidthepreferredand/orprobablefuture• Capturetherightdecision• Plausible,withinrealisticlimits• Includerealalternatives• Consistent• Different• Memorablenames• Challengethestatusquo

In addition to creating scenarios, we need to translate events into effects and apply thescenarios.Fivecategoriesofeffectsforsupplychains:

• Impactonsourcingpatterns• Impactonflowdestination• Impactonrouting• Impactonflowvolume• Impactonvaluedensity

ApplyingScenarios1. Immersealargegroupofpeopleineachscenario2. Bringeveryonetogetherandevaluate,compareandcontrastthesolutions/strategies

proposedacrossthedifferentscenarios3. Eliminatethenogainerstrategies4. Monitorwithsensorsinthegroundwhethertoapplystrategiesthatareonlyapplicableto

somescenarios

ProgressiveformulationThe third challenge is to craft an improved supply chain strategy. These are the steps toperformaprogressiveformulation:

• Identifyastartingpoint:arevisedoverallstrategy• Identifyareasofdecisionoractivityandinterest,addordropareasaccordingly• Identifysequenceofeventsthatyouwanttofollow• Useevaluationcriteriaoneachareaofdecision• Repeatthisprocessineachlevelofabstraction

LearningObjectives

• Learnbasicconceptsofbusinessandsupplychainstrategy• Identifythemostcommonbusinessstrategyframeworks


41

• Understandthatthereisnotasinglebestsupplychainforeveryfirm• Outlineaprocesstodevelopandimproveasupplychainstrategy• Learnhowtotackletheproblemofsupplychain“strategizing”• Identifythemaincriteriaforevaluatingasupplychainstrategy

References• Porter,M.(1996).“WhatisStrategy.”HarvardBusinessReview,4,11-12.• Andrews,K.R.(1987).TheConceptofCorporateStrategy,Irwin,Homewood,IL.• Fisher,MarshallL."WhatIstheRightSupplyChainforYourProduct?“HarvardBusiness

Review(1997).• Lee,HauL."Aligningsupplychainstrategieswithproductuncertainties."California

ManagementReview44.3(2002):105-119.• Mintzberg,H.,1978.Patternsinstrategyformation.ManagementScience24(9),934-

948.• Perez-Franco,R.(2016)Rethinkingyoursupplychainsstrategy.Abriefguide.MITSupply

ChainStrategyLab• Shapiro,R.D.,&Heskett,J.L.(1985).LogisticsStrategy:casesandconcepts:West

PublishingCompanySt.Paul,Minnesota.• Stevens,G.C.(1989).Integratingthesupplychain.InternationalJournalofPhysical

Distribution&MaterialsManagement,19(8),3-8.• Additionalreferencescanbefoundhere:strategy.mit.edu

Week1


42

GlobalSupplyChainManagement

SummaryThisreviewcoversglobalsupplychainmanagementconceptsandexplainthechallengesandopportunitiesoftradingbetweencountries.Sincemostsupplychainsareglobal,itisimportanttoconsiderthemanyfactorsthatwillinfluenceyoursupplychain.Itisalsoimportanttonotethatwhileguidanceisprovidedhereonhowtoworkinglobalsupplychains,someoftherulesanddatachangesallthetime.

GlobalSupplyChainManagementConceptsFrom1950tonow,globalpopulationhasincreasedby2.8xandWorldtradehasincreased20x.

WorldTradeOrganization(WTO)TheWorldTradeOrganization(WTO)wasfoundedin1995topromotefairtrade.Itsprincipalsinclude trade without discrimination, freer trade, predictable, more competitive and morebeneficialforlessdevelopedcountries.ProblemswiththeWTOincludeTradebarriershaveshiftedandLDCabuseofrules.

DutydeterminationDutyistheamountoftaxpaidonanimportedgood.Theamountofdutythatanimporterhastopayisdeterminedbythreefactors:

• Thetypeofgoods(theirclassification)o HarmonizedTariffSchedule(HTS)isa10-digitcodeusedtodescribeallgoodsin

tradeforduty,quota,etc.Thefirst6digitsarestandardizedinternationally;thelast4digitsarecountryspecific.

o Whichcodetousebasedoncodes,dutyratesdiffer,everyonetriestotwistthedefinitionstotheirownadvantage

• Thevalueofthegoods(theirvaluation)• Thecountryfromwhichthegoodsoriginated(therulesoforigin)

DutyDrawbacksTherearethreetypesofdutydrawbacks:

• Sameconditiondrawback:whenyouimportanitemandthenre-exportthisiteminthesamecondition

• Differentconditiondrawback:orsometimesalsocalledmanufacturingdrawback,whenyouuseanimporteditemintheassemblyofanotherproduct


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• Domesticgoodsreturnedindifferentcondition:whenanitemthatwaspreviouslyexportedcomesbackaspartofanassemblyofanotherproduct

• BelowshowshowDutyDrawbackswork:

SalesTaxesonImports:VAT,GST,HST• BesideschargingDutyonimports,manycountrieschargeaSalesTaxalso:• VAT–valueaddedtax-usedinEurope,taxbasedona%ofthe(dutiablevalue+duty)• GST–goodsandservicestax–usedinCanada,Australia,NZealandandmanyothers…

definedthesameasVATbutmayapplytocostofinlandtransportalso• HST–harmonizedsalestax–usedinCanadatorepresentacombinedfederalGSTplusa

localprovincialsalestax

ValuationValuationisimportantbecausemostofthedutiesarecollectedasapercentageofthevalueofgoods,thisiscalledadvalorem.ForCustoms’purposes,valuationisgenerallytheamountbilledby the exporter and shown on the invoice. However, there are situations were the amountshown in the invoicemay not represent an “arms-length transaction.” This occurswhen theexporterandimporterare“relatedparties”suchasaparentcompanyanditssubsidiary.TherearefouralternativemethodsusedbyCustomsauthoritiesworldwidetodeterminethevalueofgoods:

• Comparativemethod:usethevalueofsimilargoods• Deductivemethod:workbackwardsfromprice• Computedorreconstructivemethod:buildupfrommanufacturingcost


44

• Methodoflastresort:makeaneducatedguess

DutiableValue:FOBvsCIF• Countriescalculate“DutiableValue”basedoneithertheFOBvalueortheCIFvalue.• FOBvalue–“FreeonBoard”

o Pricepaidforthegoodsplusthecostofassists,extrapacking,commissions,royalties,transportation,loading,unloading,handling,andinsurancetodeliverthegoodsfromtheSellerontotheshipatthePortofExport

• CIFvalue–“Cost,Insurance,&Freight”o EqualsFOBplusmarineinsuranceandinternational(ocean)freight

RulesofOriginRules of origin are important because duties may differ by origin countries. There are twomethodsusedtofigureouttherulesoforigin:

• Substantialtransformation:lastcountrywheretheproductunderwentasubstantialtransformation

o Lotsofopportunitiesformultinationalstorearrangewheretheymakethingsandrouteshipmentstotakeadvantageofdifferingdutyrates.

• ChangeinHarmonizedSystemCode:lastcountrywheretheharmonizedsystemcodeoftheproductchanged

o ThismethodistheonecurrentlyfollowedbytheUnitedStatesfortextileproducts.


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GeneralizedSystemofPreferencesDeveloped countries usually provide opportunities to developing countries to grow theireconomies by designating them as Generalized System of Preference (GSP). CountriesdesignatedasGSPbenefitfromreduceddutyratesandquotasfortheirgoods.

• US:GeneralizedSystemofPreferenceso Promoteseconomicdevelopmentbyeliminatingdutiesonupto5,000typesof

productswhenimportedfromoneof122designatedbeneficiarycountriesandterritories.

• Europe:GeneralizedSchemeofPreferences:o StandardLevel--about30countries,reduceddutieso GSP+Level–about14countries,nodutieso EBALevel–about49countries,nodutiesorquotas(EverythingbutArms)

• MostFavoredNationTradingStatuso Designationfornormaltradingpartner

FreeTradeZoneandBondedWarehouses

FreeTradeZone BondedWarehousesMainpurpose:duty-freeaccesstolowcostlabor

Mainpurposeistodelaythepayingofduties

Nodutypaidifre-exported Nodutypaidifre-exportedDutydelayedifimported DutydelayedifimportedWorkcanbeperformedonthegoods Little/noworkcanbeperformed

onthegoodsGreatforprocessinggoodsinlowcostlaborcountries

Greatfordelayingdutyonimported$$$goods

Greatforshowingoffproductstointernationalbuyers

Table:FreeTradeZonesandBondedWarehouses


46

TradingBlocs

DumpingDumping is a form of predatory pricing where producers charge a high price in the homemarketbutaverylowpriceinanothermarkettogainmarketshare.Ininternationaltradetherearetwotypesofpenalties:

• Anti-dumpingDuty:importdutytobringthepriceuptothepricechargedatthehomemarket

• CountervailingDuty:oranti-subsidyduty,importdutytoproductsthathavesubsidiesathome

LandedCostAnalysisLandedcostusuallymeansallthecostsleadinguptothepointwhereyouarereadytotakethegoodsoutoftheportofimport.ThecalculationsmustbedoneinTHISORDER:

1. CalculatetheFOBvalue2. CalculatetheCIFvalue(=FOB+oceanfreight+marineins.)3. Whatisdutiablevaluefortheimportingcountry(FOBorCIF)?4. CalculatetheDuty(=dutyratexdutiablevalue)5. CalculatetheVATtaxablevalue(=CIF+duty)6. CalculatetheVATtax(=VATratextaxablevalue)7. CalculatetheLandedCost(=CIF+duty+VAT)


47

InternationalTransportationInternationaltransportationdifferssignificantlyfromdomestictransportation.ThemainwaysarereviewedincludingINCOterms,transportationoptions,andports.

INCOtermsINCOstandsforInternationalChamberofCommerce.Thesetermsdefinewhichresponsibilitiesbelong to the buyer and which responsibilities belong to the seller during an internationalshipment.Theyalsodefinewhopaysforfreightcost,insurance,duties,costofgoods,andothervariousfees.TherearefourmaingroupsofINCOterms:E,F,C,andDwhicharegroupsbasedonresponsibilitytransfersbetweenparties.

Figure:FourmaingroupsofINCOterms


48

AirFreightvs.OceanFreightAttribute AirFreight OceanFreight

On-timereliability Veryreliable,1-2daydeliverywindow

Notreliable,1-2weekdeliverywindow

FreightCost(ignoringinventory)

Expensive5to10+timesOcean

Cheaper

BasisofFreightcost

Weightismostimportant Volumeismostimportantfactor

Transittime 1-3daysto(almost)anywhere 5to40daysPollution Veryhigh Muchlower

Table:AirFreightvsOceanFreight

TypeofshipsThemostcommontypesofshipsarepresentedbelow.

Typeofship TypeofCargoRoll-On/Roll-OfforRo-Ro

shipWheeledcargo

Break-BulkShip GeneralcargoOiltanker Oilinbulk

ChemicalCarrier ChemicalsinbulkDry-BulkCarrier Unpackagedbulkcargo

LNGshiporGasCarrier Liquefiednaturalgas(LNG)

ContainerShip Non-bulkcargoTable:TypesofShips

OceanShipmentOverview

Figure:Legsofanoceanshipment

• Dray:localhaultotheport• Demurrage:penaltyforextradaysthatcontainersstayatadock• Cabotage:whenaforeign-flaggedvesselpicksupanddropsoffinthesamecountry• TEU:twenty-footequivalentunit


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• Weeklyservice:stringofshipsfollowingeachother

TheSteamshipIndustryThesteamship industry isavolatile industry inwhichfewcarriershandlemostof thefreight.Carriers collaborate and cooperate among each other, there are known as alliances. Thisindustryischaracterizedbyhavingverydifferentfreightratesdependingonthedirectionofthetrip. Because of volume discount pricing, this industry attracts consolidators andNon-VesselOperating Common Carrier (NVOCC). Historically the steamship industry has faced the Bull-Whipeffect,whichisthetimelagincarrierresponsetothedemandcurve.TopOceanCarriers

• Thereare50-75oceancarriersofsignificance.• Topfewcarriershandlethevastmajorityofshipments.• They form “Conferences” to collude on rates and manage capacity to set rates.

(outlawedinEurope)• They form “Alliances” to cooperate on capacity by lane – same stringwill have ships

fromdifferentcarriers.VolumeDiscountPricing–themoreyoubuy,thecheaperperunit.

• ThispricingschemeisripeforConsolidators• Intransportation:

• TruckloadBroker(CHRobinson,CoyoteLogistics)• AirFreightForwarder(Damco)• NVOCC (non-vessel operating common carrier) (Expeditors Intl, UTi, APEX,

Damco)

Figure:Bull-Whipeffectinthesteamshipindustry

InternationalSurfaceTransportInternationalSurfacetransportsarerailroadsandtrucksthatcrossinternationalborders.

• Biggestchallengeso Trucktransportation:safetystandards,protectinglocaljobs


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o Railroadtransportation:differentsafetyrequirements,workrulesandinteroperability(differentwidthsbetweentracks)

PortsandTerminalsAportisageneraltermreferringtoabigcommunityofplayers,whichinclude:

• PortAuthority• TerminalOperators• WarehouseOperators• Consolidators/De-consolidators• CustomsOfficials• Railroads• DrayOperators• FreightForwarders• CustomsBrokers

Aterminalisthelocationwithinaportwhereshipsload&unload,ithas:• Quay,shiptoshorecranes,RTGcranes• Containerstorageyard• Administrationbuildings

MAJORRAILROADGAUGESINTHEWORLD

Gauge NameInstallation

(km)Installation(miles)

Percentoftrackinworld

Whereused:

1,000mm(3ft33⁄8in) Metregauge 95,000 59,000 7%

SEAsia,India,Argentina,Brazil,Bolivia,northernChile,

Switzerland,EastAfrica

1,067mm(3ft6in)

Threefootsixinchgauge 112,000 70,000 9%

SouthernandCentralAfrica,Indonesia,Japan,Taiwan,Philippines,NewZealand,QueenslandAustralia,WesternAustralia

1,435mm(4ft81⁄2in)

Standardgauge 720,000 450,000 55%

Europe,Argentina,UnitedStates,Canada,China,Korea

(South),Korea(North),Australia,India,Indonesia,MiddleEast,NorthAfrica,Mexico,Cuba,Panama,

Thailand,Venezuela,Peru,Uruguay,Philippines,Japan,

TaiwanandSpain.1,520mm

(4ft1127⁄32in)

Russiangauge 220,000 140,000 17%Russia,Finland,Estonia,Georgia,Latvia,Lithuania,

Mongolia,Ukraine1,524mm(5ft) Finnishgauge 5,865 3,644 small Finland

1,600mm(5ft3in)

Irishgauge 9,800 6,100 small Ireland,Australia,Brazil

1,668mm(5ft521⁄32in)

Iberiangauge 15,394 9,565 small Portugal,Spain

1,676mm(5ft6in) Indiangauge 134,008 83,269 11%

India,Pakistan,Argentina,Chile,SriLanka,Bangladesh,

UnitedStates


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CurrencyIssuesandFinancingInglobalsupplychainsitisessentialtounderstandcurrencyissuesandfinancing.Tounderstandthiswereviewseveralimportantconceptsincluding:exchangeraterisk,transferspricing,andprofitrepatriationanditseffectsoncorporateincometaxes.Wealsobrieflyreviewdescriptionoftradefinanceandinternationaltradepaymentmethods.

ExchangeRateRisksTherearetwofactorsthatwilltriggerexchangerateriskwhentogether:

• Twodifferentcurrencies(i.e.,buyinonecurrencybutgetpaidinanother)• Timedelaybetweenbeginningandendoftransaction

CurrencyFuturesContract:Acontracttoexchangeonecurrencyforanotheratsomefuturepointintimeatapre-specifiedexchangerate.Normallythereisafeetodothis.

Themostcommonwaystoprotectagainstexchangerateriskare:• Useonlyonecurrency• Useabanktohedgethetransaction-payafeetothebanktoguaranteethepriceyou

willgetpaid• Hedgeyourself:

o CurrencyFuturesContract:acontracttoexchangeonecurrencyforanotheratsomefuturepointintimeatapre-specifiedexchangerate(thisusuallyrequiresafee)

o Foreigncurrencyhedging:isariskreducingstrategywheretwooffsetting,oppositepositions,aretakenintwodifferentparallelmarkets.Thepositionsaresuch,thattheirendresultsoffseteachother.

Internalwaystohedgeforeigncurrencieswithinyourowncompany:• LeadingExpenditure:topayinadvanceifcurrencyisexpectedtorise• LaggingExpenditure:topaylateifcurrencyisexpectedtofall• NettingReceiptsandPayments:tohedgethenetexposure

Externalwaystohedgecurrencies:• ForwardContracts:acontractwhereabuyerandselleragreeonanexchangeratein

advance• CurrencySwaps:twopartieswithtwodifferentcurrenciestakeanequivalentloanin

theirhomecurrencyandtradethecash• ForeignCurrencyOptions:payafeetohavetheoptionalrighttobuyorsellaspecific

amountofaspecificcurrencyataspecificpriceataspecificfuturetime• SpotContracts:contractsthatarecompletedin1-3daystoavoidhighfluctuations


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CorporateIncomeTaxesCompaniescanbechargedtaxesbyanygovernmentforcorporateprofitbutalsoinventoryvalue,valueofpropertyplantandequipment.

1. Taxesineachcountryarechargedbasedonhowmuchprofitwasmadeineachcountry.2. Taxratesvarysignificantlyfromcountrytocountry.3. Profitabilitycanvarysignificantlyfromproducttoproduct.4. Marginscanvarysignificantlyfromregiontoregion(e.g.sameproductpriceddifferently

indifferentmarkets).5. Transferpricingisusedtoestablishintracompanysellingprices(andthusestablishesthe

profitmarginineachcountry).InternationalIncomeTaxesTaxesineachcountryarechargedbasedonhowmuchprofitwasmadeinthatcountry.Thetaxrate varies significantly from country to country. Profitability varies significantly by type ofproductandprofitmarginscanvarysignificantlyfromregiontoregion.TaxHavenATaxHaven is a countrywith a low corporate income tax rate such as Ireland, Switzerland,Singapore,orPuertoRico.PermanentEstablishmentA Permanent Establishment (PE) is a fixed place of business that generates income or valueaddedtaxliabilityinaparticularjurisdiction.ThetaxsystemsinsomecivillawcountriesimposeincomeandvalueaddedtaxesonlywhereanenterprisemaintainsaPEinthecountry.ThesearethethingsthatmaygetabusinesslabeledashavingaPEinacountry:

• Abranch• Awarehouse• Afactory• Amineoroilorgaswell• Amanagementoffice• Owninginventoryinacountry• Buyingorsellinginthecountry• Beingtheimporterofrecord,beingtheexporterofrecord• Owningpropertyinthecountry• Havingemployeesinthecountry


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TaxesonForeignEarnings

TypesofTaxReliefForeignTaxCredit(FTC):whencountriesallowcompaniestodeducttheamountoftaxpaidinanothercountry.ParticipationExemption(PEX):apartialtofullexemptionoftaxesforcompaniesthataresubsidiariesofcompanieswithacertainlevelofownershipinaspecificcountry.Doubletaxationagreement(DTA):treatiesbetweenapairofcountriestoprovidepartialorfulltaxexemption.

TransferPriceA transferprice isa “marketprice” for intracompany transferofgoods. It isneededbecausedutiesarechargedbasedonthevalueofthegoodsbeingimported.Thismeansthattheinvoiceamount between related parties is not always a good indication of the value of the good.Transferpriceisalsoawaytoshiftprofitfromonecountrytoanother,giventhatincometaxratesmightbeverydifferent.

• WhataretheimplicationsofaHIGHtransferprice?o Moreprofitisrealizedintheexportingcountry,lessprofitisrealizedinthe

importingcountryo Moreimportdutyispaidifthegoodsmoveintotheimportingcountry.

• WhataretheimplicationsofaLOWtransferprice?


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o Lessprofitisrealizedintheexportingcountry,moreprofitisrealizedintheimportingcountry

o Lessimportdutyispaidifthegoodsmoveintotheimportingcountry.• WhatdoestheexportingcountrywantyoutodowithregardtoTransferPrice?

o Setitveryhigh--sotheygetmoreTAXESfromyou.• WhatdoestheimportingcountrywantyoutodowithregardtoTransferPrice?

o Mixedeffect–ifsethighmightgetmoreduty,butlessincometax.Ifsetlowgetlessdutybutmoreincometax.

ProfitRepatriationProfit repatriation is bringing profits earned in a foreign country back to the home country.UsuallypaidasdividendstotheparentcompanyBarrierstoRepatriation:

• Governmentlimits• Reportingrequirements• Withholdingtaxesondividends,royalties,interestpayments• DoubleTaxation

MechanicsofProfitRepatriation:

• TransferPricing(avoidtheneedtorepatriate):Havetransferprices“rigged”soalotofprofitoccursinthehomecountry.Limitations:governmentsreviewfor“anarms-lengthtransaction.”

• RoyaltyPayments:chargeafeetoforeign-subsidiaryfortheuseoftheparentcompany’snameandbrand

• LeadingandLaggingPayments:usecurrencyfluctuationstofavorthehomecountry• HighInterestLoantoSubsidiary:loanmoneytotheforeign-subsidiarywithhighinterest• ParallelInter-CompanyLoans:partnerwithanothercompanytointerchangeloanswith

foreignsubsidiariesoftheothercompanyintheparentcompany’shomecountry• Re-InvoicingCenters(RIC):useaTaxHaventoroutebuy-selltransactions• CounterorBarterTrade:exchangegoodsinsteadofmoneybetweenparentandforeign-

subsidiary


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ManagingWorkingCapital

Figure1-1.ExampleofaCashFlowModel

Cash-to-CashCycleTime

CTC=IDS+DSO-DPOWhere,CTCisCashtoCycleTimeIDSisInventoryDaysofSupplyDSOisDaysofSalesOutstanding(AccountsReceivable)DPOisDaysofPayablesOutstanding(AccountsPayable)WaystoFreeUpWorkingCapitalThesearewaystofreeupworkingcapital.Althoughtheireffectistodecreaseworkingcapital,athoroughanalysisofthesideeffectsofeachoneoftheseshouldbeperformed.Mostcommonwaysused:

• Lowertransittime• Returnexcesstosuppliers• Lowerinventorytargets,increasedeliveriesandruns• Improvemanufacturingcycletime• Usesmallerlots• Selloffexcessandobsolete• Useshorterpaymenttermswithcustomers• Havevigorouscollectionofpastduepayments• Askforlongerpaymenttermstosuppliers(notusuallyrecommended)• Delaypaymentstosuppliers(notusuallyrecommended)

InnovativeWays


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• Billonreceipt• Usevendor-ownedadjustedtimeinventory• ImplementLeanManufacturingtechniques• Buildtoorder• Offerearlypaymentdiscount• Offerapaybycreditcardoption• Askaboutpaymentspriortoduedate• ElectronicsFundsTransfer(EFT)

TradeFinancingActions• EarlyPaymentProgram:

o OfferedbyOEM:OEMpaysSupplierearlybutchargestheSupplieratadiscountedrate

o UsingaFunder:Funderpayssupplierimmediately,andchargesapercentagetosupplier,theOEMalsogetsadiscountforusingtheFunder

• A/RFinancing-SellingReceivables:SuppliersellsitsreceivablestoaFunderwhopaystheSupplierimmediatelybutgetsadiscount,thismethodisverysimilartotheEarlyPaymentProgramUsingaFunderbuttheOEMisnotinvolvedinthisscheme

• RevolvingLineofCredit:o Suppliergoesalone:SupplierborrowscashfromaFunder,whichchargesan

interestrate(basedonthesupplier’sfinancialhealth)andtakessupplier’sinvoicesascollateralfortheloan

o OEMhelpssupplier:OEMpublishesalistof“approvedinvoices”toshowthatitiscommittedtopay.Therefore,whenthesupplierborrowscashfromtheFundertheinterestrateislowerastheinterestrateisbasedontheOEM’sfinancialhealth

• EarlyPaymentProgramtoExtendDPO:FunderisusedtopaytotheSupplierimmediatelyandtoextendthepaymenttermstotheOEM,theFunderchargestobothSupplierandOEM

MethodsofPaymentinInternationalTrade• Cash-in-Advance:meansthatthebuyerpaysbeforereceivingthegoods;thismethodis

usedinhigh-risktraderelationshipsorexportmarkets.• LettersofCredit:isadocumentissuedbythebuyer’sbankcommittingtopaytothe

sellerevenifthebuyerfailstopaytothebank;thismethodisusedinneworless-establishedtraderelationships.

• DocumentaryCollections:occurswhentheSeller’sbankcollectsalltheexportdocuments(BOL,CommercialInvoice,etc.)ofthegoodsshippedbythebuyer,theSeller’sbanksendsthesedocumentstotheBuyer’sbankdemandingpayment.The


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Buyer’sbankwillholdthesedocumentsuntilthepaymentismade,thismethodisusedinestablishedtraderelationships.

• OpenAccount:iswhengoodsareshippedbeforepaymentalongwithalltheexportdocuments.Thisarisesinsecuretradingrelationshipsormarketsorincompetitivemarketstowincustomers.

SourcingandShoringInaglobalworld,thetopicsofsourcingandshoringarehotlydebated.Tobreakapartthesetopics,weidentifythemotivationsandthechallengestomovemanufacturingabroad.Beyondtheinitialdecisiontomoveabroad,thereareadditionalkeyelementsonsocialresponsibilitythatcompanieslosegraspofwhenworkmovesfartherawaysuchasslaveryorconflictminerals.Finally,weprovideexamplesofdifferentglobalsupplychainstrategies.

ApproachesforManufacturingInternationally• ContractManufacturing:acompanyhiresanothercompanytomanufacturegoods,

usuallyinaforeigncountry• Licensing:acompanyallowsanotherfirmtouseitsintellectualpropertytomake

productsinexchangeforaroyalty• Franchising:acompanygivesanotherfirma“bundle”ofintellectualpropertyitemsand

allowthefirmtoreproduceitsentirebusinessmodelinexchangeforroyalties• JointVenture:twoormorecompaniesjointosetupanewcompanytoenteranew

marketplace• Subsidiary:awhollyownedforeigncompanythatisindependentfromtheparent

companyandgivestotalcontroltotheforeigncompany

MotivationsandchallengesofoffshoringHerearesomeofthereasonsthatexplainswhymanufacturingmovedtoAsia&China:

• Verylowlaborcost,hugelaborpool


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• Veryfewrestrictionsonpollution,workingconditions,quality,andexports• Newfactories,newequipment• Newinfrastructure• Herdmentality• Supplybasedmoved-self-fulfillingtrend.• Corporateprofitmotive&competitivepressureoutweighedloyaltytocommunity• Consumersavingsoutweighedloyaltytocommunity

Someofthechallengesrelatedtothepreviousdecisionare:• Verylongleadtimes• Longsupplylines---longdistanceoceantransportation• Timezonechallenges• Communicationchallenges---languagedifferences• Needforhigherinventorylevels• Intellectualpropertytheft,counterfeitingofproducts• Extracargosecurity• Emergencyairshipmentsarenowaverylongway

Changesinthelast20years:Chinaismoreprosperous;laborcostshaveskyrocketed;laborshortageincoastalcities;ChineseCurrencyappreciation;restrictionsonquality,workingconditions,environmentandsafety;hugecoastalfactorieshavegottenbadreputation;greenmovementfavorslocalsourcing;contaminationscares;politicalbacklash;U.S.Energypriceshavefallen.IndustryResponsetoChanges

Industry Response

Automotive Parts Growth inMexico

Aerospace Parts GrowthinMexico

Appliances Growth inUSA,Mexico

Apparel ChinastilldominantbutGrowthinBangladesh,Vietnam,otherSEAsia

Footwear GrowthinVietnam

ConsumerElectronics StayinginChina


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WhereisManufacturingMovingto:

GlobalSupplyChainDesignStrategiesVerticalintegrationThefollowingmetricsarehelpfultoanalyzingtheeffectofverticalintegration:

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛 =𝐴𝑛𝑛𝑢𝑎𝑙𝑆𝑎𝑙𝑒𝑠

𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛 =11

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛BBCDE

wherenisthenumberofplantsverticallyintegratedOutsourcing

• TypicalSituationo CompaniesimportwithTransferPricefromsubsidiarytoparentortoanother

subsidiaryo TheyhaveaPERMANENTESTABLISHMENT(PE)ineachcountryo Theypaytaxesineachcountry

• Taxavoidingstrategy:o Designanetworkthatcomplieswithexportrestrictions,minimizestaxes,and

providestheflexibilitytoshipfromandtoanywhereo AvoidPEinallbutonecountry(headquarterslocation)o Usesubcontractorsformanufacturingandexporting,usedistributorsfor

importinganddistributing


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o OEMbuysfrommanufacturersandsellstodistributorsonlyininternationalairspaceorinternationalwaters

Howtoavoidpermanentestablishment-DonotManufactureinacountry:UseContractManufacturers(CM)instead-DonotbetheExporterofRecord:CMtobetheexporterofrecord-DonotbetheImporterofRecord:CustomerorDistributoristheimporterofrecord.-Donotowninventoryinacountry:InventoryisownedbyCM,Distributors,Suppliers,Customers.-Donotsellgoodsinsideacountry:Allsalesofgoodsoccurinint’lspace

LearningObjectives• Understandmostcommonpracticesusedinglobalsupplychainmanagement• Introduceinternationaltradeconceptsandunderstandchallengesandopportunities• Understandthebasicsofinternationaltransportation• IdentifythemainchallengesfacedinAirFreight,OceanFreightandSurfacetransport• Understandcurrencyissuesandhowtoprepareagainstexchangeraterisks• Overviewconceptsrelatedtocorporateincometaxes,transferpricingandprofit

repatriation• Understandtradefinancingandhowcompaniescanhelpeachother• Identifyfourmethodsofinternationaltradepaymentandlettersofcredit• Understanddifferentwaysformanufacturinginternationally• Identifysocialissues,slaveryandconflictminerals

ReferencesForAll

• David,P.(2013),“InternationalLogistics”,Cicerobooks,4thEd.ForInternationalTransportation

• InternationalChamberofCommercehttp://www.iccwbo.org/products-and-services/trade-facilitation/incoterms-2010/the-incoterms-rules/

ForCurrencyIssuesandFinancing

• SayaliBedekarPatil,Buzzle.com,http://www.buzzle.com/articles/ForeignCurrencyHedging

• SayaliBedekarPatil,Buzzle.com,http://www.buzzle.com/articles/profit-repatriation-the-foreign-direct-investment-incentive.html

• US.Gov.TradeFinanceGuide2007pp3-28


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ForSourcingandShoring

• Markingprogressagainstchildlabour-Globalestimatesandtrends2000-2012/InternationalLabourOffice,Int’lProgrammeontheEliminationofChildLabour(IPEC)-Geneva:ILO,2013.

• TraffickinginPersonsReport,USDeptofState,July2015


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EnterpriseResilience

SummaryCompaniesarereliantontheirsupplychains,asaresultofthis,theyarevulnerabletodisruptionswhichposearisktotheirbusiness.Whileallbusinessesareatrisk,therearesomemoreresilientthanothers,meaningthattheyrecoverquickly.Tounderstandthesetwoconcepts,wefocusonhowtoestimaterisks,howtodealwiththemintermsofprioritizingandhowtopreparecompaniesfordisruptions.Finally,weanalyzehowtorespondandmitigatetheproblemsonceadisruptionoccurs.Therearetwodifferentwaystolookatdisruptions,i)thinkingaboutcausesandii)thinkingabouteffectsormodesoffailures.Causethinkinghelpsestimatelikelihoods,whileeffectsthinkinghelpsestimateimpactsandconsequences.

KeyConcepts

RisksandDisruptions

CausesofDisruptionsThesearedifferenttypesofrisksorcausesofdisruptions:

• RandomPhenomena:weatherphenomenaornaturaldisasters• Accidents:anyundesirableevent,suchasexplosions• Governments&Politics:tradebarriers,tradeembargo,militarycoups,political

instability,changesinregulations• Non-Compliance:non-complianceofstandardssuchasairpollution,water

contamination,safety,etc.• Competition:technologicalinnovation,processinnovation• Economy:macroeconomicshocksthatleadtoeconomiccontractionssuchasfinancial

economicrecessionsanddepressions• Socialdisconnect:companiesnotconnectingwithcustomers’willanddesire• Intentionaldisruptions:whenthereisasmartattackerontheotherside,whowill

attackintheworsttimeandworstplace,includingterroristattacks,strikes,cyberattacks

ModesoffailureThesearewayshowsupplychainscanfailand/oreffectsofdisruptions:

• Inabilitytoacquiresupplies• Inabilitytoship/lossofshipment• Inabilitytocommunicate• Inabilitytoconvert• Lossofpersonnel


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• Unavailablecredit• Brand/Trustdiminution

Figure:CausesandEffectsofDisruptions


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Bow-TieRiskAnalysisFrameworkOne of the classical frameworks for thinking about risk and disruption is the Bow-Tie RiskAnalysisFramework:

Figure:Bow-TieRiskAnalysisFramework

DisruptionProfile

Figure:DisruptionProfile


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ClassificationofRisksThe traditional classification used to prioritize risk, includes two dimensions: probability ofdisruption and consequences. Usually supply chain managers focus on the severeconsequences-high probability quadrant (upper right). However, themost dangerous eventsarethoseinthesevereconsequences-lowprobabilityquadrantbecausecompaniesaretypicallynotpreparedanddonotknowhowtopreparefortheseevents.

Figure:Twodimensionalclassification:DisruptionProbabilityvsConsequences

In addition to disruption probability and consequences, a three dimensional classificationincludesdetectability.Dependabilityisdefinedashowlongittakesfromthetimeweknowthataneventisgoingtohappenuntilithappens.

• Probability:investigatethecausesandestimatetheirlikelihoods• Consequences:identifyimpact,prepareoptions,drills,mitigateoptionsandwaysto

“bounceback”• Detection:developdetectionabilityanddefinedecisionrules

PowerLaw:LikelihoodandImpactLikelihoodandimpactofmanydisruptionsobeythepowerlaw,whichcanbeusedtoestimatetherelationshipbetweenthefrequencyanddamageofevents.

𝑓(𝑥) = 𝑥IJ

DetectabilityandPreparationThereisathirddimensiontocharacterizedisruptions:detectability.Thewarningsignstoidentifysuppliersarepresented.thethreetypesofelementstopreparefordisruptionarediscussed:redundancy,flexibilityandpreparation.

WarningLagThewarninglagisthetimebetweenalarmandevent.Itcanoccur:

• Aftertheattack:inthiscasethetimeofdetectionisnegative,youdiscoverthatsomethinghappenedonlyaftertheeventoccurred

• Immediate:thetimebetweenthealarmandtheeventiszero,yourealizethattheeventishappeningwhenitsoccurring


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• Shortterm:thereissometimebetweenthealarmandtheeventbutnotmuchtoprepare

• Mediumterm:thereistimebetweenthealarmandtheevent,allowingthecompanytoprepare

• Longterm:thetimebetweenthealarmandtheeventislongsothereisopportunity,enoughtimetoprepareandtakeactions

WarningSignsofSupplierFailureThese might be signals that will allow you to sense that something is happening with thesupplier:

• Financial:failuretopreparetimelyfinancialreports,multipleadjustmentstoannualreports,frequentnegotiationsofbankingcovenants,deterioratingworkingcapitalratios,lengtheningaccountspayable

• Operational:highemployeeturnoverinkeypositions,failedprojects/failedacquisitions,operatingloss,lackofcapitalinvestment,late/misseddeliveries,qualityissues,billingandinvoicingerrors,carrierselectionerrors

ResilienceFundamentalsCompaniesshouldweighthebenefitsofuncertainfuturecostagainstcertaincurrentcosts.Currentcostsarederivedfromthethreewaystopreparefordisruption:

• Redundancy:iscreating/havingsomeextracapacity,inventory,suppliers• Flexibility:meansinterchangeability,isbeingabletochangeprocessesfast,cross-

trainingpeopletobeabletoperformmorethanonetask,usingpostponementandstandardization

• Readiness/preparation:ishavingrealoptionsorthetoolstorespond


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Safetymanagement

Figure:SafetyPyramid

DuPontBradleyCurve

Figure:DuPontBradlyCurve


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Waystodealwithlimitedsupply• Allocation:usesomecriteriatoallocatewhatisavailable• Auctions:givetheproducttothecustomerwhowantsitmost• Dilution• Substitution• Demandshaping

LearningObjectives• Understandtheconceptofwarninglag• Learnresiliencefundamentals• Understandhowtopreparefordisruptions• Learnhowtothinktoprioritizeandtoprepareforrisks• Distinguishbetweendifferentcausesofdisruptionsandeffects

ReferencesSheffi,Y.(2015)ThePowerofResilience:HowtheBestCompaniesManagetheUnexpected(MITPress)

Sheffi,Y.(2005)ResilientEnterprise:OvercomingVulnerabilityforCompetitiveAdvantage


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ExogenousFactorsExogenousFactorsareexternalfactorsbeingforcedonthesupplychainthatbusinesshaslittlecontrolover.Theymaybeexpectedorunexpectedbutcanoftenshapethewaythatsupplychainsoperateandmayforcedifferentresponses.Inthislessonwewillwalkthroughexogenousfactors,theirsources,examples,andhowcompaniesrespond.

SourcesofExogenousFactors(STEEPFramework)OnewaytoorganizethevariousfactorsimpactingthesupplychainistheSTEEPFrameworkwhichconsistsofsocial,technological,economic,environmental,andpoliticalimpacts.

• Socialfactorsincludedemographics,religion,lifestylesandvalueso ex:agingpopulation,crowdsourcing

• Technologicalfactorsincludeinnovations,communication,R&D,andpatentso Ex:machinelearning,apps

• Economicsfactorsincludeinterestrates,globaltrade,taxes/fees/finesandinflationo Ex:tradebetweencountries,financials

• Environmentalfactorsincludeavailabilityofresources,air&quality,foodsafety,pollution

o Ex:drought,emissions,waterpollution,productdisclosure,laborconditions• Politicalfactorsincluderegulatorystance,Governmentstability,taxpolicies,andtrade

unionso ex:disclosure,absoluterequirements

RegulationsRegulation:aruleordirectivemadeandmaintainedbyanauthority,typicallygovernments.Economistsviewofregulationsarethattheyarebasicallyeconomicorsocial.Economicregulationssetwhocansellandwhattochargesuchasmarketentry/exit,pricecontrols.Whilesocialregulationspreventmarketfailuresbycorrectingfornegativeexternalitieslikepollution,safetyasallweinformationdisclosuretoconsumers.

Typesofregulationbymechanism:Regulationscanbeappliedincertainways–asyoucanseeinthefollowingexamples.


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Theobjectiveofregulationsistoimpactbehaviorwhetherthatbediscouragingabehaviorbybanningorencouragingabehaviorbyrequiringit.Therearemanychallengeswithregulationsincluding:

• Theyaffectalmosteveryeconomicactivitytosomedegree,• Theyareconstantlychanging–deregulationorincreaseinregulation,• Theyareofteninconsistent(andsometimeopposing)acrossregionsandcountries,and• Firmsareresponsibleforknowingandcomplyingwithallexistingregulationsandlaws.

ImpactsontheSupplyChainImpactsonthesupplychaincanberefinedtogovernment,society,naturalresources,andcustomers.Thesefactorsareactivelyinfluencinghowsupplychainsaredesignedandoperate.Firmandsupplychainbehaviorcanbeinfluencedbyboth“hard”(Government&NaturalResources)and“soft”(Society&Customers)factors.Forinstance,howcananeventorexogenousfactorsimpactfreightflows.Itcanhaveanimpactonsourcingpatterns,flowdestination,routing,flowvolume,andvaluedensity.


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Therearemanytypesofregulationsthatareimpactingthesupplychain,somewewillcoverincludefactorsrelatedtoproductsandprocesses.

• Productso Directcontent(testable)o Lifecycleorpedigree(credence)

• Processeso Endoflifeactivitieso Transportation,logistics,packagingo Sourcingpractices

RegulationsonProductContentAsfarasconsumersgo,thereisanincreasingamountofattentionandconcernbasedonwhetheraproductisingested(foodandpharmaceuticals),wornorinimmediateproximity(clothes,cellphones),orinthegeneralenvironment(metalsinelectronicgoods,carbon).VariousRegulationsacrosstheglobefocusedonhazardouscontent:Europe:regulationsfocusedonchemicalsandrawmaterialsinelectronicsandrecycling

• RoHS(RestrictionofHazardousSubstancesDirective)• WEEE(WasteElectricalandElectronicEquipmentDirective)• REACH(Registration,Evaluation,AuthorisationandRestrictionofChemicals)

China:OrderNo.39FinalMeasuresfortheAdministrationoftheControlandElectronicInformationProducts(sometimescalledthe“ChinaRoHS”)SouthKorea:ActforResourceRecyclingofElectricalandElectronicEquipmentandVehiclesCalifornia:ElectronicWasteRecyclingActof2003(EWRA).


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MonitoringCredenceAttributesCredenceattributesarethosethatarenottestablebyadownstreamcompanyortheconsumer.Therearedifferentattributesthatmakeupaproduct.Somearetestableandsomearenot.Typesthataretestablebyadownstreamconsumermightincludethecolorortextureortheexperienceofaproductlikethesweetnessorconsistency.CredenceattributesareNOTtestable.Thoseareattributesthatarepracticesinthesupplychainbutarenottestablesuchascarbonfootprint,childlabor,orfoodsafetyadherence.Howtohandleaproblemlikecredence:

• Weneedtomeasure,monitor,track,andtrace• Forenvironmentalevaluation,requiresLifeCycleAnalysis(LCA)

o Product-centric,cradle-to-graveanalysiso Boundaries(breadth,depth,precision)

• MostCommonMethodtohandlecredence:Labels§ StandardSetting:Needagreedupontargets,terminology&definitions

o Testing–objectivemeasure§ Fortestableattributes–describemethodforassessment§ Forcredenceattributes-needtoTrackandTracetopreservethe

“identity”oftheproduct(thusneedforLCA!)o CertificationProcess

§ Self-certificationversus3rdpartycertification§ Certificationoftheexternalcertifiers!

o EnforcementofStandards§ Legalversussocialversusmarket...

DisclosureRegulationsOneofthemostobviousregulatoryimpactonsupplychainsaredisclosureregulations.Thesearethatrequirecompaniestodisclosecertaininformationaboutpracticesandprocessesinthesupplychain.ExamplesincludetheCaliforniaTransparencyinSupplyChainActandUK’sModernSlaveryAct.Forinstance,companiesofacertainsizemustdisclosewhethertheyhaveforcedlaborintheirsupplychain.Forceslaborisallworkorservicewhichisexactedfromanypersonunderthethreatofapenaltyandforwhichthepersonhasnotofferedhimselforherselfvoluntarily(ILO).MostCommonFormsinSupplyChains

• Bondedlabor-workingtopayoffaneverendingdebt• Forcedlabor-forcedtowork,cannotescape• Migrantworkers-noalternativestosurvive• Domesticworkers-cannotleavethehouse

CommonIndustries:


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• Agriculture• Manufacturing• Textile&Garments• Mining• Fishing• Warehousing

Childreninemployment–allchildrenengagedinanyeconomicactivityfor≥1hour/week,forpayornot,parttimeorfulltime,insideoroutsidethefamilysetting.Childreninchildlabor–subsetofabove–workersbelowtheminimumageengagedformanyhours/weeknotdoingpermitted“lightwork.”Hazardouswork–subsetofabove–childrenengagedinworkthatisharmfultotheirsafety,healthandmoraldevelopment.Includesnightwork,longhours,exposuretophysical,psychologicalorsexualabuse;workunderground,underwater,atdangerousheights,inconfinedspaces,heavyloads,dangerousmachinery,dangeroussubstances.ComparingtheDisclosureregulationsCaliforniaTransparencyinSupplyChainsAct-acompanymustdisclosetowhatextent,ifany:

• Engagesinverificationofproductsupplychainstoevaluateandaddressrisksofhumantraffickingandslavery.Thedisclosureshallspecifyiftheverificationwasnotconductedbyathirdparty.

• Conductsauditsofsupplierstoevaluatesuppliercompliancewithcompanystandardsfortraffickingandslaveryinsupplychains.Thedisclosureshallspecifyiftheverificationwasnotanindependent,unannouncedaudit.

• Requiresdirectsupplierstocertifythatmaterialsincorporatedintotheproductcomplywiththelawsregardingslaveryandhumantraffickingofthecountryorcountriesinwhichtheyaredoingbusiness.

• Maintainsinternalaccountabilitystandardsandproceduresforemployeesorcontractorsfailingtomeetcompanystandardsregardingslaveryandtrafficking.

• Providescompanyemployeesandmanagement,whohavedirectresponsibilityforsupplychainmanagement,trainingonhumantraffickingandslavery,particularlywithrespecttomitigatingriskswithinthesupplychainsofproducts.

• ModernSlaveryAct-Anorganization’sslaveryandhumantraffickingstatementmayincludeinformationabout:

• theorganization’sstructure,itsbusinessanditssupplychains;• itspoliciesinrelationtoslaveryandhumantrafficking;• itsduediligenceprocessesinrelationtoslaveryandhumantraffickinginitsbusiness

andsupplychains;• thepartsofitsbusinessandsupplychainswherethereisariskofslaveryandhuman

traffickingtakingplace,andthestepsithastakentoassessandmanagethatrisk;


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• itseffectivenessinensuringthatslaveryandhumantraffickingisnottakingplaceinitsbusinessorsupplychains,measuredagainstsuchperformanceindicatorsasitconsidersappropriate;

• thetrainingaboutslaveryandhumantraffickingavailabletoitsstaff.Takeawaysforsupplychainmanagers:

• Requiresmappingofsupplychains• Addedvendor/suppliercompliancevetting–inclusionofa“SupplierCodeofConduct”• Riskassessmentincludesnotonlylegalcompliance,butforreputationandmarketrisks• Contractinganduseof3rdpartyauditingfirms/organizations• Butlaborisjustoneattributeofmanythatarebecomingscrutinized• Shouldfirmstreatthemallequallyordifferourresponsebasedonotherfactors?

UnintendedConsequences–AcautionaryTaleAsregulationsarewellmeaningandaredesignedtoimproveconditionsbycontrolling,practicesandprocesses,theycansometimeshaveunintendedconsequences.Forinstance,theDodd-FrankWallStreetReformandConsumerProtectionActof2010:“AnActtopromotethefinancialstabilityoftheUnitedStatesbyimprovingaccountabilityandtransparencyinthefinancialsystem,toend"toobigtofail",toprotecttheAmericantaxpayerbyendingbailouts,toprotectconsumersfromabusivefinancialservicespractices,andforotherpurposes.”InSection1502–itrequiredthedisclosureoftheuseofconflictminerals.Thecountryoforiginisessentiallyacredenceattributefortheseminerals.SupplyChainresponseforDodd-Frank

• Wherearethechallenges?o Manufactureditemscancontainhundredstothousandsofparts/components

andsuppliers/vendorso MineralcontentisusuallynotcontainedinBOMorERPo Sourcingofmaterialsisglobalandsuppliersfromothercountriesarenot

requiredtoassisto Any3TGfoundtobefromthecoveredarearequiresmuchhigherscrutinyand

detailedreporting• Whatcouldpossiblygowrong?

o Costofcomplianceformanufacturercanbeveryhigh§ Estimated>10millionpaperworkhoursannuallyspentbyfirms§ Over$10billioninadditionalcostsannually(2016)§ In2014,Intelsent90employeestoinvestigatesmeltersglobally

o ThishasledtoaninitialdefactoembargoofmineralsfromtheDRCresultinginlossofrevenuetolegitimateminesinthearea

o Continuing(orincreased)salesofconflictmineralstofirmsincountriesnotoperatingundertheseregulations


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SimilarunintendedconsequencesinEndangeredSpeciesActof1973andComprehensiveEnvironmentalResponse,Compensation,andLiabilityActof1980(superfund).

ProductOrientedRegulations/Pressures• Safety–ensuresafeoperationsacrosssupplychain

o Examples:HoursofService(HOS)Rules,TruckSizeandWeightRestrictions,DriverLicensing,ElectronicLogbooks(ELD)

o Caninfluencedesignandoperationofnetworkso Typicallytreatedasabsolutemandatesorconstraints

• WasteReduction–promotesmoreefficientuseofresourceso Examples:Truckfuelefficiency,GHGemissionsbytrucks,Smartpackagesizing,

Efficientmodeselection(TLtoIMconversion),Zero-wastefacilitieso Happycoincidencethatreductionofwaste(miles,cardboard,fuel)improves

efficiencyandusuallyreducestotalcostso Typicallytreatedascostreductionsinmakingbettertrade-offdecisions

• End-of-Life–encouragecompaniestodesignproductsforreuse,recyclability,andmaterialsreduction

o Examples:EUdirectivesandregulationsonPackagingandpackagingwaste(1994),EndofLifeVehicles(2000),WasteElectricalandElectronicEquipment(2003),BatteriesandAccumulators(2006)etc.

o Takesmanydifferentformsinvolvinggovernments,manufacturers,andotherso Introduces(imposes)entirelynewprocessestosupplychains

ForEndofLifeProcessestherearetwomainapproaches:ProductStewardshipandExtendedProducerResponsibility(EPR).Product-centricstrategyiswhereeveryoneinvolvedinthelifespanoftheproductisresponsibleforallenvironmental,health,andotherimpacts.EPRisManufacturercentricstrategydesignedtopromotetheintegrationofenvironmentalcostsassociatedwithgoodsthroughouttheirlifecyclesintothemarketpriceoftheproducts.Inrelationtothistherearetake-backlawstopreventwaste.Theirprimarygoalistopreventwasteencouragecompaniestodesignproductsthatareeasiertoreuseorrecycle,containsafermaterials,reducetheirenvironmentalimpact,andminimizewastemanagementcosts.AswellasPromoteinnovationinrecyclingtechnology&collectionsystems


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FirmResponseandApproachAcompanyneedstosegmentitsresponsetotheseissuesforstrategy.Theymustsegmentpotentialresponsesandactionbasedonpressureandimportance.Responsesareonacontinuumfrom“Donothing”to“FocusallActivities”.Awayofidentifyingwhatisimportanttothecompanyandtothestakeholdersisamaterialityassessment,thereareothersimilarframeworksfordongthis.


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Warning!Thislessonbarelyscrapesthesurfaceofanever-changingandincreasinglyimportanttopic!Itisnotintendedtomakeyouanexpert,justprovideyouwithaframeworktothinkabouthandlingexogenousforcesinyoursupplychain.

LearningObjectives• Recognizetherearemanyexogenousfactorsbeingplacedonthesupplychainincluding

social,market,government,andnatural.• Identifytypesofregulationssupplychainsareheldresponsibleandtheirimpactonthe

supplychain.• Becomefamiliarwithdifferentproductattributeslikedirectandcredence.• Reviewsupplychainprocesseslikesafety,wastereduction,andend-of-life.• Understandthatfirmscanrespondindifferentwaysandaresegmentedbyfactor,

market,etc.


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PalmOilCaseStudyPalmOilisawidelyusedoilinalargerangeofproducts.ItiscommoninmostCPGproductsbecauseofitspropertiesaswellaspackagedfoodproductsbecauseofitsshelflifeandattributesasanon-transfat.ThereasonswespendsomuchtimefocusingonpalmoilisbecauseitbringstogethermanyoftheexogenousfactorswereviewedinLesson1andculminatesindifferentresponsesfromdifferentcompaniesbasedontheirstakeholders’demandsandbusinessinterests.Palmoiliswithyoualldaylong:

TheRiseofPalmOil• 1848–oilpalm,anativeofWestAfricawasbroughtbyDutchTraderstoSEAsia• Foundusefulinsoapandlubricantforsteamengines,grewwellinSEAsia• Grewrapidlyin1960sinSEAsia,esp.inMalaysiawheregovernmentsoughttoreduce

thecountry’sdependenceonrubberandtin.


5


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• DemandgrewandplantationstookoverinMalaysiaandIndonesia,today85%ofpalmoilfromthesetwocountries

TogetherMalaysiaandIndonesiamakeupover85%ofthemarket!

AtthesametimePalmoilhasgrownrapidlyindemand,sohasareasofforestcleared.Itsclearthattherearemanyreasonsforforestcleared,butthisshowssomecorrelationbetweenthetwoprocesses.Andin2010–KitKat,NestlewasattackedfortheiruseofpalmoilbyGreenpeace.Thispropelledthisissueintothepubliceye.

Indonesia45%

Malaysia43%

Thailand2%

Nigeria1%

Colombia2%

Other7%

GlobalPalmOilProduction2015

Indonesia Malaysia Thailand Nigeria Colombia Other


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PalmOilEndtoEnd

TheProblemwithPalmOilTherapiddemandofpalmoilhasresultedinbothpositivesandnegatives.ThepositiveimpactofpalmoilisthatitprovideseconomicgrowthtocountrieslikeMalaysiaandIndonesia,itbringlivelihoodstosomethatdidnothaveviablelivelihoodprevioustopalmoil,itismoreproductivepertreethanitsnearestcompetitor,infact10xmoreproductivemeaningittakesuplessspacetoproducethesameamountofoil,anditisalsonotatransfat.

SocialandenvironmentalImpactsHowever,therapiddemandbeginningespeciallyinthe2000shascausedrapiddeforestationthatresultsincarbonemissionsasaresultofrainforestclearing,hazefromburningofrainforest,lossofbiodiversityasaresultofrainforestclearingandmore.Therearealsoextensivesocialimplicationssuchas:

OIL PALMPLANTATIONS

INITIALMILLINGCONVERSION /

PRODUCTION

PROCESSING

TRANSPORT /TRADE /

DISTRIBUTION

MANUFACTURING

RETAIL /CONSUMPTION

CRUDE PALM &PALM KERNEL

OIL

PALMKERNEL

CAKE

REFINING /FRACTIONATION

TRADERS &EXPORTERS

FEEDPRODUCERS

LIVESTOCKINDUSTRY

FURTHERREFINING &BLENDING

OELO-CHEMICALS

BIOFUELSINDUSTRY

EDIBLE OILS

FOOD INDUSTRYCHEMICAL &PERSONAL CARE

INDUSTRIES

DAIRY ANDMEAT

BIODIESEL ANDPOWER

GENERATION

SOAPS,CANDLES,

COSMETICS,DETERGENTS,LUBRICANTS,

SOLVENTS ETC.

FATS,MARGARINES,COOKING OIL,ICE CREAMS,

SHORTENINGS ETC.

PALM OIL


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• Childandfamilylaborandinsufficientprotection• Frequentuseofforced,bondedlabor• Useoffixedshorttermcontracts• Landgrabs• Complexandopaquesupplychain

TypesofPlantationsPalmoilislargelygrownon3typesofpalmoilplantationsincludingestates,associatedorschemesmallholdersandsmallholders.Bothestatesandassociatedorschemesmallholdersaregenerallymoreorganizedandeasiertoworkwith.Estatesareoftenownedbylargercorporationswhileassociatedorschemesmallholdersarestructurallyboundbycontractorcreditagreementtoaparticularmill.Smallholdersaregenerallyselffinanced,managed,equipped,andnotboundtoanyonemill.

OrganizationforSustainabilityTherearemanydifferenttypesororganizationsworkingtowardsmoresustainablepalmoil.Theyhavedifferentobjectives,strategies,andapproachesandoftenhaveconflictoverwhatsustainablepalmoilmeans.Someareadvocatingforthecause,somearecatalystsforchange,andsomesupportbusinessintheirjourneytoachievemoresustainablepalmoil.

• NGOso TheForestTrusto WorldResourcesInstituteo WildAsiao RainforestActionNetwork

• Industryassociationso RoundtableonSustainablePalmOil(RSPO)o PalmOilInnovationGroup(POIG)

• Andmanymore…Tobegintoencouragesustainablepalmoil,therearethreemainwaystotracematerialtosourcetoverifypractcesontheground.Seebelow:


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CorporateResponsesBuildontheframeworkfromLesson1ExogenousFactors,thisframeworkaddssomemorespecificsonpracticesinthe“embrace”category.Onecaninsurebyputtinginextrameasurestomakesuretheyarenotcommittingillpracticesintheirsupplychain.Theymightre-designorchangesomethingintheirsupplychaintoimprovepracticesinthesupplychain.Andinthegreatestamountofefforttheymighttransformapartoralltheirsupplychaintoensuresustainablepractices.

DifferentcorporateresponsesarereviewedbetweenNestle,Unilever,P&G’sandandDr.Bronner’sdifferentapproaches.Basedontheircompanyorientation,pressurefromNGO’s,capacitytochange,andlongtermobjectives,eachcompanyhadadifferentapproach.Nestle

Avoid

Comply

Insure

Re-Design

Transform


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spentalotoftheireffortsongettingahighleveloftraceabilitytosources,thisisparticularlybecauseofGreenpeace’sattacksandtheirnaivetyonwheretheirmaterialwascomingfrom.P&Gspentalotoftimeresearchingtheiroptionsandessentiallyfocusedtheireffortsonsupportingsmallholdersbecauseoftheirportionofspendonsmallholders.Unilever,withtheirorientationtowardsindustrywidechange,workedheavilyondifferentorganizationsandcollaborationsthatsoughttoelevatethepracticesinthepalmoilsupplychain.ForthesmallDr.Bronner’s,theirwholecompanyorientationwasonsustainablesupplychains,sotheychosetospendconsiderabletimetransformingtheirsupplychainbyverticallyintegratingwithasubsidiary.

DifferentScenariosforPalmOil• Manydifferentscenariosaswecanimagine(ScenarioPlanning)

o Allpalmoilbecomessustainable,sustainablepalmoilbecomescostcompetitiveo Companiesmoveawayfrompalmoilasakeyoilsourceo Continueonpathwithincrementalchanges

• Thisproblemisnotisolated,similarchallengeswithothermaterials:

o Socialpressureo Finiteamountso Regulationo MarketDemand

LearningObjectives• Recognizethedifferentexogenousfactorsapparentinthepalmoilsupplychain• Becomefamiliarwiththedifferentforcesbeingplacedonthesupplychainandthenew

expectationsbysocietyandconsumers• Becomefamiliarwithcommoditysupplychainchallenges• Recognizecompanieswillrespondindifferentwaysbasedontheirorientation,capacity,

andlongtermgoals• Identifydifferentscenariosandhowtheymighthelpcompany strategy