April 5, 2016

The Value of Information in Supply Chain Management

Summary of Chapter 5 of Simchi Levy

The Value of Information
5.1 Introduction
Value of using any type of information technology
Potential availability of more and more information throughout the supply chain
Implications this availability on effective design and management of the integrated supply chain

Information Types
Inventory levels
Delivery status

More Information

Helps reduce variability in the supply chain.
Helps suppliers make better forecasts, accounting for promotions and market changes.
Enables the coordination of manufacturing and distribution systems and strategies.
Enables retailers to better serve their customers by offering tools for locating desired items.
Enables retailers to react and adapt to supply problems more rapidly.
Enables lead time reductions.

Helps reduce variability in the supply chain.

5.2 Bullwhip Effect
While customer demand for specific products does not vary much
Inventory and back-order levels fluctuate considerably across their supply chain
P&G’s disposable diapers case
Sales quite flat
Distributor orders fluctuate more than retail sales
Supplier orders fluctuate even more

4-Stage Supply Chain
Effect of Order Variability
Factors that Contribute to the Variability - Demand Forecasting
Periodic review policy
Characterized by a single parameter, the base-stock level.
Base-stock level =
Average demand during lead time and review period +
a multiple of the standard deviation of demand during lead time and review period (safety stock)
Estimation of average demand and demand variability done using standard forecast smoothing techniques.
Estimates get modified as more data becomes available
Safety stock and base-stock level depends on these estimates
Order quantities are changed accordingly increasing variability
Factors that Contribute to the Variability – Lead Time
Increase in variability magnified with increasing lead time.
Safety stock and base-stock levels have a lead time component in their estimations.
With longer lead times:
a small change in the estimate of demand variability implies
a significant change in safety stock and base-stock level, which implies
significant changes in order quantities
leads to an increase in variability

Factors that Contribute to the Variability – Batch Ordering
Retailer uses batch ordering, as with a (Q,R)  or a min-max policy
Wholesaler observes a large order, followed by several periods of no orders, followed by another large order, and so on.
Wholesaler sees a distorted and highly variable pattern of orders.
Such pattern is also a result of:
Transportation discounts with large orders
Periodic sales quotas/incentives
Factors that Contribute to the Variability – Price Fluctuations
Retailers often attempt to stock up when prices are lower.
Accentuated by promotions and discounts at certain times or for certain quantities.
Such Forward Buying results in:
Large order during the discounts
Relatively small orders at other time periods
Factors that Contribute to the Variability – Inflated Orders
Inflated orders during shortage periods
Common when retailers and distributors suspect that a product will be in short supply and therefore anticipate receiving supply proportional to the amount ordered.
After period of shortage, retailer goes back to its standard orders
leads to all kinds of distortions and variations in demand estimates

When p is large and L is small, the bullwhip effect is negligible.
Effect is magnified as we increase the lead time and decrease p.

Impact of Centralized Information on  Bullwhip Effect

Centralize demand information within a supply chain
Provide each stage of supply chain with complete information on the actual customer demand
Creates more accurate forecasts rather than orders received from the previous stage

Variability with Centralized Information
Var(D), variance of the customer demand seen by the retailer
Var(Qk), variance of the orders placed by the kth stage to its
Li, lead time between stage i and stage i + 1

Variance of the orders placed by a given stage of a supply chain is an increasing function of the total lead time between that stage and the retailer
Variability with Decentralized Information
Retailer does not make its forecast information available to the remainder of the supply chain
Other stages have to use the order information

Variance of the orders:
becomes larger up the supply chain
increases multiplicatively at each stage of the supply chain.
Managerial Insights
Variance increases up the supply chain in both centralized and decentralized cases
Variance increases:
Additively with centralized case
Multiplicatively with decentralized case
Centralizing demand information can significantly reduce the bullwhip effect
Although not eliminate it completely!!
Increase in Variability for Centralized and Decentralized Systems
Methods for Coping with the Bullwhip
Reducing uncertainty. Centralizing information

Reducing variability.
Reducing variability inherent in the customer demand process.
“Everyday low pricing” (EDLP) strategy.

Methods for Coping with the Bullwhip
Lead-time reduction
Lead times magnify the increase in variability due to demand forecasting.
Two components of lead times:
order lead times [can be reduced through the use of cross-docking]
Information lead times [can be reduced through the use of electronic data interchange (EDI).]
Strategic partnerships
Changing the way information is shared and inventory is managed
Vendor managed inventory (VMI)
Manufacturer manages the inventory of its product at the retailer outlet
VMI the manufacturer does not rely on the orders placed by a retailer, thus avoiding the bullwhip effect entirely.

5.3 Information Sharing And Incentives

Centralizing information will reduce variability
Upstream stages would benefit more
Unfortunately, information sharing is a problem in many industries
Inflated forecasts are a reality
Forecast information is inaccurate and distorted
Forecasts inflated such that suppliers build capacity
Suppliers may ignore the forecasts totally
Contractual Incentives to Get True Forecasts from Buyers
Capacity Reservation Contract
Buyer pays to reserve a certain level of capacity at the supplier
A menu of prices for different capacity reservations provided by supplier
Buyer signals true forecast by reserving a specific capacity level
Advance Purchase Contract
Supplier charges special price before building capacity
When demand is realized, price charged is different
Buyer’s commitment to paying the special price reveals the buyer’s true forecast

Helps suppliers make better forecasts, accounting for promotions and market changes.

5.4 Effective Forecasts
Retailer forecasts
Typically based on an analysis of previous sales at the retailer.
Future customer demand influenced by pricing, promotions, and release of new products.
Including such information will make forecasts more accurate.
Distributor and manufacturer forecasts
Influenced by factors under retailer control.
Promotions or pricing.
Retailer may introduce new products into the stores
Closer to actual sales – may have more information
Cooperative forecasting systems
Sophisticated information systems
iterative forecasting process
all participants in the supply chain collaborate to arrive at an agreed-upon forecast
All parties share and use the same forecasting tool

5.5 Information for the Coordination of Systems
Many interconnected systems
manufacturing, storage, transportation, and retail systems
the outputs from one system within the supply chain are the inputs to the next system
trying to find the best set of trade-offs for any one stage isn’t sufficient.
need to consider the entire system and coordinate decisions
Systems are not coordinated
each facility in the supply chain does what is best for that facility
the result is local optimization.
Global Optimization
Who will optimize?
How will the savings obtained through the coordinated strategy be split between the different supply chain facilities?
Methods to address issues:
Supply contracts
Strategic partnerships

5.6 Locating Desired Products
Meet customer demand from available retailer inventory
What if the item is not in stock at the retailer?
Being able to locate and deliver goods is sometimes as effective as having them in stock
If the item is available at the competitor, then this is a problem
Other Methods
Inventory pooling (Chapter 7)
Distributor Integration (Chapter 8)

5.7 Lead-Time Reduction
Numerous benefits:
The ability to quickly fill customer orders that can’t be filled from stock.
Reduction in the bullwhip effect.
More accurate forecasts due to a decreased forecast horizon.
Reduction in finished goods inventory levels
Many firms actively look for suppliers with shorter lead times
Many potential customers consider lead time a very important criterion for vendor selection.
Much of the manufacturing revolution of the past 20 years led to reduced lead times
Other methods:
Distribution network designs (Chapter 6)
Effective information systems (e.g., EDI)
Strategic partnering (Chapter 8) (Sharing point-of-sale (POS) data with supplier)

5.8 Information and Supply Chain Trade-Offs
Conflicting objectives in the supply chains
Designing the supply chain with conflicting goals
Wish-Lists of the Different Stages
Raw material suppliers
Stable volume requirements and little variation in mix
Flexible delivery times
Large volume demands
High productivity through production efficiencies and low production costs
Known future demand pattern with little variability.
Materials, warehousing, and outbound logistics
Minimizing transportation costs through: quantity discounts, minimizing inventory levels, quickly replenishing stock.
Short order lead times and efficient, accurate order delivery
In-stock items, enormous variety, and low prices.
Trade-Offs: Inventory-Lot Size
Manufacturers would like to have large lot sizes.
Per unit setup costs are reduced
Manufacturing expertise for a particular product increases
Processes are easier to control.
Modern practices [Setup time reduction, Kanban and CONWIP]
Reduce inventories and improve system responsiveness.
Advanced manufacturing systems make it possible for manufacturers to meet shorter lead times and respond more rapidly to customer needs.
Manufacturer should have as much time as possible to react to the needs of downstream supply chain members.
Distributors/retailers can have factory status and manufacturer inventory data:
they can quote lead times to customers more accurately.
develops an understanding of, and confidence in, the manufacturers’ ability.
allows reduction in inventory in anticipation of manufacturing problems
Trade-offs Inventory-Transportation Costs
Company operates its own fleet of trucks.
Fixed cost of operation + variable cost
Carrying full truckloads minimizes transportation costs.
Outside firm is used for shipping
quantity discounts
TL shipping cheaper than LTL shipping
In many cases
demand is much less than TL
Items sit for a long time before consumption leading to higher inventory costs.
Trade-off can’t be eliminated completely.
Use advanced information technology to reduce this effect.
Distribution control systems allow combining shipments of different products from warehouses to stores
Decision-support systems allow appropriate balance between transportation and inventory costs
Trade-offs Lead Time-Transportation Costs
Transportation costs lowest when large quantities of items are transported between stages of the supply chain.
Hold items to accumulate enough to combine shipments
Lead times can be reduced if items are transported immediately after they are manufactured or arrive from suppliers.
Cannot be completely eliminated
Information can be used to reduce its effect.
Control transportation costs reducing the need to hold items until a sufficient number accumulate.
Improved forecasting techniques and information systems reduce the other components of lead time
may not be essential to reduce the transportation component.
Trade-Offs Product Variety-Inventory
Higher product variety makes supply chain decisions more complex
Better for meeting customer demand
Typically leads to higher inventories
Delayed Differentiation (Chapter 6)
Ship generic products as far as possible down the supply chain
Design for logistics (Chapter 11)

Trade-Offs Cost-Customer Service
Reducing inventories, manufacturing costs, and transportation costs typically comes at the expense of customer service
Customer service could mean the ability of a retailer to meet a customer’s demand quickly
direct shipping from warehouses to customers
Charging price premiums for customized products

5.9 Decreasing Marginal Value of Information

Obtaining and sharing information is not free.
Many firms are struggling with exactly how to use the data they collect through loyalty programs, RFID readers, and so on.
Cost of exchanging information versus the benefit of doing so.
May not be necessary to exchange all of the available information, or to exchange information continuously.
Decreasing marginal value of additional information
In multi-stage decentralized manufacturing supply chains many of the performance benefits of detailed information sharing can be achieved if only a small amount of information is exchanged between supply chain participants.
Exchanging more detailed information or more frequent information is costly.
Understand the costs and benefits of particular pieces of information
How often this information is collected
How much of this information needs to be stored
How much of this information needs to be shared
In what form it needs to shared

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