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Supply Chain Planning: Leading Practices

Introduction
Why are leading practices important?

Leading edge companies are using supply chain planning (SCP) capabilities to reduce costs,
enhance revenue and yields, and achieve other operational benefits. Such companies pull ahead
of their competitors with significantly reduced costs and/or increased yields. Supply chain leaders
put increased pressure on competitors to implement leading SCP practices as well.

A company may choose to use a subset of leading practices that best meets their industry profile
and company needs. Following are four leading practices that differentiate a company's supply
chain planning capabilities:

Global SCP
The emergence of a global economy has driven companies to rethink their competitive strategies
and globalize their supply chains. The impact on the supply chain can lead to increased lead-
times and planning complexity. Global SCP practices allow companies to take advantage of the
benefits of globalization while managing the risks and complexities across the supply chain.

Collaboration
With increased pressure to reduce lead-times and become more cost competitive, companies can
eliminate inefficiencies with trading partners by sharing information and integrating processes.
Known as collaboration, we define it as "the sharing of information among trading partners and
across enterprises for the purpose of developing a joint plan of action, and then working together
to execute that plan."

Financial Optimization
Companies are looking for techniques to optimize the cost of delivering value to customers.
Financial optimization strategies help various supply chain entities achieve the common
objectives of satisfying the final customers and obtaining dominant market share in a cost-
efficient manner.

Postponement
A strategy that delays product differentiation until a point further along the supply chain. Supply
chain inventories have a direct impact on company profitability. Companies are increasingly using
postponement to manage inventory levels while improving customer order fill rates. We will
explore the impact of postponement strategies on SCP processes.

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Objectives

After completing this module, you should be able to:

Discuss how businesses have responded to new challenges by using supply chain
planning concepts
Describe the leading practices in supply chain planning, including Global SCP,
collaboration, financial optimization, and postponement
Identify and discuss the benefits of leading practices

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GLOBAL SUPPLY CHAIN PLANNING
Overview

The emergence of a global economy is forcing companies to rethink their competitive strategies.
Many companies are embracing global initiatives that allow them to:

Pursue new markets


Achieve greater economies of scale
Leverage unique aspects of different countries and cultures
Eliminate redundancies
Improve organizational learning through international integration

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Business Drivers of Globalization

Other factors that have impacted globalization include:

Tax laws and labor costs have created opportunities for companies to remain cost
competitive with dispersed manufacturing and distribution. For example, pharmaceutical
companies realize significant tax benefits for manufacturing drugs in Puerto Rico. In
addition, the Internet has increased alliance and partnership opportunities by bringing
together companies that were either previously unknown to one another or
geographically dispersed.

Trade agreements have had a significant impact on organizational supply chains.


Implementing trade agreements in Europe, e.g., via the European Union (EU) or the
European Free Trade Association (EFTA), as well as the opening of Eastern Europe to
free markets has created newfound business opportunities. Similarly, NAFTA has made
significant advances toward integrating the North American marketplace. It has
eliminated tariff and non-tariff barriers; enhanced the ability to operate carriers across
borders; liberalized foreign investment; and standardized customs initiatives and local
content rules.

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Impact of Globalization on Supply Chains

Global supply chain entities are much more geographically dispersed. This has created some
challenges for global companies, including:

Vertical Disintegration - The impact of trade agreements allows companies to


outsource competencies and operations globally. This leads to vertical disintegration and
a greater need for information sharing in the form of collaborationa positive byproduct.

Increased Lead-Times - Consider the impact of manufacturing computer chips in


Taiwan and assembling the final product in the United Kingdom. This substantially
increases the lead-time for available material and impacts the company's supply chain.

Increased Complexity of Planning - Globalization increases the complexity of planning.


For example, a significant challenge for companies migrating to Eastern Europe is
collecting and entering freight rates into their modeling tools for transportation planning.

o Increased Nodes in the Network - The number of facilities increases and hence
the number of nodes in the network increases. This more complex network
makes it challenging to collect and calculate facility data across countries (e.g.,
cost accounting is not standardized across the globe).
o Multiple Non-integrated Cultures - Companies must adapt to very different
business cultures, work ethics, and problem solving approaches.

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Global SCP as a Response

Some companies have addressed these new challenges with global supply chain planning.
Global SCP is the process of performing supply chain planning globally rather than locally or
regionally. In the early stages of supply chain planning, SCP consisted of creating plans locally.
Factories created their production plans and "threw them over the wall" to other entities. Some
companies learned early that this silo-based process was very inefficient and began to plan
regionally. However, regional planning also had its shortcomings because it considered only
regional entities and did not take global demand and supply into account. The leading practice
today is to plan at a global level, considering global demand and the entire set of global
supply options in the process. In this topic, we consider the impact of global SCP in four
dimensions: processes, supply chain configuration, information systems, and organization.

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Impact on Processes

Global SCP implies a single planning model for the organization; that is, a single demand plan
that is used to drive the other planning activities. This single global SCP model is visible to all
participants; any change to the plans is reflected globally and enhances communication between
entities, reducing the chances for supply-demand mismatches. In a global supply chain planning
model:

Supply chain planning determines the requirements for each plant, and each plant is then
responsible for production according to those requirements.

Strategic procurement is performed centrally as well. During regional planning, each plant
or region is responsible for procuring its own materials. Several plants could be buying
materials from the same supplier but are not able to negotiate optimal volume discounts.
With a single procurement entity, the organization is now in a much better position to
negotiate such discounts and get more favorable pricing policies.

Example

Regional Planning
A large high-tech manufacturer employs a global constraint-based planning model across
more than 20 factories, producing over 30,000 products. Demand includes all customer
orders and forecasts. The company generates a production plan that takes into account
all customers and products globally. All factories worldwide then use the plan to
manufacture product.

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Impact on Supply Chain Configuration

Supply chain configuration is impacted when organizations consider facilities locations, service
levels, and factory types. As a company globalizes its business operations, for instance, it could
find that there are multiple factories producing the same goods. Also, the cost of production in
one country may be significantly lower than current production costs in a different country. Hence,
it might make financial sense to close down one or more facilities.

It is also critical for global organizations to configure their supply chains to ensure world-class
service to their customers. A company could use different supply chain configurations for serving
different products or product lines.

Another distinguishing element of supply chains is factory type.

Specialized factories are used for products that have a consistent demand pattern.
Production optimizes the use of resources and labor.

Flexible factories, capable of turning various products around quickly, are used for
products with unstable demand patterns. Such factories require extensive capital
investment and often require a well-trained and educated set of labor as well. This also
dictates the location of such factories and hence impacts supply chain configuration.

Example
A global consumer electronics manufacturer analyzes their product lines and finds that
they can classify them into two broad categoriesnew and innovative products for which
it is difficult to establish accurate forecasts, and established products for which the
demand is reasonably predictable. The company decides to serve each category using
different supply chain configurations. A supply chain that is capable of reacting to rapid
changes produces the new and innovative products. On the other hand, a highly efficient
supply chain that ensures customer orders are fulfilled at the lowest cost with an
acceptable service level produces the established products.

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Impact on Information Systems

In a single global SCP model all decision makers must have visibility into the relevant parts of the
model, including changes made to any planbuying, production, material, and promotion plans,
as well as demand forecasts. To facilitate the sharing of information, companies are developing
information systems that are tightly coupled across geographic locations.

A single global SCP model must consider information from all its global entities, requiring a
standard format from which to send and receive information. Technology enablement is therefore
crucial to global visibility and must provide the following core capabilities:

Standardization - Maintaining regional consistency so that software upgrades, rapid


deployment, and common reporting and support are possible

Architectural Performance and Stability - Deploying applications that provide adequate


response times and reliable service

Post-deployment Maintainability - Putting in place simple and effective processes that


provide consistent technical support and maintenance, global standardized training, and
timely upgrades

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Impact on Organization

Cultural Differences - Global companies conduct business in multiple countries with different
business and ethnic cultures, and even different business ethics cultures. Business practices that
are commonplace and acceptable in one country may be frowned upon in another. To be
successful globally, companies must adapt to different cultures.

Organizational Realignment - Global SCP invariably requires some organizational realignment.


For example, prior to global SCP, multiple planners were likely responsible for planning and
buying material, or for developing demand forecasts for their regions. With global SCP, planning
is done centrally. Companies must therefore redefine individual roles and responsibilities.

Collaborative Global SCP - It is equally important for organizations to involve all regions in the
design and implementation of global supply chain models. One company solved the problem by
creating a global user council (GUC) for their global supply chain implementation, responsible for
establishing global requirements and defining and shaping the global solution over time. The
counsel includes recognized business leaders, subject matter experts, key stakeholders, and IT
representatives from each site/region. This globally implemented solution has helped the
company realize their ambitious supply chain vision of centrally managing all shipment orders to
local sites, with local sites no longer responsible for creating orders and managing inventory.

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Benefits of Global SCP

Global SCP impacts a company in several ways. Responding to these impacts is a costly
process, both in terms of money and resources. Despite this, companies realize benefits that
make it worthwhile, such as:

Better Solutions
A global planning model allows for global optimization and leads to better solutions, such as
reduced lead-times and greater order fill rates.

Factory A (Region 1) 100 this week, 100 next week


Factory B (Region 2) 100 this week, 100 next week

Consider the fill rates shownthe numbers are Available-To-Promise (ATP) quantities. Assuming
a regional planning and ordering model, Region 1 can only view the ATP quantities from Factory
A, and Region 2 can only view the ATP quantities from Factory B. Suppose there is an order for
150 units to be delivered this week, and 150 to be delivered next week. If either Region 1 or 2
receives the order, they cannot fulfill the order, and it may have to be backordered or lost. On the
other hand, in a global planning (and ordering) model, both regions have access to the entire
table and that same order is fulfilled.

Improved Performance Management


Information sharing, visibility, and data availability lead to efficiencies and facilitate performance
management in the extended end-to-end supply chainincluding common training, processes,
systems, metrics, and culture. Trading partner performance can then be measured by the overall
value the partner contributes to supply chain effectiveness. For example, partners can measure
their distributors on overall stocking and inventory effectiveness.

Increased Procurement Leverage


Global planning, made possible by an effective SCP model, allows the organization to understand
the volume of business it does with each supplier, i.e., direct and indirect materials. In a regional
model, different regions may be procuring the same items from the same suppliers, but in small
quantities. By aggregating such purchases, the organization has better leverage to reduce its
procurement costs. They may also extend this leverage to include other products and services,
e.g., transportation.

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Topic Summary

Among the drivers for business globalization are the emergence of a global economy and
the Internet, international trade agreements, tax laws, and labor laws.

Globalization impacts supply chains in numerous ways, such as: increased lead-times
and planning complexity; a larger number of network nodes; and the need to integrate
multiple cultures and business practices.

Organizations are using global supply chain planning as a means to respond to these
challenges. Global SCP implies a single planning model for the organization that
considers global demand and supply options to optimize the company's supply chain
plans. Some companies have integrated information systems, streamlined business
processes, and overhauled supply chain configurations to meet customer needs.

Global SCP has helped leading companies reduce long lead-times, increase customer
order fill rates, and realize additional savingse.g., through increased procurement
savings and transportation leverage.

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COLLABORATION
Overview

Companies must effectively connect with customers and suppliers to retain competitiveness.
Without collaboration, buyers often surprise sellers with cancelled orders or with order quantities
inconsistent with forecast; sellers continue to surprise buyers with unmet delivery commitments or
short quantities. This happens when buyers and sellers do not share information about their
plans. This sharing of information is known as collaboration.

Over the past ten years, many companies have invested substantially within the "four walls"
(within their own organizations) as a result of Enterprise Resource Planning (ERP) and SCP
initiatives. They are now realizing that extended trading partner collaboration is also imminent and
a key driver to realizing benefits. In fact, of 105 companies surveyed by Meta Group, 51 percent
are currently engaged in some type of collaboration, 19 percent are in the piloting stage, and 25
percent are either planning or interested.*

*Market Study: Meta Group, The State of Collaboration, 2001.

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What is Collaboration?

Collaboration involves the strategic and tactical sharing of information between trading partners
for the purpose of developing a joint plan of action, and then working together to execute that
plan. By sharing information and integrating processes, trading partners strive to eliminate
inefficiencies. Plans are shared more and more throughout the supply chain as a result of
collaboration.

Example

Marketing is considering whether to run a promotion for certain products, with the
potential for a 10 percent lift in sales. Using SCP simulation capabilities, the company
runs a feasibility check to determine if they have the internal manufacturing capacity to
meet increased demand. Although internal manufacturing capacity is available, the plan
runs up against a constraint on the availability of a key component from one of their
suppliers in the Far East. Supply Planning immediately shares the new plans with the
vendor who is able to modify its supply plan to resolve the constraint, making it possible
for Marketing to plan the promotion. In this case, collaboration between trading partners
removes the "silo-based" approach to SCP in which different entities in the supply chain
generate plans in isolation without considering the effect on other functions.

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Types of Collaboration

Companies collaborate with one another in various ways. We will discuss five types of
collaboration:

Demand Collaboration - synchronizing output with customer demand

Supply Collaboration - synchronizing suppliers and their capacity with production


material needs

Manufacturing Collaboration - sharing information to enable real-time joint decision


making so that manufacturing produces exactly what is needed when it is needed

Logistics Collaboration - coordinating logistics providers to align


transportation/fulfillment activities with supply, manufacturing, and demand

Design Collaboration - R&D and Operations working jointly, and with suppliers and
customers, on design issues

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Demand Collaboration

Prior to developing the demand forecast for a business, trading partners share information such
as:

What their customers, e.g., retailers, think they can sell to consumers
More specific sales information, e.g., what specific colors are popular at a particular store
versus what colors are still sitting on the shelf

For demand collaboration to be effective, vendors and customers jointly develop a business plan.
They collaborate on demand forecast, promotions, and order forecast, as well as generate
purchase orders (customer) and sales orders (vendor). Exceptions are identified automatically
and both parties are notified electronically

By engaging in such collaboration, companies can increase demand forecast accuracy and
quickly resolve any demand discrepancies. They can also use this information to lower inventory
levels and improve customer service and sales.

Type of Information
Type of Collaboration Benefits
Shared
Demand Collaboration Sales Forecasts, Increase accuracy and trust in forecasts
Promotional Plans, Point- Solve demand discrepancies upfront
of-Sale (POS) Data, Improve customer service
Business Goals, Orders, Increase sales
Inventory Lower inventory levels
Provide internal and external visibility and
hence improve responsiveness of supply
chain

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Supply Collaboration

Companies on the leading edge of SCP often share relevant information with their suppliers to
respond to unforeseen circumstances and perhaps avert a small or large production catastrophe.
If the company knows a supplier's available capacity, for instance, they can plan for unforeseen
demand. In turn, they should share their order and replenishment plans with suppliers so that
they can plan accordingly. In addition, if the company's plans change, they should immediately
provide the suppliers with updated visibility.

Type of
Type of
Information Benefits
Collaboration
Shared
Supply Inventory Status, Enhanced supply visibility and rapid response to unforeseen
Collaboration Capacity supply constraints
Availability, Order Optimized relationships with multiple suppliers resulting in:
and o Preferential allocations from a supplier during times
Replenishment of short supply
Plans o Improved continuity of supply for critical components
without substitutes
o Minimized order lead-time and procurement cycle
time

Example
An overseas shipment consisting of critical subcomponents has been delayed. Plants in Illinois,
California, and Pennsylvania urgently need those components to continue production. Logging
into a newly designed system, the manufacturer looks at a partner suppliers' available inventory
and determines that there is enough inventory to support immediate needs. Despite the fact that
these items have to be air-freight, which increases costs, the manufacturer makes the decision to
procure the materials and continue production.

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Manufacturing Collaboration

Many consumer electronic manufacturers, known as Original Equipment Manufacturers (OEM),


outsource much of their manufacturing to other companies, sometimes known as an Electronic
Manufacturing Services (EMS). Since the OEM is the supplier of the final product to the
consumer, they cannot afford any surprises in the orders that they place with the EMS. The OEM
operates under the assumption that the product will be available on the dates they have
requested it from the EMS, unless they hear otherwise.

Leading SCP companies now model the EMS in their OEM planning systems as if the EMS is
one of their own facilities. The OEM also plans the production at the EMS facility. They
automatically identify exceptions and electronically notify both parties.

Type of Information
Type of Collaboration Benefits
Shared
Manufacturing Manufacturing Orders, Enables firms to get out of the reactive
Collaboration Material Availability, "fire fighting" mode of operation
Capacity Availability, Bills Improves return on assets because
Of Material, Engineering company is able to outsource non-core
Change Orders competency work
Lowers manufacturing costs

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Logistics Collaboration

Efforts to collaborate with customers and suppliers are only successful if the product is delivered
to customers when they want it. To reduce the uncertainty in this process, some companies also
engage in collaboration with their logistics providers, sharing their demand plans so the logistics
providers can ensure transportation capacity is available when needed. The logistics providers
share their resource availability with the manufacturers so that the manufacturer can use the
information in quoting accurate delivery dates to customers.

Type of Information
Type of Collaboration Benefits
Shared
Logistics Collaboration Demand Plans, Inventory Decrease in order-to-ship cycle times
Status, Transportation Decrease in days-on-hand inventories
Resource Availability Service levels in retail channels at plan

Example
Suppose a customer places an order and wants to know the delivery date. The manufacturer
looks up the transportation information and provides the customer with options, such as:

The order can be delivered in seven days, and will be shipped by truck
The order can be delivered in two days, will be air-flown to the nearest location, and
shipped by truck from there

The customer decides to air-fly the product to receive it five days earlier. The manufacturer is
able to provide an accurate delivery date because their logistics providers have shared their
resource and capacity availability.

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Design Collaboration

In this type of collaboration, Operations and R&D work together, with suppliers and customers, on
design issues. Customers provide information on new product requirements, and suppliers
provide information on the cost of materials for the new product. Operations ensures that new
products are designed in a manner that ensures effective sourcing and 'quality manufacturing.'
The manufacturer and R&D are responsible for ensuring the manufacturability of the design as
well as the product specifications.

Collaborative design helps companies reduce product development cycle times because
suppliers, designers, and customers work from the same data, and they can quickly integrate
feedback into the development and manufacturing cycle. Furthermore, companies identify
preferred suppliers early in the process, which will eventually lead to reduced material and
procurement costs.

Type of Information
Type of Collaboration Benefits
Shared
Design Collaboration Market Research, Suppliers, designers and customers work
Product/Design from the same data, documentation, and
Information, Engineering drawings
Drawings/Models, Feedback is obtained rapidly from the field
Prototypes and is integrated into the development and
manufacturing cycle
Product development cycles are
dramatically reduced by integrating
suppliers and customers into the
development process
Procurement transaction and material costs
are reduced by centralizing and
standardizing preferred supplier
information, component data, and supplier
performance
Early collaboration avoids costly and time-
consuming engineering change orders
(ECO)

Example
Consider a manufacturer that wants to introduce a new 13" television. The manufacturer is not
sure whether or not the television should have a built-in DVD player. Due to their proximity to
consumers, retailers understand consumer wants and needs. Both the retailer and the
manufacturer have a common objectivesatisfy consumer requirements. Unless the
manufacturer and retailer collaborate during the design process, the end result is unlikely to
accomplish this. Collaboration between these trading partners helps them design a product that
more accurately represents customer requirements.

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The Leading Edge of Collaboration

While most companies collaborate in one form or another, trading partners benefit more or less
depending on the extent of that collaboration. "Leading Edge" companies involved in advanced
collaboration achieve more significant benefits than those lower on the continuum, referred to as
"Basic" and "Progressive."

Demand Collaboration

BASIC PROGRESSIVE LEADING EDGE


Collect customer's monthly sales Access the customer's Suppliers and customers jointly develop a
forecast and compare it to internal weekly or daily sales data business plan by collaborating on demand
forecasts at sales & operations electronically and use it 'as- forecast, promotions and order forecast.
(S&OP) planning meeting. is' to provide input to They compare one organization's initial
internal demand planning plans with the other'sincluding previous
process. plans and actual resultsso they can
manage variances in real-time. Companies
also participate in sharing long term and
mid-term forecasts with their suppliers to
provide visibility into longer-term plans.

Supply Collaboration

BASIC PROGRESSIVE LEADING EDGE


E-mail weekly material
Advanced Planning and Scheduling
Share quarterly or monthly material replenishment plans and
(APS) system with links into a supplier's
replenishment forecasts with a forecasts to a supplier and
ERP system that enables real-time (or
supplier and ask whether they will address exceptions with
close) confirmation of production plans,
be able to provide the material. them on weekly a
and inventory and order status.
conference call.

Manufacturing Collaboration

BASIC PROGRESSIVE LEADING EDGE


Place monthly manufacturing Manufacturing maximizes Manufacturing operates from lean
orders and issue engineering asset utilization by inventory and ensures that it has
change orders as needed. participating in sales and complete visibility into any changes to
operations planning the demand plans. It also shares any
meetings. changes to such plans with external
manufacturers.

Logistics Collaboration

BASIC PROGRESSIVE LEADING EDGE


After building shipments from Shipper shares order forecasts Supplier and customer jointly
orders, shipper contacts carrier to and shipment plans with collaborate with the carrier to create a
tender the shipment. carrier and its trading partner logistics plan, share order and shipment
so they can both use the forecasts, and execute shipment
information in their own tenders, pickup, delivery, payment, and
planning processes. performance management activities.
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Design Collaboration

BASIC PROGRESSIVE LEADING EDGE


R&D shows prototype product Collaborative Product Commerce
R&D periodically collects
designs to suppliers and/or (CPC) system enables customers,
consumer/market insights about a
customers and solicits design suppliers and manufacturers to
product when designing the next
feedback. simultaneously collaborate on a
generation of the product.
product's design online.

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Benefits of Collaboration

Collaboration reduces costs, increases asset utilization, and improves customer service and
revenues. In addition, collaborating partners can achieve the following quantitative and qualitative
benefits:

Reduction of Order to Cash Cycle Time

Decreased cycle time for communication and decision making


Faster reaction to unexpected changes in demand or supply
Ability to meet end-customer needs, increasing revenue and market sharec

Insight into Trading Partner Strategic Plans

As a supplier, facilitates synchronized focus with customers


As a manufacturer, visibility to changes in suppliers' capacity or priorities

Optimized trading partner relationships

Increased accuracy in demand forecast


Reduced inventory requirements across the supply pipeline due to accurate, timely
projection of needs
Planned service levels from suppliers, including improved availability and reduced or
favored pricing
Minimized product development cycles and fewer engineering change orders with
manufacturing partners
Decreased order-to-ship cycle times
Ability to meet planned service levels from logistics partners

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Creation of Benefits Through Collaboration

Each type of collaboration drives supply chain activities that generate different types of benefits.

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Topic Summary

There are five types of collaboration:

Supply Collaboration
Manufacturing Collaboration
Design Collaboration
Logistics Collaboration
Demand Collaboration

Companies may engage in one or more types of collaboration. The greater the collaboration
between companies, the greater the benefits for all trading partners. Some benefits from
collaboration include:

Insight into trading partner strategic plans Optimized trading partner relationships
resulting in increased demand forecast accuracy, lower inventories, and improved service
levels
Reduction of order-to-cash cycle time

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FINANCIAL OPTIMIZATION
Overview

Manufacturers often face the business problem of allocating scarce resources while meeting
customer demand. Most companies must make trade-offs, allocating these scarce resources to
optimize business objectives. While finding the optimal solution to supply chain planning
problems is not always possible, companies use financial optimization techniques to accomplish
this.

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Drivers for Financial Optimization

Companies today are looking to financial optimization to stay ahead of the competition and
increase shareholder value. Solutions that merely generate profit are not necessarily sufficient; if
competitors use optimization techniques to increase their throughput and hence increase profit
margins, they will realize greater benefits. Other reasons companies use optimization techniques
include:

Low Margin Business


Many businesses operate with razor-thin margins. If they can determine how to identify and serve
their most profitable customers, they will achieve greater margins. For instance, financial
optimization is very prevalent in commodity businesses.

Varying Cost of Resources


In many capital-intensive organizations, the cost of goods sold (COGS) is significantly influenced
by the resources utilized during production. For example, a motorcycle manufacturing facility's
paint-shop could have two different painting resourcesone that uses older technology and
another that uses newer technology. The cost of production using the older resource is usually
significantly higher than using the newer resource. Using financial optimization techniques, the
manufacturer would be able to determine how to optimize the use of multiple resources.

Asset Optimization
Some industries prioritize the optimal use of assets over managing inventories. For example, the
production process in the paper industry consists of essentially two steps: first, cut trees and
convert them into paper; and, second, imprint the paper, cut it to the right shape and size, and
then use it, e.g., by putting it onto a juice carton. The capital investment in the machines as well
as the stopping-and-restarting costs is very high, while the carrying cost of excess inventory is
relatively low. Hence, the paper industry's number one priority is continuous use of the machines.

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Optimization

Optimization models seek the "best" answer to a problem by using a variety of mathematical
techniques. Such models seek to maximize a business objective, such as profit, while staying
within the constraints of the business.

Companies use a variety of techniques to achieve optimization. Complete enumeration by hand,


i.e., looking at every conceivable combination of variables in a problem, is only possible for the
most basic problems. More commonly, companies today use mathematical algorithms to achieve
optimization, including: computer-based linear programming, network optimization, integer
programming, mixed-integer linear programming, and non-linear programming techniques.*

Optimization approaches are most useful when it is important not only to find feasible solutions,
i.e., that do not violate any constraints, but that also meet business objectives, such as to
minimize cost or maximize profit.

Wagner, Harvey M. 1975. Principle of Operations Research. 1st ed. Englewood Cliffs: Prentice Hall
Winston, Wayne L. 1991. Operations Research: Applications and Algorithms. 2nd ed. PWS Kent

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Optimization Scenario Profit Maximization

A manufacturer of children's toys is considering making two types of toys: soldiers and trains.

They can sell a soldier for 15 and a train for 17. The cost of raw materials for a soldier is 12
and for a train is 15. Manufacturing each toy requires two types of operations: carpentry and
finishing. A soldier requires one hour of carpentry and two hours of finishing labor, whereas a
train requires one hour of carpentry labor and one hour of finishing labor. While the manufacturer
has an unlimited supply of raw material, they have a maximum of 80 carpentry hours and 100
finishing hours available per week.

Trains are in great demand, with unlimited sales potential, but soldier demand tops out at 40
soldiers per week. The manufacturer must determine how best to use available resources to
maximize profit. Given the constraints on labor, they will have to make some trade-offs on what to
manufacture.

Feasible Solution
One feasible solution is to manufacture 40 soldiers and as many trains as possiblefor
example, make 40 soldiers and 20 trains for a total profit of 160. This may seem like the
right solution since the contribution margin of a soldier is 3 per unit and that of a train is
2 per unit. But this solution may not maximize profit.

Maximum Profit Solution


An alternative approach is to use optimization techniques to formulate a model for this
problem and then obtain an optimal solution. By using such a technique, the optimal
solution would be to make 20 soldiers and 60 trains for a total profit of 180. This solution
provides a higher overall profit even though it manufactures more of the product (trains)
with a lower contribution margin. This optimization approach searches for the best
allocation of labor to the different products that will maximize overall profit.

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Optimization Scenario Cost Minimization

Review the following scenario about a company, which manufactures high-end bicycles, and think
about how the company could minimize costs.

The Demand for these high-end bicycles over the next four quarters is:

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total


40 70 50 20 180

Bicycles produced in a quarter can be used to satisfy demand for that quarter as well as
subsequent quarters, e.g., bicycles produced in Q1 can be used to satisfy demand in Q1 as well
as Q2, Q3, or Q4.

Costs - The bicycle manufacturer has determined that they incur the following types of costs:

400 to manufacture each bicycle


100 per bicycle at the end of each quarter for a holding cost
700 per bicycle if production is increased from one quarter to the next
600 per bicycle if production is decreased from one quarter to the next

Inventory - During the quarter preceding Q1, they manufactured 50 bicycles and sold all of them
in the same quarterthus, bicycle inventory at the beginning of Q1 is zero. Since all demand
must be met on time, the manufacturer strives to develop a production plan that will minimize total
cost during the next four quarters. In solving this problem, the manufacturer wants to balance the
cost of carrying excess inventory against the cost of increasing/decreasing production from one
quarter to the next.

Feasible Solution
One feasible solution is to manufacture just enough bicycles every quarter so that they won't
incur any inventory carrying costs. However, this will lead to high costs for increasing/decreasing
production after each quarter.

Minimum Cost Solution


Using optimization techniques, the manufacturer can solve this problem and get an optimal
solution that requires them to manufacture 55 bicycles during Q1, 55 during Q2, 50 during Q3,
and 50 during Q4for a total cost of 95,000. This implies a total production of 210 bicycles
whereas the demand is only 180 bicycles. Bringing the inventory down to zero at the end of Q4
will mean decreasing production during Q4, which will lead to very high production costs
because they incur a cost of 600 per bicycle if production is decreased from one quarter to the
next. Rather than incur this high cost, the optimal solution is to hold an inventory of 30 bicycles at
the end of Q4.

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Alternative Approaches Heuristics and Simulation Techniques

Optimization models are time and resource intensive. Typical supply chain solutions generated
today leverage alternative approaches, such as heuristic algorithms and simulation techniques
that employ approximations and generally accepted principles to quickly search for satisfactory
rather than optimal solutions.

Heuristics - Heuristic algorithms employ logical short cuts and computational procedures that
restrict the number of alternative solutions to a problem. Hence, decision makers can frequently
reiterate a plan to make faster decisions. In turn, these decisions render feasible solutions that
meet certain pre-established business criteria.

Simulation Techniques - Some companies are actively using simulation techniques to get even
better solutions. They use probabilistic techniques to model a company's environment, evaluate
that under many scenarios, and then determine the best available solution based on the
simulated scenarios. Simulation is generally used when there is uncertainty in some of the
information, be it outcomes or availability of resourcese.g., capital or labor. If a company
expects a product's demand to fall within a certain range, they could use simulation to model and
evaluate the effect of different demand numbers in the said range. Simulation tools vary from
simple spreadsheet models to large probability theory-based algorithms.

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Combining Optimization and Alternative Approaches

Traditionally, companies have not used optimization because generating optimal solutions
requires complex models and is time consuming. Most optimization models in the past also
assumed that the information presented to the model was known with certainty, which was not
the case in any real business situation. As things changed in real time, therefore, companies
were unable to respond quickly.

Companies utilizing today's "best practice" approach combine both heuristics and
optimization, enabling them to reap the benefits of cost/profit optimizing solutions while
responding quickly to changes in the marketplace, leading to improved margin performance. By
performing optimization on a weekly or monthly basis, they employ heuristics more frequently,
such as daily or weekly, to determine a feasible solution. This allows the company to continue
operating within the optimal solution's established guidelines as well as meet demand.

Companies also benefit from this approach in the consistent application of established guidelines.
For example, when a company is operating under allocation rules, these rules can be established
based on profit maximization. Hence, they avoid allocating goods based on "whoever is yelling
the loudest" or on personal relationships. This approach also reduces the number of "maverick
solutions" in an organization.

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Best Practice Example

Imagine that a manufacturer has two manufacturing plants in Bangkok and Taiwan, two
distribution centers in Kuala Lumpur and Manila, and two customers in Calcutta and Hong Kong.
The initial inventory in Kuala Lumpur is 100 units, and this stock should be maintained as a safety
stock to compensate for the volatile demand pattern of the Calcutta customer. Demand for the
Calcutta customer is forecasted as 500 units for the month at a rate of 125 per week, and for the
Hong Kong customer at 400 per month at a rate of 100 per week. We also know that the Bangkok
plant can produce 400 units per month, or 100 per week, and the Taiwan plant can produce 800
units per month, or 200 per week.

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Best Practice Example Optimal Solution

The company runs a optimization engine to find an optimal solution that minimizes the cost of
satisfying customer demand for that month.

The result of the optimization process using the Supply Chain Parameters (button below)
produces an initial monthly optimal solution (button below).

Supply Chain Parameters

Initial Monthly Optimal Solution

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Best Practice Example Impact of Increased Demand

At the end of two weeks, the Calcutta customer has already ordered 300 units50 more than the
forecast of 250. The Kuala Lumpur DC uses some of its safety stock to satisfy the higher demand
and now has only 50 units in inventory. The manufacturer revises the forecast for the Calcutta
customer to 100 per week for the next two weeks, and also runs a heuristic algorithm for each
week. They determine that the best way to increase the inventory at Kuala Lumpur is to order the
extra 50 units immediately from the Taiwan plant, because it has excess capacity, and not have
them ship anymore after that.

Supply Chain Parameters

Optimal Solution for Week 3 and 4

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As a result of combining optimization and heuristics, the company continues to operate within the
guidelines established under the optimal solution, and yet is able to respond to changes in
demand that have occurred. They are now able to reap the benefits of an optimal-cost solution
and yet respond quickly to changes in the marketplace.

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Topic Summary

Companies are turning to financial optimization to stay ahead of their competition and increase
shareholder value. These companies use optimization techniques to achieve profit maximization
and/or cost minimization. Many industries prioritize optimal asset utilization over inventory
savings because of the costs associated with purchasing, operating, and maintaining those
assets.

Companies employing leading practices combine optimization techniques with heuristic


algorithmsusing optimization to develop the optimal solution and heuristics to respond to
market changes, while staying within the guidelines established by the optimal solution.

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POSTPONEMENT
Overview

Postponement helps companies reduce exposure to inventory problems. Leading edge


companies utilize postponement techniques to delay product differentiation until a point further
along the supply chain. These techniques allow companies to optimize supply inventories
sometimes with drastic inventory reductionsand ensure the supply chain's ability to meet
customer service requirements.

There are two primary postponement strategies:

Form Postponement - stocking work in process (WIP) and sub-assemblies closer to the
customer, delaying conversion to finished goods until a firm order is received
Location Postponement - stocking finished goods centrally, delaying inventory moves
until a firm order is received

These strategies and the techniques to achieve them have an impact on supply chain planning
processes and modeling decisions.

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Impact of Inventory on Profitability

Supply chain inventories have a direct impact on company profitability in a number of ways:

When inventories are too low, customer service suffers and revenue declines;
conversely, high inventories result in excess carrying charges.

Inventories tie up working capital that could be more profitably used elsewhere.
Ultimately, excess inventories may create liquidity problems and even lead to bankruptcy.

A company can have both too much and too little inventory. This occurs when they invest
in the "wrong" inventory itemsi.e., too many items not required and too few of those
needed. A company can only ensure that it does not have the "wrong" inventory by not
carrying any inventory at all and manufacturing the product only when they receive an
order. Unfortunately, this is not always possible.

Impact of Inventory on Profitability

The graph below illustrates that both too little inventory and too much inventory have a negative
impact on profitability.

If inventories are too low, customer service suffers and revenues decline.

The width of the profitable region varies by industry. Retailer profitability is particularyly sensitive
to inventory levels. Manufacturers tend to be much less sensitive.

It is not unusual for a company to have both too much and too little inventory. This occurs when
inventory is invested in the "wrong" items.

When inventories are too high, excess carryin charges are incurred. Also, inventories tie up
working capital that could be more profitably used elsewhere. Ultimately excess inventories may
create liquidity problems and even lead to bankruptcy.

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Postponement Strategies Form Postponement

Form postponement entails stocking work in process (WIP) and sub-assemblies closer to the
customer. The company delays actual conversion to finished goods until a firm order is received.

Consider the case of a brewery that bottles its beer in 12 oz bottles and by six-pack and 12-pack
only. Compare the following scenarios:

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Postponement Strategies Location Postponement

Location postponement entails stocking finished goods centrally. A company delays inventory
moves until firm orders are receivedrefer to the figure shown. Consider the brewery in the
previous example that stored inventory at the distribution centers and the retail outlets. Let's
assume they have one distribution center (DC) and three retail outlets. Compare the following
scenarios:

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Impact of Postponement on Planning

When a company uses postponement techniques, SCP is impacted in various ways, including:

Supply Chain Network Configuration


The typical supply chain discussed thus far has been based on the principle that a company
makes a product, stores it, and then sells the product, i.e., make-store-sell. During postponement,
however, the supply chain network configuration changes. Now the company may manufacture
and store some intermediate products, and finish manufacturing the products closer to the points-
of-sale. The new paradigm becomes make-store-make-store-sell; that is; they make and store
intermediate products, then manufacture the finished goods, store them again, and then sell
them.

Distribution Network and Strategy


As a result of the new paradigm, distribution strategy is impacted. Supply planning (distribution
and inventory planning) is now conducted for intermediate goods as well as finished goods.
Furthermore, capacity planning now has to consider the ability to produce the intermediate
products as well as the finished goods, often at different locations.

Forecasting
The use of intermediate goods is equivalent to aggregating several SKUs into one SKU. Thus,
forecasting is now done at aggregated levels and not by item and customer. This tends to make
the forecast more accurate and thus provides for better planning throughout the supply chain.
Furthermore, forecasting (and production) of the final SKUs is delayed until closer to the demand
signal, making the SKU forecast more accurate as well.

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Summary of Postponement Impact on SCP Processes
Demand Planning Supply Planning Production Planning
Forecasting is
Distribution plan for SKUs
Without done for each Manufacture SKUs
Inventory plan for SKUs
Postponement SKU

With Forecasting Distribution plan for Manufacture


Postponement done at an intermediate SKUs intermediate SKUs
aggregated Inventory plan for Manufacture final
level intermediate SKUs SKUs
Forecast for Distribution plan for SKU
SKUs delayed Inventory plan for SKUs
until later, or Move inventory upstream
until better in the supply chain, closer
demand signal to manufacturing point
is available Inventory plans are now
developed using advanced
inventory theory
techniques, i.e., multi-
echelon inventory theory

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Ways to Achieve Postponement

Companies use postponement concepts to drive business benefits and delay customization
features. All supply chains are effectively a mix of Make-To-Stock (MTS) and Make-To-Order
(MTO) environments, because most companies manufacture the product to a certain point based
on forecast (MTS), and then complete the product to the specifications of an order (MTO). The
leading practice is to use postponement to determine the optimal separation point. Companies
achieve this using one or more of the following techniques:

Re-sequencing
Differentiate-to-order
Push-pull
Commonality

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Ways to Achieve Postponement Re-sequencing

Re-sequencing changes the product sequence to delay the riskiest differentiations until the point
at which better information becomes available.

For example, a fashion apparel manufacturer can forecast relatively accurately the total number
of a particular style of sweater they will sell in the fall season. When they try to forecast sweaters
by color, however, they can be significantly inaccurate, resulting in end-of-season merchandise
that must be sold at clearance prices.

One leading fashion apparel manufacturer was buying dyed cotton and wool in many colors and
then weaving the sweaters. To mitigate for the uncertainty in color demand, they changed the
order of production, dyeing the sweaters after they were weaved, and waiting until later to predict
color and dye the sweaters. With this simple step, they were able to reduce forecast errors and
inventory levels, while improving customer satisfaction levels.

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Impact of Re-sequencing on Planning

In the sweater example, re-sequencing follows the new paradigmweave-store-dye-store-sell.


Forecasting is now done at the aggregate level (weave), and the forecast for the final product is
delayed until a better demand signal is obtained. In the case of the sweaters, the demand signal
is unlikely to be actual orders and more likely to be point-of-sale (POS) data.

Consider the impact of re-sequencing techniques on supply chain planning activities:

Without Re-sequencing

Demand Planning Supply Planning Production Planning


Forecast SKUs, e.g., Inventory plan for
Manufacture SKU
red sweaters, blue each SKUcolored
(dye-weave)
sweaters, etc. sweater

With Re-sequencing

Demand Planning Supply Planning Production Planning


Inventory planning Manufacture
Forecast at aggregate
for aggregated items aggregate items and
level (sweaters)
(sweaters) SKUs
Delay forecast of color
Reduced number of Different production
until POS data is
subassemblies planning route
obtained
and/or components (weave-dye)

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Ways to Achieve Postponement Differentiate to Order

Differentiate to order is the process of producing, and possibly distributing, undifferentiated


intermediate goods and then completing the finished goods to order.

A simple example is paint. Very seldom does a do-it-yourself (DIY) paint store stock all colors,
except the most basic colors. Instead, they mix the paint at the store according to consumer
specifications, thereby differentiating to order.

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Impact on Planning

When the number of SKUs is reduced, as in the sweater example, companies plan at the
aggregate level and therefore forecast more accurately. They also develop distribution and
inventory plans for aggregated items.

Consider the impact of differentiate-to-order techniques on supply chain planning activities:

Without Differentiate-to-order

Demand Planning Supply Planning Production Planning


Forecast SKUs Inventory plan for each
Manufacture SKU
(each color of SKU (each color of
(each color of paint)
paint) paint)

With Differentiate-to-order

Demand Planning Supply Planning Production Planning


Forecast at
aggregate level
(basic paint colors) Manufacture
Inventory planning for
No forecast for aggregate items and
aggregated items (basic
SKUs needed complete SKUs closer
paint colors)
because they are to point of sale
manufactured to
order

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Ways to Achieve Postponement Push-pull

Referred to as push-pull, a manufacturer uses actual demand data to drive the supply chain back
to a certain point, and then waits for a pull signal to complete the order.

For example, a computer manufacturer knows that customers typically configure their computers
based on speed of the processor, hard disk capacity, and the amount of memory (RAM), while
other components are undifferentiated. The manufacturer thus forecasts the number of total PCs
that it will sell in the market along with the requirements for all its componentsexcept
processors, RAM, and hard disksthat they forecast separately. The manufacturer then pushes
the production of the undifferentiated PCs and completes the PCs when it receives actual
customer orders, i.e., pull signal.

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Impact on Planning

Instead of forecasting each possible PC configuration, the company forecasts the sale of
undifferentiated PCs (aggregate levelincreased forecast accuracy), as well as the number of
each differentiable component (RAM, processor, hard diskincreased forecast accuracy).
Furthermore, the company plans inventory for the undifferentiated PCs and the differentiable
components rather than for each individual configuration of the PC. Consider the impact of push-
pull techniques on supply chain planning activities:

Without Differentiate-to-order

Demand Planning Supply Planning Production Planning


Forecast SKUs (each Inventory plan for each SKU Manufacture SKU (each
configuration of PC) (each configuration of PC) configuration of PC)

With Differentiate-to-order

Demand Planning Supply Planning Production Planning


Forecast at aggregate Inventory planning for Manufacture aggregate
level (undifferentiated aggregated items items (undifferentiated
PC) (undifferentiated PC) PC) and complete SKUs
No forecast for SKUs Material plan for differentiable closer to point of sale
needed because they are components (RAM, (actual customer order)
based on customer order processors, hard disks) Two-step assembly
process (assemble
undifferentiated PC first,
then complete based on
customer order)

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Ways to Achieve Postponement Commonality

Commonality delays the differentiation point by standardizing parts and processes.

For example, a leading printer manufacturer was manufacturing printers with different power
supplies for their U.S. and European customers. However, they found that they were unable to
meet customer requirements in spite of carrying large inventoriesconsistently having the
"wrong" printers on hand; for instance, if they received an order from a European customer, they
frequently found themselves stocked out of European printers but with excess inventory of U.S.
printers.

A primary reason was that while their forecast for total printer sales was very accurate, they could
not forecast specific printer demand accurately. By shifting to dual-voltage power supplies, they
were able to eliminate an important point of differentiation between U.S. and European printer
models, reduce total inventories, and increase fill rates.

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Impact on Planning

The biggest impact of commonality is that it reduces the number of items that companies forecast
and manufacture. This has the same impact as forecasting at an aggregate level which increases
the forecast accuracy. In the printer example, forecasting total printer sales is significantly more
accurate than forecasting sales of individual printer types (European and U.S.). In addition, the
company reduces the number of raw materials or components needed.

Consider the impact of commonality techniques on supply chain planning activities:

With Commonality

Demand Planning Supply Planning Production Planning


Inventory plan for each
Forecast SKU (U.S. Manufacture SKUs (U.S.
SKU ( U.S. printer,
printer, European printer) printer, European printer)
European printer)

Without Commonality

Demand Planning Supply Planning Production Planning


Forecast at aggregate Inventory planning for
level, i.e., printers aggregated items (printers)
Reduced number of Manufacture aggregate
subassemblies and/or items (printers)
components (one type of
power supply)

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Tying Postponement with Financial Optimization

In most cases, postponement and financial optimization are related. Consider a computer
manufacturer that allows customers to customize their own computers. This is financially feasible
and even optimal for this company. The marginal utility to a customer of choosing their own
computer attributes is higher than the savings they would realize if the company built in those
attributes, which would limit the number of configurations from which customers could choose. In
other words, in this situation customers are willing to pay a higher price for customizing to their
own preferences. This is equally attractive for the manufacturer because they can recover the
cost of postponement and better serve their customers.

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Topic Summary

Inventory levels have a high impact on company profitability, revenues, and customer service. To
alleviate some of the issues associated with inventory, companies are using both form and
location postponement techniques to optimize inventories and ensure the supply chain's ability to
meet customer requirements. Companies achieve this in four ways:

Re-sequencing - change the product sequence to delay the riskiest differentiations


Differentiate to order - produce, and possibly distribute, undifferentiated intermediate
goods and complete differentiation to order
Push-pull - use actual demand data to drive the supply chain back to some point
Commonality - delay the differentiation point by standardizing parts, products and
processes

Some of the benefits of postponement include:

Reduced waste and obsolescence


Decreased inventory levels
Increased customer order fill rates
Improved forecast accuracy

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CONCLUSION
Course Summary

In this module, we have discussed several leading practices in the supply chain arena:

Global SCP - the use of a single planning model in a global business environment to
facilitate supply-demand match and information sharing throughout the organization.

Collaboration - extending the use of a single planning model beyond the entities within a
given organization. By sharing information and collaborating on several dimensions with
customers and suppliers, all partners achieve benefits.

Financial Optimization - Companies are increasingly looking to create financially


optimal solutions to plan their activities and establish operational guidelines. Companies
using today's "best practice" reap the benefits of cost/profit optimizing solutions (using
optimization techniques) while responding quickly to changes in the marketplace (using
heuristics techniques).

Postponement - delaying the production of completed goods until a better demand


signal is received.

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Note: interactive elements such as activities, quizzes and assessment tests are not available in printed form.