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Ch#4 – SC Drivers and Metrics

1. Facilities
Definition

Physical locations where products are manufactured, stored, or assembled. Two main types:

 Production facilities – factories, plants.

 Storage facilities – warehouses, distribution centers.

Activities/Practices

 Manufacturing: Assembling, processing, or fabricating products.

 Storage & Warehousing: Holding inventory for distribution.
 Distribution: Moving products closer to end customers.

Key Decisions

 Facility Role: Should it serve as a production site or storage site?

 Location: Where should facilities be located to optimize efficiency/responsiveness?
 Capacity: How much production or storage should each facility handle?
 Flexibility: Should facilities be specialized or adaptable to changing demands?

Example:

 Amazon expanded warehouses near customers to improve responsiveness.

 Blockbuster closed stores to cut costs, sacrificing responsiveness for efficiency.

1. Role in the Supply Chain

Facilities are the “where” of the supply chain:

 Manufacturing Facilities → Transform raw materials into finished goods.

 Warehousing/Distribution Centers (DCs) → Store and manage inventory before it
reaches customers.

2. Role in Competitive Strategy

Facilities impact both efficiency and responsiveness:

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 Centralized Facilities → Lower costs due to economies of scale but slower response
times.
 Decentralized Facilities → Higher responsiveness as they are closer to customers but
increase operational costs.

Example: Toyota & Honda establish manufacturing plants in multiple markets to balance
efficiency and responsiveness.

3. Components of Facilities Decisions

A. Role of Facilities

Firms must decide:

1. Flexible vs. Dedicated Facilities

o Flexible → Can handle multiple products but are less efficient.
o Dedicated → Specialize in specific products, increasing efficiency.
2. Product-Focused vs. Functional-Focused Facilities
o Product-Focused → Handles all functions (fabrication, assembly) for a specific
product.
o Functional-Focused → Specializes in a specific function (e.g., only assembly)
across different products.
3. Cross-Docking vs. Storage Facilities
o Cross-Docking → Quickly sorts and ships inventory with minimal storage time.
o Storage → Holds inventory for longer periods for future distribution.

B. Location Decisions

Companies must choose between:

 Centralization → Lower costs, but longer delivery times.

 Decentralization → Faster service, but higher costs.

Key Considerations:

 Economic factors (labor cost, tax policies).

 Infrastructure (transportation and supply chain connectivity).
 Proximity to customers and suppliers.

C. Capacity Decisions

Capacity planning balances efficiency and responsiveness:

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 Excess Capacity → Increases flexibility but raises costs.

 High Utilization → Reduces costs but limits ability to handle demand fluctuations.
 Optimal Trade-Off → Ensure facilities can meet demand fluctuations without excessive
idle time.

4. Facility-Related Metrics
Key performance indicators (KPIs) for facility management:

1. Capacity → Maximum production capability of a facility.

2. Utilization → Percentage of capacity currently in use.
3. Processing/Setup/Idle Time → Tracks time spent producing, setting up, or being idle.
4. Production Cost per Unit → Average cost per product, affecting profitability.
5. Quality Losses → Percentage of defective products, impacting costs and efficiency.
6. Theoretical vs. Actual Cycle Time → Compares ideal vs. real production times.
7. Flow Time Efficiency → Measures delays in the production process.
8. Product Variety → Higher variety increases complexity and costs.
9. Volume Contribution of Top 20% SKUs → Determines whether focusing on key
products improves efficiency.
10. Average Production Batch Size → Larger batches reduce costs but increase inventory
levels.
11. Production Service Level → Percentage of on-time and complete orders.

5. Overall Trade-Off: Responsiveness vs. Efficiency

The primary decision in facilities management is balancing:

 More Facilities → Higher responsiveness but increased facility and inventory costs.
 Larger/Flexible Capacity → Improves responsiveness but raises operational expenses.

Strategic facility decisions must align with the company’s competitive strategy to optimize
supply chain performance.

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2. Inventory
Definition

All materials and products at different stages: raw materials, work-in-progress, and finished
goods.

Activities/Practices

 Stocking strategies: Determining how much inventory to keep.

 Inventory replenishment: Deciding when and how to restock.
 Product demand forecasting: Using data to optimize inventory levels.

Key Decisions

 Quantity: How much inventory should be kept to meet demand?

 Location: Where should inventory be stored? (Centralized vs. Decentralized storage)
 Replenishment policies: When and how often should inventory be restocked?

Example:

 W.W. Grainger stocks high inventory to ensure quick customer fulfillment (high
responsiveness).
 Zara uses low inventory but fast restocking to balance cost-efficiency and agility.

Role in the Supply Chain

Inventory exists to address mismatches between supply and demand. It plays two key roles:

1. Enhancing responsiveness – Ensuring products are available when customers need

them.
2. Reducing costs – Taking advantage of economies of scale in production and distribution.

However, inventory also impacts financial performance and supply chain efficiency:

 High inventory improves responsiveness but may lead to markdowns and lower profit
margins.
 Low inventory improves inventory turnover but can result in lost sales.

Inventory also affects material flow time—the time between when materials enter and exit the
supply chain. Using Little’s Law (I = D × T), reducing inventory can decrease flow time,
improving efficiency without increasing costs.

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Little’s Law in Supply Chain Management (SCM) is a

fundamental equation that relates three key metrics in a system:

Inventory=Throughput ×Flow Time

Where:

 Inventory (I): The number of items (or work-in-progress) in the system.

 Throughput (R): The rate at which goods are produced or processed.
 Flow Time (T): The average time an item spends in the system from start to
finish.

How It Applies to SCM

1. Warehouse & Inventory Management:

o Helps determine how much inventory is needed to maintain a desired service
level.
o If flow time increases, inventory levels must also increase to maintain the
same throughput.
2. Production & Manufacturing:
o Used in Lean Manufacturing to minimize work-in-progress (WIP) and
reduce bottlenecks.
o Helps companies optimize production schedules by balancing throughput and
inventory levels.
3. Logistics & Distribution:
o Helps calculate how long products remain in the supply chain.
o Used to analyze how reducing lead times can improve efficiency and reduce
costs.

Example

A company produces 500 units per day and items spend an average of 10 days
in the system.
Using Little’s Law:

Inventory=500×10=5000 units

This means, at any given time, 5000 units are in the system. If the company
wants to reduce inventory, it can either increase throughput or decrease
flow time (e.g., by reducing lead times or improving efficiency).

Role in Competitive Strategy

The form, location, and quantity of inventory affect supply chain responsiveness and efficiency:

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 High inventory levels near customers → High responsiveness but high costs.
 Centralized inventory in raw material form → Low cost but reduced responsiveness.

Example: Amazon

 Best-selling books are stocked in multiple warehouses for responsiveness.

 Slow-moving books are stocked in fewer locations to save costs.
 Rare books are printed on demand to balance efficiency and responsiveness.

Key Inventory Decisions

1. Cycle Inventory – The average inventory used between supplier shipments.

o Large lots reduce ordering costs but increase carrying costs.
o Trade-off: Cost of holding large lots vs. cost of frequent ordering.

2. Safety Inventory – Extra inventory to handle unexpected demand.

o Example: A toy retailer must decide how much extra stock to carry for the holiday
season.
o Trade-off: Cost of excess inventory vs. lost sales due to stockouts.

3. Seasonal Inventory – Built up to handle predictable demand fluctuations.

o If adjusting production rates is costly, companies build inventory during low-
demand periods.
o Trade-off: Cost of holding extra inventory vs. cost of production flexibility.

4. Level of Product Availability – The percentage of demand fulfilled on time.

o High availability improves customer service but increases costs.
o Low availability reduces costs but risks losing customers.
o Trade-off: Cost of extra inventory vs. lost sales due to stockouts.

Inventory-Related Metrics

Inventory decisions impact the cost of goods sold, cash-to-cash cycle, assets held, and overall
supply chain responsiveness. Key inventory-related metrics that influence performance include:

 Cash-to-Cash Cycle Time – A high-level measure incorporating inventory, accounts

payable, and receivables.
 Average Inventory – Measures the average inventory carried in units, days of demand,
and financial value.
 Inventory Turns – The number of times inventory is replenished per year (ratio of
average inventory to cost of goods sold or sales).
 Products with Excess Inventory – Identifies items with high stock levels, helping to
detect oversupply or justify large inventories due to factors like slow movement or
discounts.
 Average Replenishment Batch Size – Measures the typical order size per SKU in units
and days of demand.

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 Average Safety Inventory – The average inventory available when a replenishment

order arrives, measured in units and days of demand.
 Seasonal Inventory – The extra stock purchased in anticipation of predictable demand
spikes.
 Fill Rate – The percentage of orders met on time from available inventory (measured
over a specified demand volume).
 Stockout Time Fraction – The percentage of time a product had zero inventory,
indicating potential lost sales.
 Obsolete Inventory – The percentage of inventory exceeding its obsolescence threshold.

Overall Trade-Off: Responsiveness vs. Efficiency

Managers must balance responsiveness (higher inventory ensures availability and customer
satisfaction) against efficiency (lower inventory reduces holding costs). Increased inventory can
lower production and transportation costs due to economies of scale but raises storage costs.
Optimizing this trade-off is key to effective inventory management.

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3. Transportation
Definition

The movement of inventory between locations in the supply chain.

Activities/Practices

 Shipping & delivery management: Choosing transport modes and optimizing routes.
 Load consolidation: Grouping shipments to reduce costs.
 Tracking & monitoring: Using technology to ensure on-time delivery.

Key Decisions

 Mode of Transport: Should the company use air (fast, expensive), truck (balanced),
rail, or sea (slow, low cost)?
 Route Selection: Should the shortest or most cost-efficient routes be chosen?
 Delivery Speed: Should the company prioritize fast delivery (higher costs) or cost
savings (slower transport)?

Example:

 FedEx offers fast but expensive shipping (high responsiveness, low efficiency).
 McMaster-Carr uses ground transportation for next-day delivery at lower cost.

Transportation in Supply Chain

Role in the Supply Chain

Transportation is crucial in moving products between supply chain stages, impacting

responsiveness and efficiency. Faster transportation increases responsiveness but reduces
efficiency due to higher costs. The choice of transportation mode affects inventory levels and
facility locations (e.g., Dell uses air transport for some components to reduce inventory
holding).

Role in Competitive Strategy

Companies use transportation to balance responsiveness and efficiency.

 High-value items (e.g., pacemakers) → Use fast transport and centralized inventory
for cost reduction.

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 Low-value, high-demand items (e.g., light bulbs) → Use low-cost transport (sea, rail,
full trucks) and keep inventory near customers.
 Example: Blue Nile → Uses overnight FedEx shipping to centralize diamond
inventory, reducing facility and inventory costs while maintaining responsiveness.

Key Components of Transportation Decisions

1. Transportation Network Design – Deciding if goods move directly to demand points or

through consolidation centers, and whether multiple supply/demand points are served in
one run.
2. Choice of Transportation Mode – Selecting among air, truck, rail, sea, pipeline, or
digital (for information goods) based on speed, shipment size, cost, and flexibility.
3. Transportation-Related Metrics:
o Inbound Transportation Metrics:
 Average inbound transportation cost (as % of sales or COGS).
 Average incoming shipment size (units or dollars per shipment).
 Cost per inbound shipment (assesses economies of scale).
o Outbound Transportation Metrics:
 Average outbound transportation cost (per unit or as % of sales).
 Average outbound shipment size (units or dollars per shipment).
 Cost per outbound shipment (identifies cost-saving opportunities).
o Mode Utilization: Fraction transported by mode (air, sea, rail, etc.), used to
optimize transportation strategy.

Overall Trade-Off: Responsiveness vs. Efficiency

Faster transportation improves responsiveness but increases costs. Slower, cost-efficient

transport reduces inventory holding costs but may impact service levels. Supply chain
managers must optimize this trade-off based on business strategy.

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4. Information
Definition

Data and analysis related to facilities, inventory, transportation, customers, and costs.

Activities/Practices

 Demand forecasting: Using real-time data to predict sales trends.

 Supply chain visibility: Ensuring stakeholders have access to crucial supply chain data.
 Information-sharing: Collaboration between suppliers, manufacturers, and retailers.

Key Decisions

 Data Collection: What information should be collected and analyzed?

 Technology Investment: Should advanced IT systems (AI, IoT, blockchain) be used?
 Access & Security: Who can access sensitive supply chain data?

Example:

 Seven-Eleven Japan uses real-time sales data to align supply and demand, improving
efficiency and responsiveness.
 Amazon invested heavily in AI and data analytics to optimize its supply chain.

Information in Supply Chain

Role in the Supply Chain

Information enhances asset utilization and coordination in the supply chain, improving
responsiveness while reducing costs.

 Examples:
o Seven-Eleven Japan: Uses information to improve availability and lower
inventory.
o Wal-Mart: Uses supplier shipment data for cross-docking, reducing inventory
and transport costs.
o Li & Fung: Uses supplier data to source the best manufacturer for each order.
o Airlines: Use demand information to price and allocate seats efficiently.

Role in Competitive Strategy

Information improves supply chain coordination, allowing companies to meet customer needs at
lower costs.

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 Investment in IT enhances visibility and decision-making across the supply chain.

 Goal: Share only the necessary information—too much data increases costs while
providing diminishing benefits.

Key Components of Information Decisions

1. Push vs. Pull Systems

o Push: Based on forecasts, determining production schedules and supplier orders.
o Pull: Relies on real-time demand to adjust production and distribution.

2. Coordination & Information Sharing

o Essential for maximizing supply chain profitability.
o Lack of coordination reduces efficiency and increases costs.
o Example: A manufacturer must share demand data with suppliers to ensure timely
production.

3. Sales & Operations Planning (S&OP)

o Aligns sales forecasts with production & inventory plans.
o Ensures supply chain needs are met efficiently while balancing revenue and cost
projections.

4. Enabling Technologies
o Electronic Data Interchange (EDI): Developed for paperless purchase orders
but required high upfront investment.
o Internet: Improves efficiency & responsiveness by providing a standard
communication infrastructure.
o Enterprise Resource Planning (ERP): Tracks transactions and provides global
visibility of supply chain data.
o Supply Chain Management (SCM) Software: Uses ERP data to enhance
decision-making and analytics.
o Radio Frequency Identification (RFID):
 Uses RF tags for tracking inventory.
 Improves manufacturing, warehousing, and receiving processes.
 Not yet 100% accurate and costly, limiting widespread adoption.

Key Trade-Off: Information Coordination vs. Cost

 Proper information sharing enhances responsiveness while reducing costs.

 Over-sharing can increase costs without significant benefits.
 Supply chains must balance the level of information shared to optimize performance.

Information-Related Metrics in Supply Chain

To improve supply chain performance, managers should track the following information-
related metrics:

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1. Forecast Horizon – Measures how far in advance a forecast is made. It should be at least
as long as the lead time for decisions based on the forecast.
2. Frequency of Update – Determines how often forecasts are updated. Updates should be
slightly more frequent than decision cycles to allow for timely corrections.
3. Forecast Error – Measures the difference between actual demand and forecasted
demand. High errors indicate uncertainty, requiring safety inventory or capacity
adjustments.
4. Seasonal Factors – Indicates how demand in different seasons varies from the annual
average, helping in seasonal inventory planning.
5. Variance from Plan – Identifies differences between planned and actual production
or inventory levels, highlighting potential shortages or surpluses.
6. Ratio of Demand Variability to Order Variability – Compares the standard deviation
of incoming demand and supply orders. A ratio below one may signal the bullwhip
effect, where small demand fluctuations lead to large supply chain inefficiencies.

Overall Trade-Off: Complexity vs. Value

 More information enhances efficiency and responsiveness, but excessive data

increases cost and complexity.
 Marginal value of additional data decreases as more information is shared.
 Optimal Strategy: Share only the necessary information to achieve coordination—
such as aggregate sales data instead of detailed point-of-sale transactions—to balance
cost and effectiveness

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5. Sourcing
Definition

The process of deciding who will perform supply chain activities: in-house production vs.
outsourcing.

Activities/Practices

 Supplier selection & management: Evaluating and maintaining supplier relationships.

 Outsourcing & contract manufacturing: Deciding which functions should be
outsourced.
 Procurement & negotiations: Managing purchasing agreements.

Key Decisions

 Make vs. Buy: Should the company produce in-house or outsource?

 Supplier Selection: Should suppliers be local (fast, high cost) or global (low cost, long
lead time)?
 Risk Management: How to ensure reliable sourcing without disruption?

Example:

 Motorola outsourced to China for cost savings, but had to fly in products to maintain
responsiveness, increasing transport costs.
 Flextronics balances high-cost responsive production with low-cost efficient production
across locations.

Sourcing in the Supply Chain

Role in the Supply Chain

Sourcing involves the business processes needed to purchase goods and services. Key
decisions include:

 Choosing between efficient or responsive sources.

 Deciding whether to source internally or from a third party.

Examples:

 IKEA sources low-cost furniture modules to keep prices low.

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 Dell sources some PCs from China for cost efficiency while keeping highly responsive
production in-house.
 Globalization has expanded sourcing options but also increased risks.

Role in Competitive Strategy

Sourcing decisions impact efficiency and responsiveness:

 Outsourcing for Responsiveness: Firms outsource services (e.g., next-day delivery)

when it's too costly to develop in-house. Example: Businesses using FedEx or UPS.
 Keeping Responsiveness In-House: Some firms retain control to react quickly.
Example: Zara manufactures in-house to respond rapidly to fashion trends.
 Outsourcing for Efficiency: Third parties can lower costs through economies of scale.
 Cisco sources low-end products efficiently while keeping high-end production
responsive.

Sourcing decisions significantly affect supply chain performance by balancing cost, quality,
and flexibility.

Sourcing Decisions in Supply Chain Management

Key Sourcing Decisions

1. In-House vs. Outsource

o The primary decision is whether to perform tasks internally or outsource to
third parties.
o Example: Within transportation, a firm may outsource only the responsive or
only the efficient component.
o Outsourcing should be considered if it significantly increases supply chain
surplus with minimal risk.

2. Supplier Selection
o Managers must decide on the number of suppliers for each activity.
o Selection criteria should include cost, reliability, and quality.
o Selection methods:
 Direct negotiations
 Auctions (structured for optimal outcomes)

3. Procurement
o Procurement focuses on obtaining goods and services efficiently.
o Direct materials procurement should prioritize buyer-supplier coordination.
o Maintenance, Repair, and Operations (MRO) procurement should minimize
transaction costs.

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Sourcing-Related Metrics

Managers should track sourcing performance using key metrics:

 Days Payable Outstanding – Measures how long a firm takes to pay suppliers.
 Average Purchase Price – Tracks the weighted average price of purchases.
 Range of Purchase Price – Identifies price fluctuations over time.
 Average Purchase Quantity – Evaluates order aggregation efficiency.
 Supply Quality – Assesses the reliability of supplier products.
 Supply Lead Time – Measures the time from order placement to product arrival.
 Fraction of On-Time Deliveries – Tracks supplier punctuality.
 Supplier Reliability – Evaluates lead time variability and order accuracy.

Overall Trade-Off: Increasing Supply Chain Surplus

 Sourcing should maximize total supply chain surplus by optimizing sales, service,
production, inventory, transportation, and information costs.
 Outsourcing is beneficial when third parties can enhance surplus more than the firm
itself.
 In-house operations should be maintained if outsourcing poses significant risks or fails
to improve the supply chain surplus.

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6. Pricing
Definition

Determining the cost of products/services, influencing demand and profitability.

Activities/Practices

 Dynamic pricing: Adjusting prices based on demand and supply conditions.

 Discounts & promotions: Offering incentives to influence buying behavior.
 Cost-plus pricing: Setting price based on cost plus a margin.

Key Decisions

 Pricing Model: Should pricing be fixed, dynamic, or demand-based?

 Segmentation: Should pricing differ for different customer groups?
 Profit vs. Market Share: Should the focus be on maximizing profit or increasing sales
volume?

Example:

 Transportation companies charge higher prices for urgent shipments, allowing efficient
customers to order early and responsive customers to pay more for fast service.

Pricing in Supply Chain Management

Role in the Supply Chain

 Pricing determines how much a firm charges for its products and services and
influences customer demand and expectations.
 It impacts supply chain responsiveness and shapes demand profiles.
 Pricing helps balance supply and demand, especially in less flexible supply chains.
 Short-term discounts can:
o Eliminate supply surpluses.
o Reduce seasonal demand spikes by shifting demand forward.
 Pricing is a key factor in determining demand levels and types within the supply
chain.

Role in Competitive Strategy

 Pricing is a major tool for executing a firm’s competitive strategy.

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 Costco's pricing strategy:

o Consistently low and stable prices.
o Leads to low product availability but stable demand.
o Supply chain is efficient but less responsive.
 Dynamic pricing strategies (e.g., in manufacturing & transportation):
o Prices vary based on customer response time expectations.
o Firms must design a supply chain that serves both cost-conscious and
responsiveness-focused customers.
 Amazon’s pricing strategy:
o Offers different shipping options at different price points.
o Helps identify customers who prioritize responsiveness versus low cost.
o Enables Amazon to efficiently serve diverse customer needs.

Components of Pricing Decisions in Supply Chain Management

1. Pricing and Economies of Scale

 Most supply chain activities benefit from economies of scale (e.g., large production runs
are cheaper per unit, full truckloads reduce transportation costs).
 Pricing should reflect these economies; quantity discounts are commonly used.
 Discounts must align with actual cost savings to avoid unnecessary bulk buying driven
only by discounts.

2. Everyday Low Pricing vs. High–Low Pricing

 Everyday Low Pricing (EDLP) (e.g., Costco):

o Prices are stable and consistently low.
o Ensures steady demand and efficient supply chain operations.
 High–Low Pricing (e.g., supermarkets):
o Steep discounts on select products periodically.
o Results in demand peaks during discount weeks and drops afterward.
o Creates challenges in demand forecasting and inventory management.

3. Fixed Pricing vs. Menu Pricing

 Fixed Pricing: A single price for all customers and conditions.

 Menu Pricing: Prices vary based on factors like response time, delivery location, or
service level.
o Amazon’s pricing menu aligns costs with responsiveness.
o Some firms misprice services (e.g., MRO suppliers charge extra for home
delivery but not for personal pickup, even though the latter costs more).
o Misaligned pricing can lead to customer behavior that reduces profitability.

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4. Pricing-Related Metrics

Managers should track key metrics to optimize pricing decisions:

 Profit Margin: Percentage of revenue retained as profit (e.g., gross margin, net margin).
 Days Sales Outstanding: Time between a sale and cash collection.
 Incremental Fixed Cost per Order: Costs independent of order size (e.g., setup costs,
order processing).
 Incremental Variable Cost per Unit: Costs that change with order size (e.g., picking
costs, production costs).
 Average Sale Price: Weighted average price per unit over a period.
 Average Order Size: Average quantity per order.
 Range of Sale Price: Maximum and minimum sale price per unit.
 Range of Periodic Sales: Maximum and minimum sales quantity per period to analyze
demand fluctuations.

5. Overall Trade-Off: Maximizing Firm Profits

 Pricing decisions must maximize profits by balancing costs and customer value.
 Stable pricing (EDLP) can enhance efficiency, while dynamic pricing may help
manage demand fluctuations.
 Differential pricing (charging different prices for different customer needs) can boost
revenues or reduce costs—ideally, both.

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7. Interaction Between Drivers & Trade-offs

 Supply chain drivers are interconnected—decisions in one area affect others.
 Trade-offs must be balanced:
o Low-cost furniture (e.g., Walmart) → Focus on efficiency: bulk inventory,
slow transportation.
o Custom furniture (e.g., high-end U.S. brands) → Focus on responsiveness: low
inventory, flexible production, fast transport.

8. Financial Impact of Supply Chain Performance

 Supply chain contributes to ~35% of financial performance in industries like apparel
retail.
 Key cost components:
o Markdowns (10–30%) – Discounts due to excess inventory.
o Lost sales (5–10%) – Revenue lost due to stockouts.
o Transportation (2–5%) – Shipping and logistics costs.
o Warehousing (1–3%) – Facility costs.
o Inventory (2–5%) – Cost of holding stock.

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