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Supply Chain

Management: Basics
I. Definition
What is a Supply Chain?
• What comes to your mind when you think about supply
chain management?
• What kind of flows occur in a supply chain and in which
• What are various stages in a supply chain?
• Roles?
• Is it necessary for every supply chain to have every stage?
• Can you give an example of a supply chain without a retailer?
Supply Chain at Marico

• 1.6 m retailers, 1000 Distributor
Distributor distributors and 2500
stockists Stockist
Retailer • 24% of sales come from
rural areas Retailer
• Top three rural network
Urban Rural
• Sells 35 m consumer
packs to 18 m households Consumer
II. Classification of Decisions
Supply Chain Decisions
• Imagine yourself to be responsible for supply chains
management at Patanjali Ayurved Limited (PAL).
• ~ 5,000 retail outlets, one online channel and one major
food park (with more than a dozen processing units).
Products also sold through several prominent chains such
as Reliance Retail, Hypercity, Star Bazaar, and Big Bazaar.
◦ Identify at least four strategic, tactical and operational
decisions at PAL.
Strategic Decisions
Where to locate the next food park/processing units?
What should these food parks make?
Should we continue to make Ayurvedic products in-house or should we
Should we outsource delivery or keep it in-house?
Should we purchase a supply chain optimization software suite?
Should we continue with our online channel or sell products primarily
through Amazon or Flipkart?
Tactical and Operational
Tactical decisions
Should we continue with our policy of not giving any discounts?
Which distribution centre will ship to which channel?
How many acres to contract with for herbal/agricultural ingredients?

Operational Decisions
Given orders from our own retail stores, how best to fill them?
What is the deadline for filling orders?
How best to fill orders from retail chains?
How to transport them?
III. Supply Chain Management
in India
Supply Chain Management in
Most Indian firms have traditionally neglected
• Taxation drives location decisions
• Pharmaceutical factories are located in Baddi (HP).
• AC and diesel power generator manufacturing units are concentrated in
• Due to central sales tax, most firms have a distribution centre in each state.
• How is the Indian warehousing industry?
• Poor state of logistics infrastructure
• Both warehousing and transportation industries are unorganized.
• 90% of trucks belong to owners who have less than five trucks.
• Unreliable lead-times and high in-transit damages are common.
Logistics Costs in India
• I dia’s logistics sector accou ts for % of the GDP of I dia.
• In comparison, the percentage for other countries is US (9%), Europe
(10%), Japan (11%) and China (18%)
• In India, 10 to 15% of product cost is logistics-related while in US/EU it
is about 7 to 8%
Supply Chain Management in
India: Hurdles
• FMCG/CPG Sector: Fourth largest with a size of Rs. 900 billion.
• Low unit cost but large volumes
• Characterized by complex distribution network and intense competition
• Leader in supply chain innovation

• Group Exercise (5 minutes): What are some of the hurdles faced by

firms in this sector?
Hurdles in SCM in FMCG
• Managing availability in complex distribution setup
• Several layers in supply chains and large number of SKUs.
• Infrastructure
• Poor roads, power unreliability, lack of cold-chains.
• Small pack sizes
• Counterfeit goods
• 20% of FMCG market consists of counterfeit and smuggled goods
• Example: Vicks Vaporub lookalikes raked in 54% of sales in 2007.
• Taxation
• 15% of total goods flow is smuggled.
• Unscrupulous behaviour of distributors
• Only 50% of the promotion actually reaches the consumer
• Start-up incubated on campus: School of Fish Technologies
Hurdles in SCM in FMCG
• Entry in traditional fresh products sector
• Freshness requires decentralized outsourcing, but quality control
becomes challenging

• Tension between organized retail and FMCG companies

IV. Competitive Advantage
through SCM
Competitive Advantage through
Supply Chain Management
Can you identify a few global firms that have
achieved competitive advantage through supply
chain management?

• Apple: Efficiency through outsourced

• Amazon: Efficient and reliable order fulfillment
• Amazon Warehouse
• Zara (Inditex): Speed to market
V. Supply Chain Strategy
Supply Chain Strategy
• Selecting SC strategy means taking strategic decisions
• Results in a specification of the broad structure of the supply chain
• Naturally, the SC strategy should be aligned with the business strategy.
• What is the meaning of alignment?
• Requires understanding the uncertainty imposed on the supply chain by
customer needs
• Known as implied demand uncertainty
• Not the same as demand uncertainty
• Example: Last year Amazon India introduced Prime.
• Promise to fulfil orders in 2 days.
• Implied demand uncertainty of Amazon increased even though underlying
customer demand remains same (in short-run).
Supply Chain Strategy
• More examples:
• Caterpillar promises to provide spare parts in 24 hours anywhere in the US.
• Do i o’s pro ises to deliver pizza i i utes anywhere in Bangalore.

• Greater implied demand uncertainty requires greater responsiveness in

supply chain
• What is responsiveness?
• In general, flexibility to handle a wide-variety of supply chain situations
• Ability to meet short lead-times, handle a large variety, meet high service
levels, handle supply uncertainty, innovate, and respond to wide range of
quantities demanded.
• Example: Zara
Responsiveness vs Cost
• Trade-off between cost and responsiveness
Achieving Strategic Fit
• Requires an appropriate selection of responsiveness given implied
demand uncertainty.
• More examples
• McMaster-Carr (High implied demand uncertainty)
• Barilla (Low implied demand uncertainty)
Challenges in Supply Chain
• What are some of the trends that make managing supply chains
• Increasing product variety
• Shorter product life cycles
• Higher level of outsourcing
• Shift in power structure in the chain
• Globalization of manufacturing
Drivers of Supply Chain Performance

Efficiency Responsiveness

Supply Chain Structure

Inventory Transportation Facilities; Information Pricing

Sourcing Network

Logistics spending is roughly equivalent to 18% of GDP, higher than in other developing countries
(India and South Africa spend 13-14% of GDP) and double the level seen in the developed world. Li
Keqiang, the prime minister, recently echoed industry’s complaints that sending goods from Shanghai
to Beijing can cost more than sending them to America.

Most warehouses are old and unmechanised. Goods are transferred up to a dozen times from vehicle
to vehicle as they make their way across the country. There are no cargo hubs that help link freight
from rail to road. The decrepit and overloaded lorries that ply the new highways are unable to find a
return cargo on more than one third of their trips.

China has over 700,000 trucking operators, most of them one-man outfits. (America has about 7,000.)
Scale is essential to the business, but the top 20 firms together make up barely 2% of the market.
Nancy Qian of KXTX, a logistics firm, observes that companies compete so fiercely on price that
most barely make any money, and so lack the funds needed to modernise or achieve economies of

The industry is carved into niches, making it hard for integrated service providers to emerge. Sleepy
state-owned enterprises such as Sinotrans and China Post control the markets for air freight and
domestic post. Foreign express-delivery firms are salivating over the market but FedEx and UPS, for
example, have been granted only limited licences for domestic delivery. More importantly, foreign
firms are burdened with high costs that make it hard to compete for frugal customers against lean
local rivals.

For all firms, local or foreign, a tangle of regulations, local protectionism and corruption makes
getting goods across China a problem. Logistics, broadly defined, falls under the authority of nine
ministries and commissions. Local governments often levy taxes on operators and demand they obtain
special licences to operate. There are also heavy tolls on China’s roads, and lorries are restricted from
entering most urban areas so must transfer goods onto smaller vehicles.

The road ahead

The good news is that moves are afoot to improve the industry. The central government is concerned
about its inefficiency and cost. At a meeting last month of the State Council, China’s cabinet, leaders
approved a new plan for reform, though details are still being finalised. The goal is to lower costs and
develop larger companies.

But the brighter hope for reform is coming from the private sector. Much money, including from
private-equity funds, is now going into creating bigger logistics firms. Some four dozen deals have
recently been done. Initiatives are also under way to organise data-sharing platforms so that trucking
firms can match up with customers to reduce the number of empty return journeys.

E-commerce firms in particular are worried that a bottleneck in logistics could choke off their
spectacular recent growth. Even more than industrial customers, consumers demand high levels of
customer service at low prices. Fox Chu of Accenture, a consultancy, observes that the average
purchase online in China is below 100 yuan ($16), but he reckons the delivery cost of the last leg
alone could be 8-15 yuan.

Concerned about this, online retailers are taking matters into their own hands. JD, a leading e-
commerce firm, is developing its own distribution network of warehouses, lorries and deliverymen. In
this, it is inspired by the “asset heavy” approach taken by Amazon, an American e-commerce pioneer.
Ye Lan, chief marketing officer of JD.com, said recently that the firm’s own logistics system can now
reliably deliver goods either the same day or next day in some 300 cities across the country. Whether
the firm can afford to expand its excellent logistics network to less populated areas remains to be
Alibaba, China’s biggest e-commerce firm, prefers an “asset light” approach. Rather than owning its
own delivery trucks, it has joined hands with a number of existing courier firms who plan to invest
some 100 billion yuan to develop a “smart logistics” network relying on big data. Among other
things, this coalition plans to analyse customer information so that resources can be deployed more
efficiently. It has also recently entered into a strategic co-operation pact with China Post. By sharing
warehouses, processing centres and delivery personnel, the firm hopes to be able to deliver online
purchases within 24 hours even to small cities and villages.

The future is mechanised

To see where all this could be heading, visit a group of warehouses run by Global Logistic Properties
(GLP) in Suzhou, not far from Shanghai. With over 500 warehouses in China, the Singaporean firm is
the biggest foreign builder of logistics facilities in the country. It recently entered into a $2.5 billion
partnership with several influential local firms. Jeffrey Schwartz, GLP’s boss, says that, whereas his
clients were once focused on exports, most are now using his facilities to serve the local market. With
warehouse space per person in China at less than a tenth the level in America, he believes growth will
be “supercharged”.

GLP’s warehouse is large and well laid out, which helps clients organise their goods. With
mechanisation, it can be run by just six people. Wireless scanners and bar codes enable inventory
management to be digitised. A raised loading bay allows shipments, neatly stacked on palates, to be
transferred by forklift truck into waiting lorries. Valuable goods such as integrated circuits are secured
with electronic locks and tracked by GPS. If officials would just get out of the way, China’s domestic
logistics system could yet take off.
Z-Chart & Loss Function
F(Z) is the probability that a variable from a standard normal distribution will be less than or equal to Z, or
alternately, the service level for a quantity ordered with a z-value of Z.

L(Z) is the standard loss function, i.e. the expected number of lost sales as a fraction of the standard
deviation. Hence, the lost sales = L(Z) x sDEMAND

Z F(Z) L(Z) Z F(Z) L(Z) Z F(Z) L(Z) Z F(Z) L(Z)

-3.00 0.0013 3.000 -1.48 0.0694 1.511 0.04 0.5160 0.379 1.56 0.9406 0.026
-2.96 0.0015 2.960 -1.44 0.0749 1.474 0.08 0.5319 0.360 1.60 0.9452 0.023
-2.92 0.0018 2.921 -1.40 0.0808 1.437 0.12 0.5478 0.342 1.64 0.9495 0.021
-2.88 0.0020 2.881 -1.36 0.0869 1.400 0.16 0.5636 0.324 1.68 0.9535 0.019
-2.84 0.0023 2.841 -1.32 0.0934 1.364 0.20 0.5793 0.307 1.72 0.9573 0.017
-2.80 0.0026 2.801 -1.28 0.1003 1.327 0.24 0.5948 0.290 1.76 0.9608 0.016
-2.76 0.0029 2.761 -1.24 0.1075 1.292 0.28 0.6103 0.274 1.80 0.9641 0.014
-2.72 0.0033 2.721 -1.20 0.1151 1.256 0.32 0.6255 0.259 1.84 0.9671 0.013
-2.68 0.0037 2.681 -1.16 0.1230 1.221 0.36 0.6406 0.245 1.88 0.9699 0.012
-2.64 0.0041 2.641 -1.12 0.1314 1.186 0.40 0.6554 0.230 1.92 0.9726 0.010
-2.60 0.0047 2.601 -1.08 0.1401 1.151 0.44 0.6700 0.217 1.96 0.9750 0.009
-2.56 0.0052 2.562 -1.04 0.1492 1.117 0.48 0.6844 0.204 2.00 0.9772 0.008
-2.52 0.0059 2.522 -1.00 0.1587 1.083 0.52 0.6985 0.192 2.04 0.9793 0.008
-2.48 0.0066 2.482 -0.96 0.1685 1.050 0.56 0.7123 0.180 2.08 0.9812 0.007
-2.44 0.0073 2.442 -0.92 0.1788 1.017 0.60 0.7257 0.169 2.12 0.9830 0.006
-2.40 0.0082 2.403 -0.88 0.1894 0.984 0.64 0.7389 0.158 2.16 0.9846 0.005
-2.36 0.0091 2.363 -0.84 0.2005 0.952 0.68 0.7517 0.148 2.20 0.9861 0.005
-2.32 0.0102 2.323 -0.80 0.2119 0.920 0.72 0.7642 0.138 2.24 0.9875 0.004
-2.28 0.0113 2.284 -0.76 0.2236 0.889 0.76 0.7764 0.129 2.28 0.9887 0.004
-2.24 0.0125 2.244 -0.72 0.2358 0.858 0.80 0.7881 0.120 2.32 0.9898 0.003
-2.20 0.0139 2.205 -0.68 0.2483 0.828 0.84 0.7995 0.112 2.36 0.9909 0.003
-2.16 0.0154 2.165 -0.64 0.2611 0.798 0.88 0.8106 0.104 2.40 0.9918 0.003
-2.12 0.0170 2.126 -0.60 0.2743 0.769 0.92 0.8212 0.097 2.44 0.9927 0.002
-2.08 0.0188 2.087 -0.56 0.2877 0.740 0.96 0.8315 0.090 2.48 0.9934 0.002
-2.04 0.0207 2.048 -0.52 0.3015 0.712 1.00 0.8413 0.083 2.52 0.9941 0.002
-2.00 0.0228 2.008 -0.48 0.3156 0.684 1.04 0.8508 0.077 2.56 0.9948 0.002
-1.96 0.0250 1.969 -0.44 0.3300 0.657 1.08 0.8599 0.071 2.60 0.9953 0.001
-1.92 0.0274 1.930 -0.40 0.3446 0.630 1.12 0.8686 0.066 2.64 0.9959 0.001
-1.88 0.0301 1.892 -0.36 0.3594 0.605 1.16 0.8770 0.061 2.68 0.9963 0.001
-1.84 0.0329 1.853 -0.32 0.3745 0.579 1.20 0.8849 0.056 2.72 0.9967 0.001
-1.80 0.0359 1.814 -0.28 0.3897 0.554 1.24 0.8925 0.052 2.76 0.9971 0.001
-1.76 0.0392 1.776 -0.24 0.4052 0.530 1.28 0.8997 0.047 2.80 0.9974 0.001
-1.72 0.0427 1.737 -0.20 0.4207 0.507 1.32 0.9066 0.044 2.84 0.9977 0.001
-1.68 0.0465 1.699 -0.16 0.4364 0.484 1.36 0.9131 0.040 2.88 0.9980 0.001
-1.64 0.0505 1.661 -0.12 0.4522 0.462 1.40 0.9192 0.037 2.92 0.9982 0.001
-1.60 0.0548 1.623 -0.08 0.4681 0.440 1.44 0.9251 0.034 2.96 0.9985 0.000
-1.56 0.0594 1.586 -0.04 0.4840 0.419 1.48 0.9306 0.031 3.00 0.9987 0.000
-1.52 0.0643 1.548 0.00 0.5000 0.399 1.52 0.9357 0.028

Z & L(z) for special service levels

Service Level F(z) z L(z)
75% 0.67 0.150
90% 1.28 0.047
F(Z) = 95% 1.64 0.021
Service Level 99% 2.33 0.003

z z-scale
Fill Rate and Cycle Service
Fill Rate = Fraction of demand satisfied from stock/on time

Cycle Service Level

(a) Percentage of replenishment cycles without a stockout.
(b) Probability of not stocking out in a replenishment cycle.
Fill Rate and Cycle Service
Level: Non-Perishable Product
The following table shows customer demand for each of 12 months for
a particular item. Suppose at the start of each month the inventory
stock is replenished to exactly 100 units to satisfy demand over the
month. So, in the first month the demand of 73 is satisfied, the stock is
replenished back to 100 and so the next month the demand of 80 is
satisfied. However in the third month the demand exceeds 100 units, 22
units are left unsatisfied (and are backlogged). Compute fill rate and
cycle service level. Month Demand Month Demand
1 73 7 109
2 80 8 88
3 122 9 83
4 103 10 93
5 90 11 104
6 99 12 120
• Periodic review vs continuous review systems
• Base stock/critical number/OUL policy
• Backlogging vs lost-sales
• Ex-ante vs ex-post performance measures
• Why might the two not be the same?
I. Model
Short Life Cycle Product
What is the trade-off between ordering too
much and too little?
Ordering too much
◦ Inventory leftover at season-end
◦ Inventory sold at loss
Ordering too little
◦ Not all demand is served
◦ Losing out on revenue
Please refer to Chapter 13 of textbook for details
Problem Parameters
• Single retailer, single product
• Wholesale price: W
• Selling price: R
• Demand: D (random variable)
• Salvage value: S (S<W)
• Retailer orders Q units (decision variable)
• Excess demand is lost.
• Only one opportunity to buy/order
• How much should the retailer order?
Problem Analysis
• Using incremental analysis: Q → Q+1
• Additional profit is
• _______ if additional unit is sold
• _______ if additional unit not sold

• Expectation of additional profit is

• How to determine the optimal Q?

• What is the incremental profit for Q=0?
• What happens to incremental profit as Q increases?
Problem Analysis
• Determine Q such that the expected marginal/additional
profit = 0.
Pr(D > Q) (R-W + Pr D ≤ Q S-W) = 0
R W
Pr( D  Q ) 


Cu  C o
Cu  R  W ; C o  W  S
Cost of having too little Cost of having too much
An Example
• Demand: Normally distributed with a mean = 350 units and standard
deviation of  = 150
• Purchase price = Rs. 100
• Retail price = Rs. 250
• Salvage value = Rs. 80

How many units should be ordered?

What is the safety stock? How does it change as Cu and Co increase?
What is the effect of σ on it?
Example Continued
• Cu = 150
• Co = 20
• Critical ratio = Cu /(Cu + Co) = 0.8824
• Pr(D ≤ Q* ) = 0.8824 or Q* = 528 units
• Can use either table or Excel (Norm.Inv(0.8824, 350, 150) or 350 +
150 x Norm.S.Inv(0.8824)).
• Safety stock = ?
Quick Revision
Compute the optimal order quantity for the following three datasets:
1. R=150, W=75, S=40, µ=1000, σ=250.
2. R=200, W=90, S=50, µ=500, σ=175.
3. R=250, W=110, S=90, µ=250, σ=125.

Answers: Critical fractile/z/optimal order quantity

• 0.682/0.473/1118
• 0.733/0.623/609
• 0.875/1.15/394
II. Performance
Performance Measures in
Newsvendor Problem
For any order quantity we would like to evaluate the following performance
– Expected lost sales
» The expected number of units demand exceeds the order quantity
– Expected sales
» The expected number of units sold
– Expected leftover inventory
» The expected number of units leftover at the end of the season.
– Expected profit
– Expected fill rate
» The fraction of demand that is satisfied immediately (from inventory)
𝑆𝑎 𝑠
– In-stock probability/Cycle service level
» Probability all demand is satisfied Pr⁡ ≤
Performance Measures in
Newsvendor Problem
Can you relate demand, sales and lost-sales?
Demand = Sales + Lost Sales

How about order quantity, sales and leftover inventory?

Order quantity = Sales + Leftover Inventory

Is the following true?

E(Demand)=E(Sales)+E(Lost Sales)
Order quantity=E(Sales) + E(Leftover inventory)
Performance Measures in
Newsvendor Problem
• Expected Sales = Mean Demand (µ) – Expected Lost-Sales
• Expected Leftover Inventory = Q – Expected Sales
• Can you express expected profit in terms of expected sales
and expected leftover inventory?
• Expected Profit = (R-W) x Expected Sales – (W-S) x
Expected Leftover Inventory
• Observation: Enough to know E(Lost-Sales)
Expected Lost-Sales

______, ⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡ ≤
𝐿𝑜 − 𝑎𝑙 = ∗
______, ⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡ >
• If Demand is Normally-distributed

𝐿𝑜 − 𝑎𝑙 = 𝜎𝐿 𝑧
𝑄∗ −𝜇
• In Excel:
where z is defined in A1. [Mathematically, f(z)-z(1-F(z)); f=pdf and F=cdf]
• Demand: Normally distributed with a mean = 350 units and standard
deviation of  = 150
• Purchase price = Rs. 100
• Retail price = Rs. 250
• Salvage value = Rs. 80
• With optimal order quantity=528, calculate expected lost-sales,
expected leftover inventory, expected sales and expected profit.
• 8.6/186.7/341.4/47,469.
III. Insights
(1) Expected Profit
𝑜 𝑖 =Π =
−𝑊 . −
− 𝑊 . max − , 0 + ⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡⁡ 𝑊 −

= Maximum Profit – Mismatch Cost

(2) Impact of Improving Forecasts
(Lower σ )
Demand: Normally distributed with a mean = 350 units and standard
deviation of  = 150
Purchase price = Rs.100
Retail price = Rs. 250
Salvage value = Rs. 80

How many units should be ordered as  changes?

(2) Impact of Improving Forecasts
 Q* Expected Expected Expected
Overstock Understock Profit
150 528 186.7 8.6 47,469
120 492 149.3 6.9 48,476
90 457 112.0 5.2 49,482
60 421 74.7 3.5 50,488
30 386 37.3 1.7 51,494
0 350 0 0 52,500
IV. Multi-Item
Multi-Item Newsvendor Model
Example: A Retail store has space for 1500 family pack units
of ice cream. The store manager has to place order for 3
flavors of ice cream. Just before the expiry date the
manager sells the remaining inventory at heavy discount.
How many units should the manager order?
Multi-Item Newsvendor Model

Capacity (1500 units) has exceeded

Multi-Item Newsvendor Model
If you have a capacity for one unit, which item will you
Multi-Item Newsvendor
Marginal Profit of the i-th item is

𝑖 −𝑊𝑖 𝑖 > 𝑖 + 𝑖 −𝑊𝑖 𝑖 ≤ 𝑖 .

At 𝑖 = 0:

Vanilla Strawberry Ole

74.997 109.679 136.36
Multi-Item Newsvendor Model
Capacity Units Marginal Value
Vanilla Strawberry Ole Vanilla Strawberry Ole
1500 0 0 0 74.997 109.679 136.36
1490 0 0 10 74.997 109.679 135.611
1350 0 0 150 74.997 109.679 106.103
1340 0 10 150 74.997 109.617 106.103
Multi-Item Newsvendor Model
Compute Marginal Profit

Capacity Left Units Marginal Profit

Vanilla Strawberry Ole Vanilla Strawberry Ole
1500 0 0 0 74.997 109.679 136.360
1490 0 0 10 74.997 109.679 135.611
1480 0 0 20 74.997 109.679 134.739
1470 0 0 30 74.997 109.679 133.727
880 10 380 230 74.996 73.033 70.170
870 20 380 230 74.995 73.033 70.170
290 580 400 230 69.887 67.422 70.170
280 580 400 240 69.887 67.422 65.101
1 789 446 264 53.073 53.176 52.866
0 789 447 264 53.073 52.850 52.866
Multi-Item Newsvendor Model
What happens if Retail Price, Cost and salvage price are
equal for all the three variants, only the mean and standard
deviation are different?

Capacity Constraint is 1500 units

Multi-Item Newsvendor Model
Capacity left Vanila Strawberry Ole Vanila Strawberry Ole
1500 0 0 0 124.995 124.679 121.587
1200 300 0 0 124.617 124.679 121.587
850 500 150 0 121.587 121.587 121.587
845 500 150 5 121.587 121.587 121.250
620 600 225 55 116.780 116.294 116.093
300 750 325 125 101.202 101.202 101.202
190 800 360 150 93.222 93.222 93.222
0 886 421 193 76.371 76.124 76.371

Probability that Vanilla has no stockout = 32.3%

Probability that Strawberry has no stockout = 32.6%
Probability that Ole has no stockout = 32.3%
Contracts in Supply Chains
I. Another Reason for
Suboptimal Supply Chain
Retailer-Manufacturer Price
• Consider a supply chain consisting of a manufacturer and a
• Assume newsvendor setting.
• Sequence of events:
• Manufacturer chooses a unit wholesale price W.
• Retailer chooses a purchase quantity Q.
• Manufacturer produces the units at a cost of M per unit and ships to
• Random demand realizes (unit retail price=R).
• Leftover units are salvaged at S per unit.
• What is the quantity bought by the retailer? What are the
expected profits of the retailer and the manufacturer?
Retailer-Manufacturer Price
Quantity bought by retailer

 R W 
Q(W )  F  
 RS 
 R W 
 m (W )  (W  M ) F 

 RS 

Ma ufa turer’s e pe ted profit

Retailer-Manufacturer Price
• Ma ufa turer’s produ tio ost (M) is Rs. 30/unit.
• Wholesale price (W) to retailer is Rs. x/unit.
• Retailer’s selli g pri e (R) is Rs. 100/unit.
• Salvage value (S) is Rs. 20/unit.
• Assume demand is N(1000,300).
Expected Profit as a Function of
Wholesale Price

What do you observe from the figure?

Observations from the Figure
• Supply chain profit is maximized when W=M=30.
• Ho e er, a ufa turer’s profit is a i ized he W=90 (approx.).
• Both suppl hai a d retailer’s profit de rease as W increases.
• Ca ou e plai h retailer’s a d a ufa turer’s profits ar i this
Retailer-Manufacturer Price
• Suppose that manufacturer chooses W to maximize his profit.
• So, W=Rs. 84/unit.
• Determine the optimal order quantity and the profit for the
manufacturer, retailer, and supply chain.
• Determine the optimal order quantity and the profit for the
integrated firm.
Decentralized Supply Integrated Firm
Optimal Order Quantity 748 1,345
Ma ufa turer’s Profit 40,392 65,110
Retailer’s Profit 9,248
Supply Chain Profit 49,640
Retailer-Manufacturer Price
• Compared to the two-firm supply chain, 31% more expected
profit for the integrated firm.
• So, what can we conclude?
Even in the absence of bullwhip effect, supply chain
performance may not be optimal.

• Why does the integrated firm perform better?

Why Does Integrated Firm
Perform Better?
• How do the order quantities compare in the two
• Why?
• Cost of understocking is smaller and cost of overstocking
is greater in the decentralized supply chain
• Double marginalization
What Can Be Done?
• What can the manufacturer do to induce the retailer
to place a supply chain optimal order quantity?
• Why should it bother?
• Should it reduce the wholesale price?
• Ans: Reduce risk of leftover inventory.
II. Two (of the) Remedies:
Revenue-Sharing and
Buyback Contracts
Revenue-Sharing Contracts
M: unit cost W: Wholesale price R: Unit revenue

Manufacturer Retailer D: Demand

S: Salvage value
for unsold units

1   : Fraction of unit revenue retained by the retailer

Key: W has to be lower compared to wholesale price contracts.
Revenue-Sharing in Practice
• Telecom operators distributing music, video, ring
tones to end consumers
• Revenue sharing in the computer gaming industry
(online and mobile)
• Revenue sharing in the video rental industry
• Blo k uster i late 90’s: $60-75 vs $8 + 50% revenue
Revenue-Sharing Contracts
• Ma ufa turer’s profit
𝜋𝑚 = 𝑊 − ∗ +𝛿 [ 𝑎𝑙 ]
• Retailer’s profit
𝜋𝑟 = −𝛿 −𝑊 𝑎𝑙 + −𝑊 [ 𝑣 𝐼 𝑣 𝑦]
• For computation of optimal order quantity, what are Cu and Co?
∗ 1−𝛿 −𝑊
• ≤ =
1−𝛿 −

• With 𝛿 = %, 𝑊 = , compute the optimal order quantity,

a ufa turer’s a d retailer’s e pe ted profits. Other para eters:
= , = , = , ~ , .
• How does the supply chain profit compare with that of the wholesale
price contract?
Pros and Cons of Revenue-
Sharing Contracts
• Requires extensive infrastructure to monitor sales at
• Difficult when retailers are many and small.

• Potentially lower sales effort from retailer

• Unlike buyback contracts (to be discussed shortly), no
need to physically return products.
III. Buyback Contracts
Buyback Contract
• Manufacturer chooses a wholesale price W and
buyback price B.
• Retailer orders Q units from the manufacturer
• Ma ufa turer’s u it produ tio ost is M and ships Q
• Retailer sets the retail price R and random demand
• Unsold units are returned to manufacturer and retailer
receives B per unit.
• Manufacturer salvages bought back units at Sm per unit.
• Where should B be relative to S and W?
Buyback Contracts in Practice
• Common in publishing industry
• Started in 1932 by Viking Press.
• 100% credit (retailer pays for shipping)
• Between 30-35% books are returned.
• Book covers used as proxy for books
• Also, prevalent in music industry in the US.
• Return credit is 95% (approx.)
• Perishables in kirana stores
Buyback Contracts
• Ma ufa turer’s profit
𝜋𝑚 = 𝑊 − − 𝑚 𝑣 𝐼 𝑣 𝑦
• What is the retailer’s profit?
• What are the new costs of understocking and
• What about the optimal order quantity?
• For 𝑊 = 8 , = , 𝑚 = , compute the optimal order
quantity and expected profits of the retailer and
manufacturer. Other parameters: = , = , =
, ~ , .
Optimal Buyback Price

= ℎ𝑖 𝑖 + − −𝑊
where S is the salvage value for the integrated firm.

Assuming shipping cost to be zero, what is the

optimal B for our data?
Ans: Rs. 81.7
Buyback Contracts: Pros and
• Cost of returning products reduces supply chain profits.
• Alternative: Manufacturer gives markdown allowance after verifying sales.
• Da pe s retailer’s i e ti e to sell.
• Worse, it may get misdirected.
• Retailer may be irrational.
• Salvage value at retailer is higher.
• Helps manufacturer protect its brand image by preventing markdowns
• Also foils strategic shoppers
• Facilitates redistribution of inventory among retailers
• Signals to retailers that it will commit significant marketing effort
Konys: An Overview
• What does Konys do?
• What are the challenges associated with the products made by it?
• Which part do we have to focus on and who supplies it currently?
• What happened last year with LCD module? Why were the suppliers unhappy?
Comparison of Long-Term Contracts,
Spot Purchases and Option Contracts
• What are long-term contracts, spot purchases, and option
• Compare the three contracts in terms of
• Per unit cost
• Quantity flexibility
• Quality risk
• Type of demand volatility for which the contract is appropriate for (low,
medium, high)
• Who bears the risk of demand uncertainty (buyer or supplier)?
Review of Parameters
• What is the anticipated price for procurement through long-term contracts?
• What is the salvage value of leftover LCD modules?
• What are the reservation and exercise fees for the option contracts?
• What is the production cost per unit for all other inputs and what is the revenue per unit?
Exercise I
Consider only the first quarter of production (Q3) of the MC20.
Suppose Konys signs a purchase contract with Paravan Systems for
2,170,000 units at $17 per LCD module. Assume that other parts
necessary for the production of the MC20 are available. Also
assume availability of spot market for LCD module. What is Konys’
expected profit in Q3?
• What is the revenue?
• What is the amount paid to Paravan Systems through long-term contract?
• What are the leftover inventory and spot order quantity?
• What are the spot purchase cost and salvage revenue?
Spot Price and Demand
• What are spot price and demand?
• What is the meaning of fitting a distribution to past data?
• What is Monte Carlo simulation and what happens in it?
Exercise II
Assume that Konys can source the LCD module from the spot market. Moreover,
the long-term contract (2,170,000) continues to exist. Also, as before, consider
only Q3.
• What quantity should Konys contract for using the option contract? Note that
the o pa y’s poli y agai st forward uyi g fro the spot also applies to
quantities exercised in an option contract.
• What is the change in Konys’ profit whe the optio o tra t is i orporated?
• Why does profit change?
• Compared to the previous exercise, which of the following change?
• Revenue
• Long-term contract purchase cost
• Leftover inventory
• Spot price distribution
• Demand distribution
• Spot order quantity
• When are options used and what is the number of options utilized?
Conclusions on MC Simulation
• Allows us to explore the impact of uncertainty on key metrics
• Possible to have multiple metrics/outputs
• Does not require high level Math.
• Optimization is possible, but globally optimal solution is not guaranteed.
• Optimization is difficult with many variables.
• Applicable in a wide variety of scenarios.
Outsourcing and
Offshoring: Costs and
Why do Companies Outsource?
• Lower cost: Why?
• Lo er la our ost i a ser i e pro ider’s geography due to less regulatio , lo er ages.
• Better utilization of capacity due to multiple customers
• Outsour ed fu tio is ser i e pro ider’s ore o pete y
• Cost-effective technology

• Lack of internal capability

• Not a core competency
• Cost may go up, but increase in revenue more than makes up for the increase in cost

• Saves capital expenditure or converts capital expenditure into operational expenditure

• Insufficient internal capacity and lead-time for capacity build-up is high
Risks Associated with Outsourcing
• Innovations may get copied
• Loss of internal capability
• Employee disenchantment
• Poor quality
• Unreliable deliveries (in terms of lead-time and/or quantity)
• Lower cost (compared to on-shoring)
• Prevents copying of innovation
• Not much loss of capability
But there are a few concerns as well
• Employee disenchantment may still arise
• Political and macroeconomic risks
• Communication and cultural obstacles (in managing labor)
• Managing a business unit from long distance
Electronic Sourcing and Procurement


I. Basics of Auctions
Auctions: Overview
• What is an auction?
• What are various ways in which an auction can be
• Purpose: Sell or buy (reverse)
• Sealed-bid or open
• Duration
• Single unit or multiple units
• Determination of final price
• Can anyone participate or is there a qualification mechanism?
• Does the buyer have the ability to pay?
• Procurement auction: Does the seller have the ability to do the job?
• Reserve price and whether it is announced.
• Minimum bid increment
• What is the USP of auctions?
Auctions in Practice
Some examples of auctions being used in retail environments
• Christie’s a d Sothe y’s
• Ebay
• Google
• Priceline.com
• Treasury auctions
• IPOs
• ForeclosureIndia.com
Auction Mechanism
Sealed-bid auctions
◦ First-price
◦ Second-price (Vickrey)

Open auctions
◦ English
◦ Dutch
II. Principles of Auction
Auction Design
(1) Should a buyer use sealed-bid or open auction format?
• When one supplier has clear cost advantage
• When two or more suppliers have similar costs

(2) Should incumbent be included in the auction?

• Yes: More competitors means more favourable pricing.
• Catch: What if auction is being conducted because supplier has failed to
meet cost reduction target?

(3) How long should an open auction run?

• Several days?
• Usually, 20 minutes to a few hours
• Possible provision: Auction duration increases by a few minutes every time a
supplier submits a new bid.
Auction Design
• Possible variations of electronic auctions
(1) Lowest bidder wins auction and pays his bid/second lowest bid.
◦ Applicable when part is a commodity or when technical audit is complete

(2) Lowest bidder wins auction subject to passing the technical audit.
◦ Must be disclosed in advance (suppliers find it unethical)
◦ Useful when technical audit is expensive

(3) Winner will be chosen on the basis of best total cost-quality

◦ Induces a supplier to bid aggressively even if he has the lowest bid.
◦ Must be disclosed in advance.
III. Indian Case-Studies in E-
E-Procurement: Tata Motors
• Lost Rs. 5 billion (~ USD 110 m) in 2001.
• E-sourcing helped reduce costs by USD 175 million over next two years.
• By 2007, USD 1 billion.
• All sourcing above USD 10,000 to be done online.
• Started with direct materials
• 65% of cost of a vehicle came from direct materials.
• First year: Fasteners, tyres, lead springs, oils and lubricants.
• Second year: Castings, sheet metals, seat, injection mouldings, and bumpers.
• Vendor: FreeMarkets (later acquired by Ariba).
• E-sourcing was also credited for low cost of Nano.
• Tried to combine product design with e-sourcing while designing Nano.
• Was initiated in 2000 with soyabean
• Objectives for ITC
• Direct sourcing from farmers: lower cost and better quality
• Cross-sell other products such as seeds and fertilizer

• Benefits for farmers

• Better productivity by access to information on good practices
• Transparency in prices
• Better prices compared to mandi

• How does the mandi system work? Why is it deemed exploitative?

• Choupal means village meeting place.
• E-Choupal initiative had two parts:
(1) Portal
a) Information on crops, prices and volumes traded
◦ Mandi prices, ITC prices and CBOT prices
b) Communication facility with ITC about its products
c) Weather forecasts, news, best practices

(2) Hardware/kiosk
a) Setup in house of a literate, respectable person (Sanchalak)
b) Served around 600 farmers from 8-10 villages within a 5-km area
c) Kiosk had a computer, printer, modem and a solar battery charger.
d) Sanchalak received commission on number of transactions in kiosk.
e) Also aggregated village demand for ITC products and placed orders.
• Supply chain before e-Choupal:

Farmers Mandi ITC Factories

Other Buyers

• Supply chain after e-Choupal

Farmers E-Choupal ITC Hub Factories

Mandi Other Buyers

E-Choupal: Key Features
• Did not build a new system
• Farmers could still go to mandi if they wanted
• Except that they now had information to make decisions ahead of time

• Appointed former commission agents as Samyojak

• Helped in identifying Sanchalaks
• Helped in procurement from Ma di’s
• Assisted ITC in weighing and bagging and with cash payment.

• ITC hub
• Located within driving distance
• Place where farmers deposited grains
• A marketing channel for sale of ITC products
• Included laboratories with soil-testing capabilities
• Boosted soy produ tio a d far ers’ i o e.
• Four million farmers in 35,000 villages from 10 states were using 6,100
• In 2007, 87% of farmers in the e-choupal area knew about its services
• 78% were using them.

• Expanded to include other crops such as wheat, rice, pulse and coffee
• Plus shrimps and prawns.

• However, no expansion since 2007 due to regulatory hurdles.

Marico Copra Procurement
• Marico purchases 1 lakh tonnes of copras per year.
• Old process
• Brokers and suppliers make phone calls to central purchasing office
• Negotiations would follow
• Result: Low buying efficiency
• Marico was unsure about the prevailing market price

• New process: Stage 1

• Eliminated negotiations
• Three sessions of one hour each every day: Sellers had to quote price and
• What kind of auction is this?
• Bidding over phone but started using internet and email to communicate
Marico Copra Procurement
• New process: Stage 2
• Created e-marico.com
• Shifted the bidding process to internet

• Challenges
• Attempts to discredit the auction system by traders
• New process did not prevent hoarding

• Further steps
• Setting up coconut collection centres
• Centres process coconuts into copra
• Attempts to buy directly from producers
Supply Chain Cost Optimization

Somnath Chatterjee
Head Procurement & Logistics
ITC Foods

IIM , Bangalore


Need for Efficient SCM
• With intensifying competition across sectors
• Millions of Rupees at stake!
• Excess Inventory / Freight costs
• Volatile commodity markets
• Lost sales / Stock-out
• Shorter product life cycles
• Higher demand on time and energy
• End customer satisfaction
• Real Estate Costs - Warehousing

Nowadays, it’s supply chai s that co pete with supply chai s!

- Price Waterhouse Coopers

9 C’s

Collaboration Commodities

9 C’s

Cost Country

Crude Competition

Key Challenges In Agri Commodity

1. Global Characteristics

i) Global in Nature
Implication: efficient & effective sourcing across the globe

Major Producing countries Wheat Sugar Veg Oil

ii) Weather Vagaries
Implication: consistency of availability & price volatility
• El Nino – causes extra warming- affected Oceania, Indonesia, Australia. E.g.
Increase in veg oil prices due to concern over soya crop in USA due to less
• La Nina effects – causes extra cooling- extra rains in Africa, Asia, South

La Nina

El Nino

iii) Food vs. Fuel War
Implication: Price Volatility

• Govt. Initiatives – Ethanol doping Bio-diesel Phase

• Environment concern
e.g. Flex Fuel vehicles

• Maize / Sugar- Ethanol

• Veg Oils- Bio Diesel

• Biofuels from crops such as maize, sugar and palm oil have more than tripled since
• 40% of maize crop in US goes to production of fuel & fuel additives.
• Brazil, largest sugar producer toggles between production of sugar or ethanol (40:60)
depending on price of petrol in the world market.



Currency Fluctuations-

Implication: price volatility

Dollar Index

iv) Currency Fluctuation

Brent Crude ($/bbl)

• Geopolitical tension, political decisions, affect the currency in a major way

Crude Oil (LHS)


v) Commodity Exchanges

• CBOT – Soy Bean, Maize, Wheat
• LIFFE – Sugar
• NYMEX – Crude Oil
• BURSA – Palm Oil

• NCDEX – Soy Bean, Maize, Wheat, Sugar
• MCX – Soy Bean, Maize, Wheat, Sugar
• NSE - Soy Bean, Maize, Wheat, Sugar

vi) Seasonality
Implication: in- season buy v/s round the year

Country Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec



Palm Oil



Soy Beans






EU -27






vii) Geopolitical Tensions/Natural Calamities
Implication: price volatility & supply disruption
• Geopolitical tensions domestically & internationally
are causing supply disruption in agri – commodities &
leading to price volatility

• Issues with election of the president at Ivory Coast

lead to disruption in Cocoa supply.

• North Korea nuclear fear has kept World on their toes

• Venezuela crisis has lead to uncertainty in Crude Oil


2. Government Laws &

Government Laws & Regulations
Implication: restricted sourcing & frequent change in planning strategy

Export &
Policies PDS
Tariff & System



Govt. W&M
Policy Act


• Long Term Benefits but Short Term Challenges - Evolving Food

Safety Laws & Regulations.

• Consumer/Industry Awareness & Expectations have Increased

significantly throwing fresh challenges

• Food Labelling in both Consumer & Bulk Packs as become

extremely important.

i) Characteristic- Monsoon Dependency
Implication: restricted sourcing & frequent change in planning strategy
• Indian agriculture is dependent on
monsoons even today.

• Monsoons are unpredictable and

causes price volatility.

• 2011 monsoons were early & IMD

had predicted normal monsoon.
However, as the season progressed,
it is showing deficit rains & crop
estimates are changing.

Sugar cane crop in Maharashtra, was

expected to be higher however, now
yields may decline.

ii) Characteristic- Festivals / Strikes
Implication: Supply bottleneck
Festivals & Peak Seasons
• Logistics constraints
• Kanwar festival in July in Haridwar: roads get blocked for one month
• Kumbh Mela
• Mango / Wheat / Rice season: FCI gets rake, private parties don’t.
• Telanga movement - strikes & impacting stock movement
• Transporters strike against toll fee, tax on diesel, third party insurance, etc.

Kanwar Mela

iii) Characteristic- Shelf Life
Implication: increased cost on supply chain

• Perishability - Most of the agri - commodities are perishable in nature &

hence, need controlled conditions during storage & also, similar conditions
have to be maintained during transit as well, leading to logistics constraints.
– Butter: temperature to be maintained at -18 0C during storage
– Milk: fresh milk to be stored at chilling temp 1-4 0C
– Fresh Vegetables: chilling temp upto 10 0C

• To overcome the challenge of highly perishable nature of fresh produce,

most of the bulk consumers use the processed form of it.
– Tomatoes to tomato paste/ puree
– Garlic to garlic paste
– Spinach to frozen spinach paste

iv) Characteristic- Post Harvest
Implication: non-availability/high price during lean season
• Lack of processing facility in India

• An estimated 38% of fresh produce is wasted owing to lack of infrastructure

for storage

• As per a study, only 2.2% of perishable products undergo processing in


• Vision 2015- processing of perishable food to increase to 20%

v) Characteristic- Area Diversion
Implication: supply & demand gaps & increase in price

• Herd mentality

Cane surplus Low prices of sugar

Delayed payments to farmers

Large cane area

Increase in prices of sugar Diversion of cane area to Maize

Hobsons Choice for Managers

Ultra thin margins in FMCG business cannot absorb input cost increases

Ca ’t pass o pri e i reases to o su er without riski g arket share

How ITC Optimized supply chain

1. Transformation in wheat supply

ITC : Largest buyer of Wheat after GOI

Pan India Requirement :

11 Lakh MT

Plants in East

In- Season Purchase Buying through e-choupal and Mandis

50 % stock movement from North to

South & East (Wheat deficient belts)
Plants in South
Traditional Supply Chain for ITC

Round the Year


South Warehouses
North Warehouses
Field, Mandi ,

Cost optimization through 3 year analysis

• Lower freight during Monsoon due to less Infrastructure activity. (Steel,

• Additional Freight incentive scheme of 15 % in Monsoon

Transformation in supply chain for ITC


North South Warehouses Manufacturing

Warehouses Unit
ITC Transformed supply chain
Field, Mandi ,
2. Co- Loading for freight

Why co-load?

• Co-located facilities
• Wheat Flour + Snacks

• Common customers

• Common transportation requirement

Exploit supply network synergies for

cost reduction and competitive advantage
The opportu ity…..to opti ize out ou d load

Dead space
Wheat Flour

Wheat Flour

9 MT
Current Truck loading pattern

Opportunity to utilize dead space generated in

transporting Wheat Flour
The opportu ity…..to opti ize out ou d load

Dead space Snacks


Wheat Flour Wheat Flour

1 MT

Current Truck loading Proposed Truck loading

pattern pattern

Cost - benefit

• Loadabilty improvement of 6%

• Potential combined, current freight bill reduction by ~15%

3. Collaborative Procurement

Collaboration – Win Win

Rs 20 Rs 20 Rs 20 Rs 20 Rs 10 Rs 10 Rs 100



Rs 20 Rs 20 Rs 18 Rs 17 Rs 10 Rs 10 Rs 95

4. Hedging

Price Volatility
Wheat Prices Delhi (NCDEX) El-Nino effect.
1.640 Hoarding
1.580 Crop damage ruled
out. arrivals OMSS &
1.520 News- Crop international
1.500 damage prices
01.Apr.14 01.Mai.14 01.Jun.14 01.Jul.14 01.Aug.14

Striking right cord

is important

Buyer’s dile a……How u h to uy ? Seller’s dile a…….How u h to sell ?

38 38
Having a view is most important
 Procure hand-to-mouth
 Everyday Low price
 Be alert for point of inflexion

 If below the plan price, hedge a certain %

 If above the plan price, cover hand-to-mouth

 If within the plan, start hedging in small tranches

 Period of cover would depend on the risk appetite
 Have a target stop loss in mind

39 39
Planning is indispensable

Price Supply
Forecast Projection

Growth Target


40 40
Monitoring- Its all about timing
NYMEX Crude Oil,
CBOT Soy Oil, Dalian rates for
S.America weather & Soybean & Soy oil
Crop condition

Release of
USDA data

BMD, Crop &

MPOB data
Saudas closed

Trade on domestic
Physical market & exchanges start
high seas trade starts, (MCX & NCDEX),
get quotes from currency markets
vendors open

41 41
I. Transportation Decisions and Key
Transportation Decisions
• Strategy: Designing the most effective way of transporting products to markets from plants.
• In-house vs outsource
• Size and number of trucks
• DC or no DC
• Milk runs or direct shipping
• Cross-docking along the way?
• What is cross-docking and why is it a strategic decision?

• Mode: Choosing the most effective mode of transport.

• Air
• Water
• Truck
• Rail
• Pipeline
Drivers of Transportation Decisions
(1) Transportation cost structure
• Marginal cost (per kg per km) decreases with weight and distance.
• Cost from city A to city B may not be same as the return trip
• Del to Kol: 1830; Kol to Del: 2278
• Courier companies may charge a flat amount depending upon weight and
independent of the distance.
• TCI-XPS has divided India into 6 zones and pricing within a zone is uniform.

(2) Value Density: Ratio of rupee value of a product to its weight

• High value density: Is use of a fast mode of transport justified?
• Electronics
• Low value density: Is use of a fast mode of transport justified?
• Cement, coal, and commodity products
• Captures transportation-inventory trade-off
Drivers of Transportation Decisions
(3) Demand characteristics
(a) Demand uncertainty
• A faster mode of transport reduces need for safety stock for products with high demand uncertainty.
(b) Demand volume
• Frequent shipping possible at TL.
• Low transportation cost and low cycle stock
• Low
• Need to choose between high transportation cost (due to LTL) or high cycle stock
II. Trade-off between Transportation
and Inventory Costs
Trade-off between Transportation Cost
and Inventory Cost
(1) Suppose a company reduces transportation cost by
• Switching to a slower mode of transport.
• In addition to safety stock, which other type of stock gets affected?
• Increasing lot size
• What type of inventory gets affected?
(2) If an e-commerce company tries to reduce outbound
transportation cost by opening more warehouses, then which type of
inventory gets affected?
III. Exercise
Eastern Electric (EE) is a major appliance manufacturer that purchases all the
motors (1,20,000 per year) for its appliances from Westview Motors at a price of
$120 per motor. Demand is relatively constant. Each motor weighs about 10 lb
and EE purchases in lots of 3,000 motors. EE carries a safety stock equal to 50%
of lead-time demand. The lead-time is one day + transit time. Holding cost rate
is 25%.
Compare the following two options:
Carrier Min Lot Size (lb) Shipping Cost ($/100 Transit Time (Days)
Railway 20,000 6.5 5
Truck 10,000 7.5 3
IV. Network Choices
Network Choices
• Direct or through DC?
• Storage in DC or no storage?
• Milk run or no milk runs?
• Direct shipping
• Direct shipping with milk runs
• Toyota in Japan, India and US

• All shipments via a DC with storage

• W. W. Grainger and Home Depot

• All shipments via a DC with cross-docking (no storage)

• Walmart

• Shipping via a DC with milk runs (with or without storage)

• Combination of the above
V. Best-Practice Cast Studies
Cross-Docking at Toyota-Kirloskar
• Anyone aware of it?
• Trucks from suppliers in Gurgaon meet in Delhi and shift parts to a larger truck that travels to
• In Pune, the truck cross-docks again with supplies coming from west India suppliers.
• A single truck then travels to Bidadi plant.
• Similar, cross-docking takes in Chennai and Bangalore.
• Delivery frequency: Once from Gurgaon/Pune, four times a day from Chennai and 4-16 times a
day from Bangalore.
• Advantages
• Less inventory, more frequent deliveries
• Transport unreliability has less impact
Transportation: Sabare Group
• Manufacturer and exporter of home furnishings such as bedding, door mat,
• Turnover of USD 3.75 B (2006-07 – last available)
• Shifted pillow-filling from India to US and saved 20% in total cost.
• Higher labor cost in the US but transportation cost is lower due to greater volumes of pillows.
I. Basics of Revenue
Basics of Revenue
What is revenue management?
Initial motivation
◦ PeopleExpress airline

Initial days
◦ Vacation traveler was required to book 14-21 days in advance
◦ Saturday night stay requirement

◦ Fares move dynamically in response to supply and demand

Almost all airlines use it. Hotels and car rental companies also utilize the
Basics of Revenue
Success stories
◦ Revenue at American Airlines increased by USD 500
million per year
◦ Price optimization at Inter-Continental Hotels increased
revenue by USD 400 million per year
◦ National Car Rental was facing bankruptcy in 1993.
Implementation of RM increased revenue by USD 56
million in the first year and saved the company.
Airline Seats, Hotel Rooms and Car
Rentals: Basic Characteristics
Product characteristics
• Product or service is perishable.
• Total capacity is difficult to adjust.
• Fixed costs are high and variable costs low.

Characteristics of implementation
• Customers are segmented, with different prices for each segment.
• To discriminate among different customer segments
• Commitments (prices and corresponding capacities) are made when future
demand is uncertain.
• Similar product serves all segments.
Revenue Management
• Revenue management is also applicable when
(1) Demand has seasonal and other peaks.
(2) Product is sold both through long-term contract and on the spot market.

• What does revenue management usually not include?

• Different (quality) products being sold at different price points
• Price optimization for a single product
• Price discounts for promotional reasons (e.g., Barilla)
• May be: Discount due to high inventory levels
II. Application to Airlines:
Revenue Management: Basic Concepts
• Consider a flight leg with two fare classes or buckets (i=1, 2) with fares
f1 and f2.

• The lower the index, the higher the fare (f1 > f2).

• Q = Protection level for class 1 from class 2

= Number of seats reserved exclusively for class 1
Revenue Management - Basic Concepts
• Booking limit for a class
= maximum number of seats that can be sold in the class

• Booking limit for class 2 =?

• total seats - protection level for class 1

• Often there are more than 2 classes.

• Protection levels are specified in aggregate terms.
Group Exercise: Five Minutes
Consider a plane with a capacity of 100 seats, with
a total of three fare classes. Suppose the
protection level for class 1 is 25 and protection
level for class 1 and 2 combined is 60. Further, let
demand for class i is Di.
• Determine the number of seats sold in each fare
• Determine the booking limit for each fare class.
Three Fare Classes
Seats protected for class 1

Seats protected for class 1 and 2

BL for Class 1

from fare class 3

BL for Class 2

BL for Class 3

BL: Booking Limit

III. Application to Airlines:
Computation of
Protection Level
Determination of Protection Level: An
• Ticket Prices :
Class 1 = f1 = Rs. 5,000
Class 2 = f2 = Rs. 3,000
• 100 seats available in the aircraft
• Demands for both classes (D1 and D2) are uncertain and
• Let D1 ~ N(20, 8).
• How many seats do we protect for class 1?
Fi d Q so that

f1 Pr( D1  Q)  f 2
Pr( D1  Q) 

Also called: Expected Marginal Seat Revenue

(EMSR) Rule.
The Solution
f1 = Rs. 5000

probability density
Std. Dev. = 8
f2 = Rs. 3000

Find Q so that prob{D1 ≤ Q} = _________

z-value =
20 seats
Q* =

Booking limit for class 2 =

Three Fare Classes
• Let D1 and D2 be demands for top two fare classes.
• Approximate method
• Find q1 and q2 such that
= >
= >
• Find Q as before.
• Aggregate protection level for two highest classes: q=q1+q2
• Protection level for fare class 1: Q.

• Exact method
• = > AND + >
• Protection level for two highest classes=q
• Protection level for highest class=Q.

• Or, use Monte Carlo Simulation

Revenue Management
• I stead of ha i g ultiple fare classes, hy do t so e airli es just
buy smaller planes and serve only the business travellers?
• That is, why did the industry not segment on the basis of the type of
• Business travellers usually do not travel on weekends and not much likely to
travel during mid-day.
• Few flights => Low asset utilization.
• Airlines benefit a lot more from several low-revenue flights than fewer high-
revenue flights.
Another Tool: Overbooking
• Overbooking takes advantage of no-shows to sell more tickets than
• Let p be the average price, c be the marginal cost for a passenger and b
be the cost of denying a seat.
• Assume that cancellations are a random variable.
• Computation of optimal overbooking is a Newsvendor problem.
• Let O*= Optimal level of overbooking.
• If ca cellatio s ≤ O*, cost=
• If cancellations > O*, cost=
• How to characterize O*?

𝑙𝑙 𝑖 ≤ =
− +
IV. Other Applications and
Indian Context
Other Instances of Revenue
• Gradual reduction in prices over time for fashion apparel
• Differential prices in off-season and peak-season for hotels
• Differential rates for data/voice during night and day time
Revenue Management in India
• IndiGo and Spicejet use airRM revenue management solution.
• Flight tickets are more expensive in mid-mornings and late afternoons than
other times.
• Fares rise as date of departure approaches.
• Fares more expensive on festivals.
• End-of-season sales increase discounts gradually
• Multiplexes charge less on weekdays than on weekend.
• Hotels and resorts charge significantly greater amounts in peak
seasons than otherwise.
• Taxi surge prices
• Any other examples?
Distribution Network
Distribution Network Design
• Objective of distribution network: To transport products from
a ufa turer to retailer/ usto er’s ho e.
• Two primary questions:
(1) Will products be delivered to the customer location or will they be
picked up from a pre-arranged site? How?
(2) Will products flow through an intermediary (or intermediate
◦ Discussed under Transportation
Distribution System Design Options
• Manufacturer storage with direct shipping
• Also known as drop-shipping
• Retailer takes orders and forwards them to manufacturer/another retailer
• Permits manufacturer customization: Lower inventory costs
• Examples: Infibeam, eBay.in, eBags.com, Amazon.com FBM, PayTM Mall.
• Variation # 1: Seller is also responsible for storing and shipping
• Amazon.in, Flipkart
• Variation # 2: Seller is responsible for last-mile delivery
• Grofers, PepperTap (now extinct)
• Variation # 3: Single order with multiple items
• Dell CPU with Sony monitor
Distribution System Design Options
• Distributor/retailer storage with carrier delivery
• Example: Amazon.com, McMaster-Carr

• Variation: Distributor/retailer storage with Last-mile delivery

• Example: BigBasket, GM service parts operations
• Greater transportation cost than with carrier delivery

• Manufacturer/distributor storage with customer pickup

• 7dream.com, Walmart
• Piggybacks on existing distribution system and saves on last-mile delivery cost
• Similar idea: Amazon.in gives a choice to pick up from a nearby location.
• Why do customers opt for it?
Distribution System Design Options
• Retailer storage with customer pickup
• Could include multiple options of order placement (over phone, internet,
• Example: Tesco (order online or walk-in)
• High inventory and facility costs but low transportation cost
• Network design depends on product characteristics and strategic
• Possible to have a combination of multiple delivery networks
Supply Chain Network Design Decisions
• What are some of the key supply chain network design decisions?
• What role should each facility play?
• For a manufacturer: Manufacturing and/or storage?
• What kind of products are made/stored?
• Fle i ilit i To ota a d Ho da’s pla ts
• Where should facilities be located?
• How much capacity be allocated to each facility?
• What markets should each facility serve? Which supply sources should feed
each facility?
• Which of the above decisions are strategic and which are tactical?
• All decisions are inter-dependent.
Designing Production Network at CoolWipes
• Set up in 1980.
• Has one plant in Chicago where it manufactures two products: Baby
wipes and diaper ointment
• US is divided into six regions for transportation planning.
• Looking to rationalize production network due to increased
transportation cost.
• Considering three new plant locations: LA, Atlanta, and Princeton.
Designing Production Network at CoolWipes
• Given data
• Fixed cost for each city/plant for each product
• Variable cost for each city/plant for each product
• Unit transportation cost for each plant-market pair (same for both products)
• Capacity at each city for both products
• Demand for both products in each market
• Objective: Should the company set up additional plants in addition
to Chicago? For each market, which plant should satisfy its
General Formulation
Define (for wipes)
fi=Fixed cost of running a plant in location i
Dj=Demand in region j
cij=Unit cost of transporting the product from location i to region j
xij=Units shipped from location i to region j
yi=Binary variable indicating whether wipes plant at location i is operational or not
Ki=Capacity of plant at location i
Ci=Unit variable cost of manufacturing at plant i.
Define variables similarly for the ointment. Write a linear programming formulation in terms
of these variables. Assume that a city may have wipes plant, ointment plant or both.
Additional Constraints
• What if Chicago plant cannot be closed?
• What if a city can have an ointment plant only if it has a wipes
• What if a city must have either both plants or none?
Factors Affecting Network Design
• Strategic factors
• How do you characterize the difference in locations of BigBasket’s DCs and
Relia eFresh’s retail stores?
• Recently, BigBasket started opening dark stores. How do their locations
compare with those of Relia eFresh’s retail stores?
• Technological factors
• Economies of scale vs labour-intensive
• Macroeconomic factors
• Tariffs and taxes
• Exchange rate
• Freight and fuel costs
Indian Institute of Management Bangalore
Supply Chain Management

Wills Lifestyle in India: Case Analysis Questions

A. 1% credit: (Yes/No) We have registered ourselves on Moodle.

B. 1% credit: (Yes/No) We have not written our names anywhere on the submission.
C. For the remaining 98% credit, answer the following questions.

For all analyses, assume that the margin associated with internal production is 30% (of cost) per
style and the average cost of overstocking is 10%. Thus, a short that retails for Rs. 1,300 has a cost
of Rs. 1,000, a margin of Rs. 300, and a cost of overstocking of Rs. 100. For all analysis, use the
seasonal demand (for the six-month season) shown in Exhibit 7.

1. What are some challenges in the Indian market that make it difficult to establish and
succeed with a chain of retail stores? Given the challenges, how do you think Wills Lifestyle
was positioned at the time of writing the case?
2. First consider the case in which LRBD sources from a third party (as was the case prior to
2003). The third party has a unit cost that is Rs. 50 per style lower than the costs implied in
Exhibit 7. The manufacturer requires advance commitment (i.e., a single order for the
season) and a minimum lot size of 2000 units. What are the performance metrics that LRBD
should focus on when judging performance of the third party? How much could LRBD
benefit if the third party reduced the minimum order size but maintained the requirement
of a single advance order for the season?
3. What are the metrics that LRBD hoped to improve by bringing production in-house to a
more flexible and responsive facility?
4. Consider the revised process implemented by LRBD since 2003. The LRBD divides the sales
season into three periods and arranges for multiple replenishments after bringing in an
initial order quantity. Assume that each order cycle averages about one-third of the
season’s demand. What quantity of each style should LRBD ask for in the initial order (and
successive replenishment orders) if the minimum order quantity is 2000? How is the
optimal ordering policy affected as the minimum order quantity drops from 2000 to 500, in
increments of 500? Do you think that LRBD should make an effort to reduce minimum order
quantities below 500?
5. How should the LRBD structure its sourcing strategy? What are appropriate metrics to judge
the sourcing strategy?
6. What are the threats and opportunities for the LRBD as the Indian apparel retailing sector is
opened to foreign competition? What role can the capabilities that the LRBD has developed
play in the global apparel supply chains?

Increased responsiveness
Reduction of financial risk

Development and production of new styles

Improved service levels

Improvement in product quality

Addressing the apparel business’s need for variety and rapid changes major challenge
Indian Institute of Management Bangalore
Supply Chain Management
New Balance Athletic Shoes, Inc.: Case Analysis Questions

1. Evaluate New Balance’s current operations strategy. What are the key decisions
implicit in this strategy?
2. Assuming that the total US market for athletic footwear was 400 million pairs in
2005, how costly was New Balance’s decision to maintain 25% of its manufacturing
in the US? (Derive a dollar figure.) What is your assessment of that decision?
3. How should the Davises react to Adidas’ planned acquisition of Reebok? What
aspects of New Balance’s operations strategy should they change?
4. Moving forward, how important is the NB2E initiative for New Balance?
Supply Chain Management

Case Submission: Strategic Outsourcing at Bharti Airtel Limited

Roll numbers

Executive Summary
Bharti Airtel Limited, formerly known as Bharti Tele-Ventures limited, is the country-wide
market leader in wireless communication, with 25% market share. Initially a regulated sector,
the wireless communication market saw an increase in subscribers from 4.2 Million in 1989 to
54 Million in 2003 due to liberalization and foreign direct investment.

As of now in 2005, the wireless communication network is highly commoditized where there
is no difference in product offerings and low ARPU among competitors. Thus, the players try
their best to provide value-added services which require more bandwidth in upcoming
technologies like 2.5G and 3G. This, in-turn, requires heavy capital investment.

Bharti Airtel also faces issues in terms of keeping up with the pace of network expansion,
frequent negotiations with vendors, hiring and retaining the best employees and obsolescence
of equipment. Bharti Airtel has an inherent conflict with the vendors of 'boxes' like MSC, BSC
etc. The vendors want to sell a high quantity of boxes to increase their profits while the
operators want to maximize their coverage with minimum equipment requirement and reduce
the risk of product obsolescence.

Faced with this situation Bharti Airtel has come with an option to strategically outsource its
responsibility of build-up, maintenance and servicing of telecom networks to its vendors. This
option is being discussed with different functions (IT, Operations, HR, etc.) and board of Bharti
Airtel. The initial response has been negative. Also, this first of its kind option has also made
its vendors hesitant. How Bharti Airtel is going to deal with the current challenge depends on
how this negotiation would proceed.
With the ramp-up of operations and the growing capital expenditures, it is the need of the hour
to implement lean principles and invest in innovation.

1. To improve its operating margin, Airtel should focus on improving the operational metrics
such as ARPU (Average monthly Revenue per customer). This can be done by providing value-
added services (VAS) to the customers in the form of digital payments, wallets, caller tunes
etc. Keeping the pricing competitive and increasing the VAS, will enable Bharti Airtel to
capture a larger market share while maintaining cost leadership. Focusing on VAS with low
prices will also be useful against local service providers like Spice in rural and semi-urban

2. Bharti leads the wireless market segment with a market share of 25%. Growth is expected
to increase exponentially in the coming 18 months. Currently, Airtel has mobile operation
licenses in 15 circles out of 23. To maintain its position as the market leader, Airtel can exploit
first-mover advantage by expanding into states like Gujarat, Madhya Pradesh, and Eastern
states where its presence is not prominent but where there is a growing and large user base
(Exhibit 9).

3. Telecom industry is plagued with high debts due to huge capital expenditures. IT capital
expenditures form a major part of the Capex which needs to be kept in control by developing
a lean and predictable cost structure. By outsourcing its telecom network, Bharti Airtel will be
able to convert their fixed costs into variable costs which is the key to become the lowest-cost
producer of minutes. As this is going to be the first ever outsourcing plan by any telecom
operator at such a scale, Bharti Airtel should invest in Vendor Management Systems to reduce
lead time and bring in operational efficiencies. Relationship management with its vendors will
also be crucial if Bharti goes forward with the outsourcing proposal.

4. As the industry becomes increasingly competitive, Bharti Airtel should also focus on
developing a customer-centric approach to attract and retain its customers. Since mobile phones
and mobile services are offered separately in India, switching costs of the consumer to other
mobile networks is lower. Airtel should focus on increasing these switching costs by providing
users with value-added services, increasing the involvement level of the consumer with the
‘Airtel’ brand will enhance brand loyalty and recall.

5. Finally, a step in the right direction would be to work towards outsourcing IT and
communication technology to competent vendors which will allow Airtel to focus on network

Core Competency
Airtel’s core competency lies in its operations and a large customer base that will be difficult
to replicate for any new entrant in the telecom industry. A diversified portfolio of mobile,
broadband, individual and business services gives Airtel a competitive edge in the telecom
industry. This also provides a sustainable core proposition against the competitors.
To arrive at a decision, we need to see both, positives and negatives, of such agreements.
The advantages of outsourcing agreements are:
1.Transfer of risk/uncertainty to vendors: With the proposed outsourcing agreement, the
responsibility of build-up, maintenance and servicing of the telecom network is transferred to
the vendors. Therefore, any need to install excess capacity, to meet the uncertainty in demand,
lies with the vendor.

2. Charges as per actual usage: As per the agreement, Bharti makes the actual payment only
when the installed capacity is commissioned and used by the customers. Presently, Bharti
follows industry practice of 40% excess capacity to compensate for any forecasting error. This
outsourcing agreement would avoid the payment of unused excess capacity.

3. Low cost of Human Resource: The development of IT and network infrastructure require
huge human capital which is a scarce resource. With the outsourcing agreement, the burden of
human resource is eliminated. Also, the transfer of 1000 present employees to vendor
companies would significantly bring down the cost of HR.

4. Quality control: To ensure better quality service to end consumers, the Service Level
Agreements (SLA) lay down several quality checks which are linked to penalties and rewards
for vendors.

5. Easy adaptation to new technologies: The telecom equipment vendors can utilize their
industry experience and expertise to upgrade to technologies such as 2.5G or 3G services. This
outsourcing agreement can bring efficient technologies in future.

The disadvantages of outsourcing agreements are:

1. Dependence on vendors: Outsourcing a business activity, especially one in which the

company has operating expertise (here, operations and network management) would create
excessive dependence on vendors.

2. Concern for transferred employees: The cultural differences between the companies and
the unwillingness of employees to transfer to vendor companies would pose difficulties in
managing around 1000 employees within the company.

3. Limited flexibility: Outsourcing to IT equipment vendor would restrict the usage of

hardware and software technologies provided by other vendors. This will lead to restricted

4. Security and confidentiality threats: Since the vendors would be providing services to
multiple telecom companies, there could be a chance of critical information leakage.

5. Efficient outsourcing concerns: It is for the first time that these kinds of outsourcing
agreements related to network management and operations have been proposed. Since there is
no reference, it is uncertain whether such an arrangement will yield the desired results.

A careful evaluation of both, positives and negatives of the proposed agreements, shows that
even though there are risky elements in the contracts, the positives outweigh the negatives and
thus, Bharti must go ahead with the contracts. Their focus at this point must be on expanding
the network infrastructure into different geographic locations, which requires huge capital
outlay. Hence, it is logical to go ahead with the proposal made by Gupta.

For Bharti Airtel, outsourcing the business activities makes sense if it can increase their supply
chain value. Outsourcing will help Bharti to divert its resources and expertise to focus on
building its core competencies. The overall cost of operation is expected to come down by
outsourcing since the vendors aggregate capacity and achieve economies of scale. Hence,
Bharti can free up their capital as there is no need to invest in excess capacity and maintenance
of the equipment. Another benefit of outsourcing is that the human resource issue would be
resolved. Also, by having multiple vendors for outsourcing, the risk in business activities would
be diversified. Thus, the possibilities of building upon core competencies would be spread out.

Outsourcing to giants like IBM and Nokia, Siemens or Ericson comes with its own set of
challenges. Some of them are:

1. Intellectual Property Concerns: In a country like India where IP regulations are not
stringent and often not followed, there is always the risk of proprietary information getting

2. Hidden Costs: Forecasting costs is currently a challenge for Bharti Airtel. It needs to ensure
that long-term outsourcing costs are not underestimated.

3. Increased Dependence: Dependence on the vendors may prove to be risky in future for the
company as it will be hard to survive if it loses the vendors’ services. Handing over the network
management and operations of the company is also a source of concern as it will lead to loss
of internal capabilities of the company

4. Limited Availability of New Technology: One of the major concerns about entering an
outsourcing agreement with IBM is the limitation to available software and applications that
IBM does not provide. Bharti Airtel needs to discuss this with IBM so that outsourcing to IBM
does not result in the unavailability of third-party software and hardware that have worked well
and may work well for Bharti Airtel.

5. Human Resource Management: Provided the environment of India’s job sectors, it will be
very difficult to transfer as many as 270 IT staff and 800 network staff to the vendors’
companies. There is a huge cultural difference in working methods and work environments of
the Indian companies and worldwide companies like IBM, Nokia etc. which will also be a
concern to all the employees and Bharti Airtel in this transfer of employees to vendors. Bharti
Airtel needs to ensure that this transition and integration of different work cultures is in
coherence with Bharti Airtel’s strategy of providing a good working environment to its
Agreement Structure
1. Payment Structure: Bharti Airtel should break down the costs into fixed and variable
components. Instead of an upfront fixed payment for network capacity, Bharti Airtel should
reach an agreement to pay the vendor when the network capacity is up and running and is being
used by the subscribers, effectively eliminating payment for unused capacity.

2. Revenue Sharing Agreement: An agreement that clearly states the revenue sharing terms
would reduce uncertainty in an unpredictable market. Bharti should clearly articulate that
(keeping in line with the very encouraging growth predictions), the percentage of shared
revenue will decrease as the overall revenue increases.

3. Personnel Management: Bharti employees performing tasks that would be outsourced,

would need to be transferred to the vendor. Thus, staffing of the new employees must be taken
care of by the vendor. Proper arrangements should be in place to ensure the smooth transfer
and assimilation of Bharti Airtel employees who get transferred. Care should be taken that jobs
are not lost in the process.

4. Service Level Agreements: To ensure that the quality of Bharti Airtel’s service is not
compromised, it is imperative that quality controls be in place. Bharti Airtel should sign an
SLA that clearly delineates the service quality levels in terms of network quality measures like
the percentage of dropped calls and incomplete calls. It is the vendor’s responsibility to ensure
that the service provided is top-notch. An incentive program should be designed with rewards
and penalties built into the contract.

5. Network Compatibility: IBM must cooperate with other vendors to support the network
operations of Bharti. The agreement should entail that IBM must upgrade its systems to
accommodate software or hardware applications (especially those used by Bharti Airtel’s
marketing and IT) not compatible with IBM. Bharti Airtel should prevent the loss of supply
chain visibility.

6. Time to Market: Bharti should clearly lay down that the time to market for new IT services
should not go up, at the same time, steps in the development process should not be skipped lest
a substandard service should be rolled out.

7. Data Compliance: Outsourcing will open the possibilities of compromising sensitive data,
especially if the vendors serve Bharti Airtel’s competitors. A strict onsite server access policy
should be formulated to prevent leakage of data. IP breaches must be avoided by all means.

8. Ownership and Maintenance of Assets: It should be clarified that the ownership of assets
on completion would be transferred to Bharti Airtel, but the responsibility for maintaining the
network rests with the vendor.

Governing Mechanism
A governing coalition is necessary to ensure that the decision-making stays with Bharti
Airtel. It will also be the go-to authority in case of any conflict. Here is our proposed governing
IBM’s Concerns
Revenue Sharing and Heavy Investment: IBM will have to enter an initial contract of 5-year
revenue sharing with Bharti (extendable for 5 more years). The estimation of Bharti’s revenues
over the 5 to 10 years will be very crucial for IBM as it has to estimate its revenues accordingly
and invest in software, human resources, hardware. Also, IBM will have to upgrade the existing
software facilities of Bharti Airtel, which would demand heavy investments from IBM.

Quality Controls: IBM will be subject to a number of quality controls as specified in the SLAs
(ex: hotline satisfaction of customers). In line with these controls, IBM will be under a penalty
and reward system which may prove costly for IBM.

No Scope for Price Negotiations: A fixed contract for 5 years implies no or very little scope
for price negotiations for this duration. It is very unlikely that IBM would be able to raise the
prices of equipment.

Human Capital: IBM would also be burdened with costs of retraining and cross training as it
must accommodate former Bharti Airtel’s employees into its organization.

Nokia’s Concerns
Risk of Under-Utilization and Over-Investment: Bharti wants to transfer the risk of
investing in equipment by outsourcing to vendors like Nokia. Airtel would be paying Nokia
for the actual erlangs used. This transfers the risk of unused and excess capacity to Nokia.
Although a one-time fee will be paid by Bharti for the installed capacity to Nokia, this would
not cover Nokia’s investments. The highly volatile customer demand coupled with potent
competition from other players places Nokia at higher risk.

Forecasting Costs and Demand Uncertainty: In the vendor-managed inventory model

proposed by Bharti, the threats of inventory management and forecasting are passed on to the
vendors like Nokia. But actual demand forecasting is done by Bharti. Nokia cannot challenge
Airtel’s estimations and is entitled to install the equipment for the given estimated capacities.
There is a possibility of Airtel spiking the safety margins and transferring the risk to Nokia.
Low Bargaining Power of Vendors: Outsourcing to multiple vendors may decrease the
bargaining power of vendors and increase their costs. Also, lack of operations experience puts
the vendors on the back foot in negotiating SLAs.

Saturation of Revenues: Falling ARPUs and increased competition in India would lead to
saturation in the number of subscribers. This will force Airtel to operate at lower rates leading
to a sag or dip in Airtel’s revenues, ultimately this will affect the revenues of Nokia.
Nokia is also subject to Quality Controls and Human Resource Costs as was the case of IBM.

1. As the work cultures are very different, mandatory training classes for employees that require
certifications should be in place.
2. A complete understanding of financial obligations, investment risks and rewards should be
achieved. A payment structure with two components; fixed, for equipment and training costs,
and variable i.e. revenue sharing based should be implemented. This will reduce the unlimited
risk to vendors and make Bharti cautious of the expenses.
3. The SLA should have well-defined parameters and it should also allow some flexibility in
certain criteria, as the contract period is large. A system must be put in place for the long-term
and skill-based resource management and performance management for quality and SLA
4. Policies regarding renewal of employee contracts and transferring back of employees to
Bharti if they don't meet expectations and standards should be laid down clearly.
5. Full corroboration and collaboration between the two parties to share their innovations and
benchmarking practices should be established.
6. There should be a clause based and periodic review for risk assessment.
7. There should be a strategic alignment between all the verticals for best practices for value
delivery which is a vital ingredient for customer satisfaction.

Governance Mechanism:
Here is our proposed governing mechanism:
Indian Institute of Management Bangalore
Supply Chain Management

Strategic Outsourcing at Bharti Airtel Limited: Case Analysis Questions

1. What must Bharti do well to succeed in the Indian mobile phone market? What are Bharti’s
core competencies?
2. Do you think Bharti should enter the outsourcing agreements outlined by Gupta? What do
you see as advantages and disadvantages of such agreements? How do the different
outsourcing agreements work towards building these core competencies?
3. If you were Bharti, what major concerns would you have about entering an outsourcing
agreement with IBM? With Ericsson, Nokia, or Siemens?
4. How would you structure the agreements to address your concerns and capture any
advantages you have identified? What governance mechanism would you design for the
5. Assume the role of IBM or Nokia. What major concerns would you have about entering an
agreement with Bharti? How would you structure the agreement and the governance
Indian Institute of Management Bangalore
Supply Chain Management
Movie Rental Business: Case Analysis Questions

Roll numbers

Executive Summary
Blockbuster was the largest brick and mortar video rental chain in 2010. Established in 1985, it
had generated a revenue of $5.5 billion in 2007. It provided videos through an in-store rental
service, Blockbuster online services, and Blockbuster direct access. But by 2009, its market
capitalization dropped by 47% to $62 million primarily because of stiff competition from
competitors like Netflix and Redbox.

Netflix, which was launched in 1997, provided DVDs on rent and video streaming and
subsequently became world’s largest subscription service provider with 13 million subscribers.
Redbox, through its 23,000 kiosks, rented DVDs of latest videos to customers instantly.
Moreover, big players like Amazon, Google and Apple entered the business.

Blockbuster, which was valued at $8.4 billion when it was bought by Viacom in 1994, was
valued at a meagre $24 million in 2010. Thus, with the shift of customer preference from DVDs
to internet streaming, Blockbuster which was once a market leader in the video rental business,
was facing serious financial trouble and was looking at possible bankruptcy.
Answer 1)
Transportation: Blockbuster’s physical store model incurred low transportation cost, while
Netflix had to bear the high shipping cost of transporting DVDs by mail. Redbox incurred low
replenishment cost in restocking its kiosks.

Aggregating the demand for numerous stores decreased the inbound transportation cost for
Blockbuster while the outbound transport cost was borne by the customer.

In 2010, Netflix had 60 regional distribution centers (DC) across the United States. Operation
through regional DCs resulted in very low inbound transportation cost. However, shipping about
two million discs each month contributed to relatively high outbound transportation cost. Netflix
estimated this number would rise to $600 million in 2010.

Redbox had to incur high inbound transportation cost to keep its 23,000 kiosks stocked in 2010.
Also, since customers could return DVDs to any kiosk, the redistribution cost would be high.
However, outbound transportation did not result in any cost.

Facility: Blockbuster used a high-cost brick and mortar model. Blockbuster leased the stores in
popular neighborhood locations frequented by public at high costs. Managing multiple stores
increased the facility cost.

In contrast, Redbox utilized low-cost vending machines in popular locations such as grocery
stores, malls, and had to pay lower facility costs (23% of its sales) when compared to
Blockbuster (62% of its sales). Some retailers also offered discounts to install kiosks (because
they increased customer footfalls) and that brought the rental cost further down.

Netflix had a no retail store model with a wide range of titles available in centralized DCs.
Netflix had about 60 DCs, from where DVDs were shipped across the US. These DCs were
located close to post offices, enabling Netflix timely processing and delivery at relatively low
cost. Thus, Netflix had much lower facility costs than Blockbuster.

Inventory: Inventories at Blockbuster were high (as a percentage of revenue) because of its
decentralized operations. Carrying many low-volume rental titles aggravated the inventory
requirements. This increased the inventory cost for Blockbuster.

Netflix had low inventory costs (2.21% of revenue) compared to that of Blockbuster (15.73% of
revenue). Netflix had a wider range of titles in its DCs but was able to carry lower inventories
because of aggregation. Netflix generally had contracts with the studio wherein after the
completion of the rental term they could either return, destroy or buy the DVDs. This helped
manage the inventory.
Redbox stocked newly released DVDs, which were rented in large volumes with relatively
predictable demand. As a result, they had far lower levels of inventory. On an average Redbox
rented its DVD 15 times before they sold them to their customers. This high inventory turnover
and subsequent sale helped them in reducing their inventory costs.

Answer 2)
Studios: The various channels of revenue were theatres, digital releases, DVDs and VOD or per
view payments. DVD purchases were more profit making for studios than rentals. They earned
up to $18 on each DVD purchase as compared to $4 on the rentals.

Theatres: Theatres were usually the first to release the movies and played them anywhere from
2 weeks to 12 months. In the opening weeks the studios had a greater cut from 70% to 90% of
the sales on tickets and the theatres’ share increased over the later weeks. In recent years, the
theatrical window length had declined.

Retail store for DVDs: The DVD formats were released to retailers like Walmart after the
theatre release window. Because of the high profitability as compared to other revenue channels,
the studios were more attracted to the retail stores channel. To tap the huge revenue potential
from these channels, the DVD release to rental and other channels was delayed by the studios.

Blockbuster: By adopting a highly efficient and smooth running computerized technology

system for controlling inventory and checkouts, and by maintaining an inventory which was
highly larger than its competitors, Blockbuster enjoyed great success. Through aggressive
expansion and acquisition of rival chains that dominated the local market, it became the leading
supplier of game entertainment and in-home movies. Blockbuster arrived at a new revenue
sharing deal with the studios to obtain the videos at lower costs. In response to the stiff
competition from Netflix, Blockbuster started its online services with a monthly cost of $19.99
where members could rent unlimited online DVDs.

Netflix: Netflix started as a pay-per-rental and an order by mail video rentals company. Its
reputation was built on unlimited rentals which were flat fee and mandated no penalty fees, due
dates, free shipping and delivery charges. It differentiated itself by heavy promotions and by
partnering with DVD player companies. Its strategy was to offer a large collection of titles and
faster delivery to the customers. It offered customers more than 1,00,000 DVD choices which
included foreign and individual films not carried by competitors.

Netflix introduced a recommendation program called CineMatch which used the customer’s
history of rentals and preferences and coupled them with the ratings by other users to make
recommendations to the customers. Netflix users were encouraged to rate the movies. The
ratings and the recommendations reduced the search time and cost. Netflix was also successful in
generating revenues for the older titles by using CineMatch. Netflix uniquely strategized to offer
a wide range of choices in a low-cost subscription service.

Redbox: The target customers of Redbox were the budget-conscious renters of movie.
Delivering content at lower costs at easily accessible and nearby kiosks was the primary value
proposition of Redbox. By setting up vending machines at high-traffic locations like
supermarkets and restaurants, and offering lower rental rates as low as $1, Redbox was able to
serve the needs of the customers who are underserved. By this Redbox was able to meet its needs
and surpass blockbuster by mid-2010.

Video on demand(VOD): VOD was the most convenient service for the customers in renting
and watching movies. Customers could easily rent and watch movies directly through the TV
sets and if they had a cable subscription and a set-top box. Studios also preferred VOD channels
as they earned more revenue through VOD than DVDs.

Digital on-demand channels: Digital channels like pay-per-view and on-demand channels
looked very attractive and hence players like Apple, Google, Amazon also became active in this
space and new devices such as Apple Tv, Roku, Google TV were developed. These devices
allowed the digital content by these companies to be streamed directly on TVs. Netflix was also
an active player in this space.

Answer 3)
Following factors led to the growth of Netflix in the very competitive movie rental business:
1. Business model: Their business model was based on flat and very low fee for unlimited
rentals without due dates, late fees, shipping and handling fees. One of the reasons for the
low cost was the difference in the operating expense of Blockbuster and Netflix. While
Blockbuster had operating expenses of $2533m, Netflix’s expenses were only $399m.

2. Vast range of titles: Netflix had a large pool of DVD titles from which their customers
could select according to their choice. Its inventory included 100,000 DVD titles against
Blockbuster’s 3000. These DVD titles included old and new titles, foreign and independent
films which were usually not available by other companies.

3. Recommendation system: This system gave recommendations to customers on basis of

their rental history and preferences along with ratings given by other users of similar
interests. This search and recommendation function helped customers as they could easily
find relevant content from the large pool of available content and save time and money.

4. Promotion and partnerships to increase customer base: Netflix spent heavily on

promotions and partnered with Roku, Microsoft Xbox and PlayStation 3 for launching set-
top boxes. They partnered with TiVo for digital video recorders, LG, Sony etc. For Blu Ray
players and HD TVs. This increased their availability through multiple channels and helped
in creating a large customer base.

Blockbuster should have responded in the following manner:

1. Efficiency and responsiveness across channels: They should have used their unique ability
to deliver across all channels (both online and offline) in a more efficient way. Quick
response to the competition must have helped in a good way.

2. Adjust according to changes and diversify: They should have been proactive in analyzing
and adjusting to the changing market demands and customer behaviors which Netflix did
wonderfully. They should have diversified from their high cost rental store model early in
response to the growing online streaming requirement.

3. Increase variety: Blockbuster should have increased the variety of content (titles) offered by
them. Availability of only 3000 titles against 100,000 titles by Netflix was a major letdown
for its customers. Also, features like “late fees” and the limited availability of content were
not liked by their customers which worked in Netflix’s favor.

Answer 4)
In 2002, Redbox was started as a venture by McDonald’s to pull crowd to restaurants and was
later developed into a DVD rental kiosk. In a movie rental market dominated by Blockbuster and
Netflix, Redbox tackled the competition by targeting the budget-conscious movie renter in the
new-movie segment. The business model of Redbox focused on low cost and convenience to

Following are the factors that caused Redbox’s growth and allowed it to capture the already
crowded market:
1. Low cost business model: Redbox initiated the concept of vending machine which eventually
led to the DVD kiosk model in 2004. Unlike Blockbuster which had a high cost physical store,
Redbox’s business model of DVD kiosk was relatively inexpensive. Each kiosk costed $15,000
and generated average revenue of $30,000, $40,000 and $50,000 in year 1, 2 and 3. The revenue
resulted from renting DVDs as well as from sale of used DVDs.

2. Strategic location and convenience: Redbox setup DVD kiosks at many locations such as
grocery stores, supermarkets and restaurants which are high customer traffic zones in US. By
2010, Redbox had reached approx. 23000 kiosks across the country. Customers found kiosks as a
convenient way to rent the DVDs as they had easier access to kiosks than making an additional
trip to a Blockbuster store. Also, customers could return the DVD to any kiosk in the network
without any membership requirement.
3. Tie-up with partners: Another reason for the growth of Redbox kiosk business is the support
from retailers. Retailers who were witnessing low customer traffic felt that the installation of a
Redbox kiosk would increase the footfall. Certain retailers offered discounts or free installation
of a kiosk. Also, the revenue sharing model i.e. 15% of rental income incentivized the retailers to
have the kiosk.

4. Low price: Since the target customer group is budget conscious, the price offered is $1/night
rental which is relatively cheaper than the alternatives provided by Netflix and Blockbuster.
Hence customers preferred to pick DVD from Redbox kiosks. By 2010, DVD vending
companies captured 19% of DVD rental market and the number was expected to reach 30%
within a year.

The change in the preference of the customers from buying DVDs to renting them was a drastic
one. In this scenario, Blockbuster was not able to sustain the physical store model due to high
competition from Netflix and Redbox. Redbox also surpassed Netflix in annual sales and
emerged as the number one competitor by the end of the year 2010.

Answer 5)
The online on-demand rental option is continuously growing and with new players like Amazon,
Google and Apple also entering the fray, it looks highly probable that DVDs would be replaced
in the future, and content would be delivered via the internet.

Netflix is aware of the changing trend and has provided the option of online streaming in its
subscription plan. The challenge for Netflix is to decide the content that it should focus on and
the cost of acquiring that content. They buy older DVDs from studios at a reasonable cost but
given the high initial cost of purchase for newly released DVDs, Netflix generally prefers to wait
for a few weeks before they buy new content. Thus, customers do not get entirely fresh content
from Netflix.

Netflix should pursue more licensing deals with movie studios so that it can offer the latest
content for its customers. Furthermore, since Netflix has a strong customer base in "long tail"
section, it can have tie-ups with studios providing obscure and niche content. Moreover, Netflix
should invest more in upcoming technologies that can be disruptive. Currently, Blockbuster is
struggling because the trend has shifted from brick and mortar to online streaming. Netflix
should not let that happen to it.
Redbox has a niche wherein they operate. They rent out DVDs through their kiosks very
cheaply. Currently, they do not have a presence in the streaming business. They should look at
possible partnerships with companies that can provide them capabilities to stream their content.
This hybrid model would be helpful as through this model, Redbox can direct customers to their
preferred channels. Kiosks would serve price-sensitive customers who are looking for recent
content while the streaming option would cater to customers looking for variety.

Redbox can also look at international expansion. This might help them gain new customers like
Asian customers who are generally price sensitive. The cost of setting up a kiosk is very small in
comparison to the revenues that it can generate. It will help the company to derisk by not
focusing on one particular type of customer. Moreover, they should work with studios like 20th
Century Fox to reduce the 28 days wait period that they mandate.

Blockbuster failed to make the transition from brick and mortar to online streaming. They have
filed for bankruptcy protection and now they should focus on ways to divest successfully.

Answer 6)
Let us consider a network consisting of p number of kiosks. The demand distribution of these
kiosks is a normal distribution with mean demand µ and standard deviation σ i.e N (µ, σ). Let us
assume that the demand of each kiosk be identical and is independent of each other.

Kiosk Network

If Redbox lets the customer know the availability of their preferred DVDs, it essentially is
integrating all the kiosks to meet the demand. The entire system acts as a single kiosk with a
demand which is normally distributed with
Mean = N* µ
Standard Deviation (S.D.) =√N*σ
Demand uncertainty is determined by the standard deviation of the demand. Since S.D. of the
integrated system decrease by factor √N, the demand uncertainty faced by kiosk decreases.
Redbox can also understand the demand pattern for DVDs across various geographies. If a
particular kiosk (say, K2) experiences high demand for a particular DVD, the resources (i.e.
DVDs of same title) of another kiosk with less demand (say K5) can be transferred to K2 to
minimize the probability of a stockout at K2. Hence, the demand uncertainty decreases.
Indian Institute of Management Bangalore
Supply Chain Management
Movie Rental Business: Case Analysis Questions

1. Compare the supply chains of Blockbuster, Netflix and Redbox in terms of total
(inbound as well as outbound) transportation cost, facility cost, and inventory
holding cost.
2. How do the different players in the movie rental value chain provide and capture
3. What factors led to the growth of Netflix? How should Blockbuster have responded
to the challenges posed by Netflix?
4. What factors led to the growth of Redbox? How and why it was able to capture
market already dominated by big players such as Blockbuster and Netflix?
5. How would you advise these companies to modify their strategies and structures
going forward?
6. Redbox lets customers know which of the nearby kiosks has the DVD they are
looking for. Does it increase or decrease the uncertainty of demand faced by a
Global Supply Chain
Management V2 Simulation
How to Play Guide

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permission of Harvard Business Publishing.
When companies provide extensive product options, it makes predicting
and fulfilling customer demand highly complex.

This simulation illustrates how a few key decisions can improve the
ability of a company to accurately predict and fulfill demand.

You have just been hired as the Supply Chain Manager responsible for
production of two new lines of mobile phones. You will be able to make
key decisions and see the impact of your decisions on the performance
of your company over the span of 4 years.
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permission of Harvard Business Publishing.
Your Objectives
• You are in charge of releasing two models of mobile phones:
• Model A, a base model
• Model B, a high end model

• Decide which features to include and with whom to outsource the work.

Important Info:
• Sales season is May through December—there is no demand before May or after December
• Demand is anticipated to be consistent over these months

You will be judged on the following criteria:

Gross Margin
Gross Margin %
Number of Votes of Confidence by Board Members

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Design Room
• Add up to four options to the base model
• *Pay attention to the estimated change in
demand created by each option, its impact on
profit per unit, and other variables

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permission of Harvard Business Publishing.
Forecasting Room
• Predict the demand of the two phone
models for each year

• *Remember, demand is spread out

evenly across all months from May to

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Production Room
• After choosing suppliers you will advance
month by month and observe the accuracy of
your forecasts
• You will be able to change your production
schedule, but this will require a significant
payment to your suppliers

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permission of Harvard Business Publishing.
Board Room
• Review your financial
• See how well your strategic
choices have played out over the
year based on Board Member

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permission of Harvard Business Publishing.
• When the board meeting ends, return to the Design Room to
start the next year
• You will repeat the cycle of design, forecasting, production,
and board evaluation for four years
• Remember that you can track your progress using the
scorecard on the left-hand side of the screen
• You can refer to previous decisions you made by clicking on
the Decision History section.

Good Luck!

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permission of Harvard Business Publishing.