Supply Chain Management in Operations Management

Why sup­ply chain man­age­ment is impor­tant#

Con­sider a packet of bis­cuits in a neigh­bour­hood shop. Wheat, sugar and oil come from farm­ers and proces­sors; pack­ag­ing comes from a print­ing firm; the fac­tory bakes and packs the bis­cuits; a ware­house stores them; dis­trib­u­tors and retail­ers carry them to the shelf. If any link fails, the shelf is empty and the sale is lost. SCM coor­di­nates all these links so that they act like one sys­tem.

Good SCM:

• reduces total cost across pur­chas­ing, pro­duc­tion, stor­age and trans­port;
• improves prod­uct avail­abil­ity and deliv­ery speed;
• cuts excess inven­tory while avoid­ing stock-outs;
• improves coor­di­na­tion between depart­ments and part­ner firms;
• helps the busi­ness respond to changes in demand and to dis­rup­tions.

The main idea is that each firm should not opti­mise only its own part. Deci­sions are judged by their effect on the whole chain.

Stages of a sup­ply chain#

Sup­plier#

Pro­vides raw mate­ri­als, com­po­nents and ser­vices. Sup­pli­ers may them­selves have sup­pli­ers, form­ing tiers.

Man­u­fac­turer#

Con­verts inputs into fin­ished prod­ucts.

Ware­house#

Stores raw mate­ri­als and fin­ished goods, and often sorts, packs and con­sol­i­dates ship­ments.

Dis­trib­u­tor#

Buys in bulk from man­u­fac­tur­ers and sup­plies smaller quan­ti­ties to retail­ers over a wide area.

Retailer#

Sells to final con­sumers through shops or online stores.

Cus­tomer#

The final user, whose demand dri­ves the whole chain.

The side nearer to sup­pli­ers is called upstream; the side nearer to cus­tomers is down­stream.

The three flows in a sup­ply chain#

• Mate­r­ial flow – raw mate­ri­als, parts and fin­ished goods move down­stream towards the cus­tomer; returns, repairs and recy­cling move upstream (reverse logis­tics).
• Infor­ma­tion flow – moves in both direc­tions: orders, sales and fore­casts go upstream; sched­ules, stock lev­els, ship­ping notices and deliv­ery sta­tus come down­stream.
• Money flow – pay­ments move upstream from cus­tomer to sup­plier, shaped by prices, credit terms and invoic­ing.

Oper­a­tions man­age­ment ver­sus sup­ply chain man­age­ment#

Objec­tives of sup­ply chain man­age­ment#

Ensure a smooth flow of mate­ri­als#

Inputs and prod­ucts should move with­out inter­rup­tion.

Reduce total cost#

Cut the com­bined cost of buy­ing, mak­ing, stor­ing and mov­ing, not just one of them.

Improve cus­tomer ser­vice#

Raise avail­abil­ity, speed and reli­a­bil­ity of deliv­ery.

Reduce inven­tory prob­lems#

Avoid both over­stock­ing and stock-outs.

Improve coor­di­na­tion#

Share plans and data among part­ners so that deci­sions line up.

Increase speed and effi­ciency#

Shorten lead times and the cash-to-cash cycle.

Com­po­nents of sup­ply chain man­age­ment#

• Pur­chas­ing (sourc­ing) – select­ing sup­pli­ers, nego­ti­at­ing and buy­ing inputs.
• Pro­duc­tion – mak­ing the prod­uct to plan, on time and to qual­ity.
• Inven­tory man­age­ment – decid­ing how much stock to hold and where.
• Ware­hous­ing – stor­ing, han­dling and con­sol­i­dat­ing goods.
• Trans­porta­tion – choos­ing modes (road, rail, sea, air, pipeline) and car­ri­ers.
• Infor­ma­tion man­age­ment – ERP sys­tems, bar­codes, elec­tronic data inter­change and track­ing.
• Dis­tri­b­u­tion – design­ing the net­work that deliv­ers prod­ucts to cus­tomers.

Impor­tance of infor­ma­tion in SCM#

Infor­ma­tion is what allows part­ners to act together. When sales data, stock lev­els and fore­casts are shared, each stage can plan pro­duc­tion and orders more accu­rately. When infor­ma­tion is miss­ing or delayed, each stage guesses, adds its own safety mar­gin and the chain holds more stock than it needs.

The bull­whip effect#

The bull­whip effect is the ten­dency for order quan­ti­ties to swing more and more as one moves upstream, even when cus­tomer demand is fairly steady. Its causes include each stage fore­cast­ing from its own incom­ing orders, order­ing in large batches, price pro­mo­tions that encour­age for­ward buy­ing, and rationing dur­ing short­ages. Shar­ing point-of-sale data, reduc­ing lead times, order­ing in smaller lots, sta­ble pric­ing and ven­dor-man­aged inven­tory all reduce it.

Sup­ply chains in man­u­fac­tur­ing and ser­vices#

Man­u­fac­tur­ing exam­ple#

A car maker buys steel, tyres, glass and elec­tron­ics from many tiers of sup­pli­ers, assem­bles cars and sends them through deal­ers to buy­ers. Its sup­ply chain is mostly about phys­i­cal goods.

Ser­vice exam­ple#

A hos­pi­tal's sup­ply chain brings med­i­cines, equip­ment, food and linen, and depends on lab­o­ra­to­ries, ambu­lance ser­vices and insur­ers. Here the cus­tomer often takes part in the process, so capac­ity and infor­ma­tion mat­ter as much as goods.

Sup­ply chain strat­egy and struc­ture#

Ver­ti­cal inte­gra­tion#

A com­pany owns more than one stage of its own chain. Back­ward inte­gra­tion means own­ing sup­pli­ers, such as a steel maker buy­ing iron ore mines; for­ward inte­gra­tion means own­ing dis­tri­b­u­tion, such as a man­u­fac­turer open­ing its own show­rooms. It reduces depen­dence on out­siders but needs large invest­ment and reduces flex­i­bil­ity.

Hor­i­zon­tal inte­gra­tion#

A firm joins with other firms at the same stage, for exam­ple one man­u­fac­turer merg­ing with another. It increases scale and mar­ket share and may reduce com­pe­ti­tion.

Effi­cient and respon­sive sup­ply chains#

Func­tional prod­ucts with sta­ble demand, such as salt or soap, suit an effi­cient chain focused on low cost and high util­i­sa­tion. Inno­v­a­tive prod­ucts with uncer­tain demand, such as fash­ion gar­ments or new phones, suit a respon­sive chain focused on speed and flex­i­ble capac­ity.

Chan­nel strat­egy#

Chan­nel strat­egy decides how the prod­uct will reach the final buyer: through whole­salers, dis­trib­u­tors, retail­ers, online stores or direct deliv­ery. The choice affects cost, speed, mar­ket reach and cus­tomer expe­ri­ence.

Out­sourc­ing#

Out­sourc­ing means giv­ing activ­i­ties such as trans­port, pack­ag­ing, ware­hous­ing or com­po­nent man­u­fac­tur­ing to out­side spe­cial­ists, includ­ing third-party logis­tics (3PL) providers. It can reduce cost, bring exper­tise and let the firm focus on core activ­i­ties, but heavy depen­dence on out­siders cre­ates risk and must be man­aged through con­tracts and mon­i­tor­ing.

Role of sup­pli­ers and ven­dor rat­ing#

Sup­pli­ers pro­vide the first inputs, so a weak sup­plier weak­ens the whole chain. Firms choose sup­pli­ers on qual­ity, price, deliv­ery reli­a­bil­ity, lead time and ser­vice, and mea­sure their per­for­mance with ven­dor rat­ing sys­tems that score sup­pli­ers on fac­tors such as qual­ity, cost and deliv­ery. Price alone is a poor guide, as the exam­ple below shows.

Worked exam­ple: total landed cost of two sup­pli­ers#

Sup­pose a man­u­fac­turer needs 10,000 units of a com­po­nent a year, used evenly over 250 work­ing days, that is 40 units a day. Two sup­pli­ers are avail­able.

Assume each defec­tive unit costs ₹50 to rework, and that the longer lead time of Sup­plier 2 forces the firm to keep 8 extra days of stock ($8 \times 40 = 320$ units) at a hold­ing cost of ₹15 per unit per year.

Sup­plier 1:

• Pur­chase: $10{,}000 \times 48$ = ₹4,80,000
• Trans­port: $10{,}000 \times 2$ = ₹20,000
• Extra hold­ing: ₹0
• Rework: $10{,}000 \times 0.005 = 50$ defec­tives, and $50 \times 50$ = ₹2,500
• Total landed cost = ₹5,02,500

Sup­plier 2:

• Pur­chase: $10{,}000 \times 45$ = ₹4,50,000
• Trans­port: $10{,}000 \times 4$ = ₹40,000
• Extra hold­ing: $320 \times 15$ = ₹4,800
• Rework: $10{,}000 \times 0.02 = 200$ defec­tives, and $200 \times 50$ = ₹10,000
• Total landed cost = ₹5,04,800

Although Sup­plier 2 is ₹3 cheaper per unit, Sup­plier 1 is cheaper over­all by ₹2,300 a year. Once trans­port, inven­tory and qual­ity are counted, the lower price does not give the lower cost.

Lead time in the sup­ply chain#

Lead time is the time between plac­ing an order and receiv­ing the mate­r­ial or prod­uct. If a com­pany orders raw mate­r­ial on Mon­day and receives it on Fri­day of the same week, the lead time is 4 days. Shorter lead time improves response speed and reduces uncer­tainty and stock. It also sets the reorder point when demand is steady:

$$\text{Reorder point} = d \times L$$

where $d$ is daily demand and $L$ is lead time in days. In the exam­ple above, Sup­plier 1 needs a reorder point of $40 \times 4 = 160$ units, while Sup­plier 2 needs $40 \times 12 = 480$ units, before any safety stock is added.

Mea­sur­ing sup­ply chain per­for­mance#

Two com­mon inven­tory mea­sures are:

$$\displaystyle \text{Inventory turnover} = \frac{\text{Cost of goods sold}}{\text{Average inventory}}$$

$$\displaystyle \text{Days of supply} = \frac{365}{\text{Inventory turnover}}$$

Worked exam­ple: inven­tory turnover#

Sup­pose a dis­trib­u­tor has an annual cost of goods sold of ₹60,00,000 and aver­age inven­tory of ₹7,50,000.

1. Inven­tory turnover $\displaystyle = \frac{60{,}00{,}000}{7{,}50{,}000} = 8$ times a year.
2. Days of sup­ply $\displaystyle = \frac{365}{8} = 45.6$ days.

The dis­trib­u­tor holds about 46 days of stock. Rais­ing turnover, for exam­ple to 10, would cut this to 36.5 days and free work­ing cap­i­tal. Other mea­sures include order fill rate, on-time deliv­ery per­cent­age, per­fect order rate and the cash-to-cash cycle.

Sup­ply chain and cus­tomer value#

A good sup­ply chain increases cus­tomer value because prod­ucts are avail­able when needed, deliv­ery is faster, stock-outs are fewer, goods arrive in good con­di­tion and ser­vice is more reli­able.

SCM in e-com­merce#

When a cus­tomer orders a phone online, the order infor­ma­tion reaches the sell­er's sys­tem, stock is checked at the near­est ful­fil­ment cen­tre, the item is picked, packed and handed to a courier, track­ing updates flow back to the cus­tomer, and pay­ment moves through the pay­ment gate­way to the seller. Speed depends on stock place­ment, ware­house processes and last-mile deliv­ery work­ing together.

Links with inven­tory and pro­duc­tion#

SCM decides where stock is held and how much, so inven­tory con­trol is a core part of it: too much stock ties up money, too lit­tle causes lost sales. SCM also depends on pro­duc­tion: the pro­duc­tion plan sets what mate­ri­als must be bought and when, and the deliv­ery promise depends on the pro­duc­tion sched­ule. This is why SCM is closely tied to pro­duc­tion plan­ning and con­trol and to pur­chas­ing.

Prob­lems in sup­ply chain man­age­ment#

• Delayed sup­ply – late inputs stop pro­duc­tion.
• Trans­port issues – vehi­cle short­ages, poor roads, port con­ges­tion and fuel price changes.
• Inven­tory imbal­ance – excess stock in one place and short­age in another.
• Poor coor­di­na­tion – part­ners work­ing on dif­fer­ent plans and data.
• Demand uncer­tainty – fore­casts are wrong, feed­ing the bull­whip effect.
• Qual­ity issues – defec­tive inputs cause rework, returns and delays.
• Global dis­rup­tions – nat­ural dis­as­ters, pan­demics, con­flicts and trade restric­tions.

Ben­e­fits of good sup­ply chain man­age­ment#

• Lower total cost and bet­ter profit mar­gins.
• Higher prod­uct avail­abil­ity and cus­tomer sat­is­fac­tion.
• Less work­ing cap­i­tal tied up in stock.
• Faster response to mar­ket changes.
• Stronger, longer-term rela­tion­ships with sup­pli­ers and chan­nel part­ners.
• Bet­ter resilience against dis­rup­tions.

Key terms#

Sup­ply chain

The net­work of organ­i­sa­tions and activ­i­ties that deliver a prod­uct from raw mate­r­ial to the final cus­tomer.

Upstream and down­stream

Upstream is towards sup­pli­ers; down­stream is towards cus­tomers.

Bull­whip effect

The grow­ing vari­abil­ity of orders as they move upstream in a sup­ply chain.

Lead time

The time between plac­ing an order and receiv­ing the goods.

Ver­ti­cal inte­gra­tion

Own­er­ship of more than one stage of the sup­ply chain by one firm.

Total landed cost

Price plus trans­port, inven­tory, qual­ity and other costs of get­ting an item to the point of use.

Inven­tory turnover

Cost of goods sold divided by aver­age inven­tory; how many times stock is sold in a year.

Third-party logis­tics (3PL)

An out­side firm that per­forms trans­port, ware­hous­ing or other logis­tics work for a com­pany.

Ven­dor rat­ing

A sys­tem that scores sup­pli­ers on fac­tors such as qual­ity, cost and deliv­ery.

Com­mon ques­tions#

What are the three flows in a sup­ply chain?#

Mate­r­ial flow, which moves mainly down­stream; infor­ma­tion flow, which moves both ways; and money flow, which moves mainly upstream.

How is sup­ply chain man­age­ment dif­fer­ent from logis­tics?#

Logis­tics deals with the move­ment and stor­age of goods. SCM is broader and also cov­ers sourc­ing, sup­plier rela­tions, pro­duc­tion coor­di­na­tion, demand plan­ning and infor­ma­tion shar­ing across firms.

What causes the bull­whip effect and how can it be reduced?#

It is caused by fore­cast­ing from orders rather than real demand, batch order­ing, price pro­mo­tions and short­age gam­ing. Shar­ing sales data, shorter lead times, smaller orders and sta­ble pric­ing reduce it.

Why should a firm not choose the sup­plier with the low­est price?#

Because trans­port, inven­tory, qual­ity and deliv­ery reli­a­bil­ity add costs. In the exam­ple above, the cheaper sup­plier cost ₹2,300 more per year once these were counted.

What is the dif­fer­ence between ver­ti­cal and hor­i­zon­tal inte­gra­tion?#

Ver­ti­cal inte­gra­tion joins dif­fer­ent stages of the same chain, such as a man­u­fac­turer own­ing its sup­pli­ers. Hor­i­zon­tal inte­gra­tion joins firms at the same stage, such as two man­u­fac­tur­ers merg­ing.

Ref­er­ences#

1. Chopra, S. and Meindl, P. Sup­ply Chain Man­age­ment: Strat­egy, Plan­ning, and Oper­a­tion. Pear­son.
2. Heizer, J., Ren­der, B. and Mun­son, C. Oper­a­tions Man­age­ment: Sus­tain­abil­ity and Sup­ply Chain Man­age­ment. Pear­son.
3. Chase, R. B. and Jacobs, F. R. Oper­a­tions and Sup­ply Chain Man­age­ment. McGraw-Hill Edu­ca­tion.
4. Kra­jew­ski, L. J., Mal­ho­tra, M. K. and Ritz­man, L. P. Oper­a­tions Man­age­ment: Processes and Sup­ply Chains. Pear­son.
5. Dick­son, G. W. (1966) "An analy­sis of ven­dor selec­tion sys­tems and deci­sions". Jour­nal of Pur­chas­ing, 2(1), 5–17.

Related read­ing#

• Pro­duc­tion Plan­ning and Con­trol (PPC) in Oper­a­tions Man­age­ment
• What is Pur­chase Man­age­ment?
• Ven­dor Selec­tion and Ven­dor Rat­ing