4 Supply Chain

Learning Objectives

Explain the term supply chain, describe its flows, and the organizations that participate in a typical supply chain.

Identify types of inventory in the supply chain and reasons for carrying inventory.

Define the term logistics and give advantages and disadvantages to various forms of transportation.

Describe the various forms of communication and technology in the supply chain.

Calculate inventory turnover and days of supply as measures of supply chain performance.

 

Supply Chain refers to the group of organizations that are linked together by their participation in order to fulfill a customer order from the sourcing of raw materials through the production of goods to distribution and sale. Each organization has a role to play in adding value for the final customer. The organizations that participate in a supply chain include suppliers, manufacturers, transporters (also known as carriers), distribution centres, wholesalers, retailers and end-consumers.

Every link in this chain of supply is very important. As they say, “a chain is only as strong as its weakest link.” This has implications for the supply chain management in a sense that it is not enough for the companies just to focus on their own internal operations. They need to regularly check with their supply chain members to make sure that everybody is performing at their best. One weak member in any supply chain will impact everybody else.

For example, if a retail store is not doing a good job at replenishing their inventory on time, the product will not be available to some end-consumers when needed, and as a result, lost sales happen and that supply chain will be affected financially. Let’s think about it for a second: fewer products had got ordered from the manufacturer, and thus, fewer raw materials were ordered (by the manufacturer) from higher tiered suppliers. This way, everybody in the supply chain sold less than what they could if the retailer had ordered the right quantity at the right time.

Managing Main Flows in the Supply Chain

There are three types of main flows that happen in any supply chains: flow of materials/goods, flow of money/cash, and flow of information. There is a forward flow of materials/goods for the regular flow that happens all the way from higher tier suppliers (upstream) to the end-consumer (downstream). In addition, if there is any returns for any reason, there will be a reverse flow of materials/goods in the opposite direction to the forward flow.

Flow of money (cash flow) happens from downstream to upstream. For example, the retailer needs to pay the distributor for the goods they have received from them.

Flow of information happens both ways in the supply chain since organizations will need to share different type of information with each other so that the whole supply chain can make better decisions to improve overall performance.

Figure 4.1: Upstream and downstream of a supply chain and its flows.

Foundational Elements of Supply Chain Management

Each organization in a supply chain needs to manage four key elements. These include supply management, managing the internal operations, distribution management, and managing the integration of all of these so that all parts of the supply chain are working with each other in harmony. The following sections will cover some of the things that are done in relation to each one of these elements. Figure 4.3 depicts the foundational elements.

Figure 4.3: Example of a company’s supply chain; Credit: Stern / Wikimedia / https://commons.wikimedia.org/wiki/File:A_company%27s_supply_chain_(en).png

Supply Management includes purchasing and managing the suppliers and the relationships with them. Internal Operations is consisted of managing whatever the company does to add value. For example, a manufacturer does “Production”, along with managing inventory of raw materials and finished goods, human resources, etc. Distribution Management deals with managing the customers and the relationships with them. In order to do this, the organization needs to have a deep understanding of its customers and their needs to be able to deliver the right product/service to the right customer at the right time. Integration Management uses several technologies such as ERP systems to make the collaboration among the different elements easier and more accurate.

Supply Chain Design

Supply Chain Design is a strategic decision which determines who needs to take on what role or responsibility in the supply chain and where they should be located. Different companies choose different design or structure for their supply chains. For example, Walmart has always used traditional brick and mortar stores to serve its customers, while Amazon has been using an online platform to get customers’ orders and then, ship them directly from their distribution/fulfillment centres.

When designing a supply chain, two main things to consider are Efficiency (cost reductions) and Responsiveness. The balance between these two could be different for different companies. That is, depending on the customers’ preferences, the company decides to have a certain structure for their supply chain. For example, if the customers for a particular company are willing to wait for 5-7 days to get their ordered products online, the company can store its inventory in fewer locations and use the longer time of transportation to serve its customers. However, if the customers want to have their products right away, the company may need to open quite a few stores and keep enough inventory in each one to be able to respond faster to its customers’ needs.

A company may decide to use other companies for parts of their supply chain or to have their own entities. This includes Vertical and/or Horizontal integration. Vertical integration is a term that is used when a firm owns more than one portion of its supply chain. For example, for a manufacturer company, they may have their own distributors or even retail stores to sell their products to the end-consumers (forward integration) or they may choose to own one or more of the suppliers that provide the company with certain materials or components (backwards integration).

Horizontal Integration is a situation where a business chooses to increase their holdings by acquiring or merging with another firm in the same market. An example of this was the 2015 merger of Kraft foods and Heinz, or Marriott International’s purchase of Starwood hotels in 2016.

Example

A complex surrounding the Highland Park Plant included a power plant, machine shop, and foundry. Ford was starting to bring together the various stages in the manufacture of automobiles, a strategy called vertical integration. By the 1920s, Ford had purchased a rubber plantation in Brazil, coal mines in Kentucky, acres of timberland and iron-ore mines in Michigan and Minnesota, a fleet of ships, and a railroad. These efforts to vertically integrate helped Ford make sure his company would have raw materials and parts when they were needed, guaranteeing a continuously operating assembly line. These efforts also enabled the company to profit from more of the processes involved in producing the automobile.[1]

Example

Netflix is one of the most significant backward vertical integration examples in the entertainment industry. In the past, Netflix was established at the end of the supply chain because it was a platform to distribute films and TV shows created by other content creators. Although this was a profitable means of doing business, Netflix leaders realized that they could generate greater revenue by creating their own original content. This would offset their reliance on outside content creators, and fill what Netflix discovered was a desire among their subscribers for original content. Netflix leaders understood that they could leverage their existing distribution platform to promote original content to a captive audience. This strategy has become vital to Netflix’s continuing success because as more and more film studios end their licensing agreements with the streaming giant, the company’s original content will become the main attractor for new subscribers.[2]

The Role of Inventory in the Supply Chain

Managing inventory is one of the most important activities in a supply chain. Materials/goods are needed to provide manufacturers with the exact items that they need, in the right order, the right quality, delivered to the right location, and at the right time. Without all of this happening, it will be impossible to produce high quality goods and meet commitments to our customers. In addition, when goods are ready for shipment, the outbound supply chain needs to be organized in such a way that customers receive their requested orders in a cost-efficient manner.

Types of Inventory in the Supply Chain:

  • Finished goods
  • Raw materials
  • Purchased components and operating supplies
  • Work-in-process

Reasons for holding inventories:

Many reasons exist for keeping stocks of inventory. Some of the most common include:

  • Manufacturers often build up inventories throughout the year because of seasonal demand.
    • An example is a Chocolate manufacturer who does not have the capacity to produce all the product that is needed for Christmas. They may begin building inventory in late spring in order to have enough on hand for orders in November and December.
  • At the same time, a manufacturer may carry large amounts of inventory if they have some uncertainty or risk in their supply base. If suppliers have some risk of shortages, work stoppages, poor quality or late deliveries then more stock may be carried.
  • Firms may be tempted by extra discounts often provided by purchasing large order sizes. Perhaps they may want to minimize transportation costs. There may also be some worry about future price increases that can cause organizations to build up their inventories.
  • Retailers carry inventory to ensure that they do not run out of what they anticipate their customers may want. Distributors and retailers may try and balance the cost of keeping large inventories on hand with providing excellent customer service with few or no disappointed customers. However, it is often a challenge to anticipate exact customer behaviour.
  • It is a challenge to synchronize incoming flow of materials and goods in order to meet production schedules and ship to customers as promised. As a result, inventory may be stored at many locations along the supply chain. This causes extra cost and inefficiencies for each organization.

Logistics

Logistics refers to the activities of coordinating and moving resources, particularly inputs into the transformation process, and finished goods out to customers. Originally, the term logistics was from the military and referred to moving troops, equipment and supplies. Managing logistics involves making decisions such as the following:

  • Choosing to operate and manage the firm’s own transportation, or whether to outsource this activity
  • Selecting suppliers that have the capability to ship goods safely and securely within the required time frame
  • Choosing the correct mode of transportation and the most effective route
  • Negotiating the shipping rate

Modes of Transportation

There are several modes of transportation available to companies. We discuss them in the following:

Trucking

The majority of goods are shipped by truck completely or at some point during the shipping. Trucking is the most flexible of all modes of transportation. Trucking is categorized by “truck-load” (TL) when the entire truck is hired and delivered directly, or “less-than-truckload” (LTL) which generally includes using several orders to increase the utilization of the truck. A serious issue facing Canada at this time is the expected shortage of qualified drivers. Demand for drivers continues to increase every year, and the average age of drivers is increasing. The trucking industry will face challenges to make driving more attractive to entice new workers into trucking jobs.[3]

Railroads

Rail can be a very cost effective means of transporting goods that need to travel long distances. Goods in containers, or products that are bulky and heavy are ideal for train transport. Canadian rail ships products including cars, fertilizer, food and beverages, forest products, grain, metals and minerals and petroleum products. Often, large manufacturers  locate themselves near rail lines to make for easy shipment of raw material into, and finished goods out of their facilities. Compared to trucking, shipping by rail is very energy efficient, and removes many trucks from congested highways. Canada has a very old and well-established rail system.[4]

Airfreight

For goods that are expensive, small and light, air shipping may be a good choice. Air carriers charge by a combination of the weight and size of the shipment. This mode of transport is generally used when speed is more important than cost. Shipping by air is very reliable.  Firms may want to consider the environmental impact of regular use of air shipping.

Waterway

This is a very common way of shipping goods. The goods that travel by water include chemicals, stone, cement, sugar, coal and other heavy commodities. Millions of containers travel by ship each year. Do you know what goods travel by ship? Read here.

The Great Lakes St. Lawrence Seaway System is a 3,700 kilometer marine highway that runs between Canada and the United States. Opening in 1959 the seaway is a major trade artery that serves many industries to ship iron ore, coal, limestone, steel, grain and cement. The cost for shipping by waterways is inexpensive. Most low-cost products are shipped by waterways.[5]

Pipelines

Crude oil, natural gas and other petroleum products are shipped by pipelines. Once the pipelines are built, the cost per kilometre for shipping is very inexpensive. There is a lot of opposition and concern over new pipelines because of worry over spills and leaks that may contaminate land and waterways.[6]

Multimodal/Intermodal shipping

This refers to the use of a combination of different types of transportation to move goods from origin to destination. A common example is a combination of truck/ship/train. The goal is to ship the goods as efficiently as possible. The goods are shipped under a single contract with a carrier, and can be easily tracked. It also uses several modes of transportation but also uses a container so that freight does not have to be handled each time it changes modes. Each mode will have a carrier responsible for the shipment. The use of containers increases the security, reduces loss and damage and increases the speed of shipment.

Figure 4.4: Diagram summarizing various modes of transportation.

Distribution Management

Distribution management refers to the process of overseeing the movement of goods from supplier or manufacturer to point of sale. Distribution management is an important part of the business cycle for distributors and wholesalers. The profit margins of businesses depend on how quickly they can turn over their goods. The more they sell, the more they earn, which means a better future for the business. Having a successful distribution management system is also important for businesses to remain competitive and to keep customers satisfied.

Distribution involves diverse functions such as customer service, shipping, warehousing, inventory control, private trucking-fleet operations, packaging, receiving, materials handling, along with plant, warehouse, store location planning, and the integration of information.

The goal is to achieve ultimate efficiency in delivering raw materials and parts, both partially and completely finished products to the right place and time in the proper condition.[7]

The combination of distribution and transportation is logistics. The most important factor in any logistics is quickly delivering product in perfect condition. Read here how Amazon has used its supply chain management to fuel its rise to the top.

Crossdocking

A broad definition of crossdocking is the transfer of goods and materials from an inbound carrier to an outbound carrier without the products actually entering the warehouse or being put away into storage. Thus, the products “cross the docks” from the receiving dock area to the shipping dock area. It can provide significant inventory savings, and the cost of holding inventory and the costs of handling the inventory are reduced. Crossdocking helps to provide excellent customer service by speeding up customer deliveries.[8]

Communication and Technology in the Supply Chain 

Electronic Data Interchange (EDI)

Electronic Data Interchange (EDI) is the computer-to-computer exchange of business documents, such as purchase orders and invoices, in a standard electronic format between business partners, such as retailers and their suppliers, banks and their corporate clients, or car-makers and their parts suppliers.

EDI enables the companies to transfer the documents without having any people involved. The documents are automatically transferred from one computer (account) to another. As a result, there are many advantages to using EDI.  The primary benefit is the speed and accuracy of the information transmitted. Information is made available in real time and errors that may have previously been caused during the data entry process are eliminated.

Common information exchanged using EDI include:

  • Purchase orders
  • Invoices
  • Advance shipment notices (ASN)
  • Customs documents
  • Inventory information
  • Shipping status
  • Payment documents
  • Bill of lading
  • Sales/price catalogues
  • Shipment status messages

Barcodes

Barcodes have been used extensively since the 1970s, and consist of data that is displayed in a machine-readable form that can be scanned by barcode readers. The information contained on the barcode is typically pricing information, product number and description and any other pertinent information. Barcodes have become the norm in retail operations allowing for pricing accuracy and easy price changes. This data provides point-of-sale information to allow retailers to track items being sold, update inventory, identify fast and slow moving products and assist in forecasting.

QR

Quick Response (known as QR) is using bar codes and EDI to make sales data available to vendors so that vendors can quickly replenish goods in the correct quantity. This is thought of as JIT in the retail industry. The goal is to reduce out-of stock incidents, as well as using smaller more frequent deliveries to reduce inventory and operating expenses.

Radio Frequency Identification Device (RFID)

This technology uses radio waves to communicate information contained on a tag attached to an object. The information contained on a tag may include things such as the products origin, date of production, shipment information, pricing info, and any other pertinent info. In order to transfer this info, both a tag and a reader are needed. There are two types of tags, active and passive. An active tag contains a power source such as a battery and can operate a great distance from the reader. Passive tags use energy from the reader. Unlike barcodes, the RFID tag and reader do not require line of site in order to transmit the information.

RFID applications include the following plus many more:

  • Retail use to protect from theft
  • Toll road payments
  • Identification (i.e. tracking of animals and people)
  • Passports
  • Shipping tracking – to identify location and contents of orders
  • Asset tracking (e.g. laptops, expensive tools, medical devices in hospitals)
  • Race timing for marathons
  • Tracking luggage during travel

Supply Chain Collaboration

Vendor Managed Inventory (VMI)

Vendor Managed Inventory (VMI) is an advanced supply chain relationship whereby a vendor (often a manufacturer) has access to their customer’s inventory information and the vendor takes the responsibility for maintaining an agreed-upon level of product at the customers location. This arrangement can be used with manufacturers, distributors and retailers.

VMI has numerous benefits for both the supplier (vendor) and the customer. The vendor has strong motivation to ensure that shelves are fully stocked, any slow-moving stock is discontinued and that employees have full understanding of the product offerings. The customer benefits from these VMI relationships because less work is involved on the buyers’ end. Due to EDI, there are few errors and goods flow quickly. Point-of-sale data updates the inventory and determines what items are needed.  Salespeople from the vendor often provide assistance by training sales staff and assisting customers when possible.

Collaborative Planning, Forecasting and Replenishment (CPFR)

Collaborative Planning, Forecasting and Replenishment (CPFR) is an arrangement where two trading partners in a supply chain collaborate to agree on forecasts and orders between the manufacturer and distributor/retailer. The distributor/retailer will have collected POS data and added any additional information, such as promotion plans, inventory status or forecasts. That information gets shared with manufacturers who will then compare it with their own forecasts and capacity. Both teams can collaborate to solve any discrepancies, eliminate gaps and agree on a final set of numbers. Collaborating in this way will enable both firms to reduce inventory as well as reducing problems such as shortages and capacity problems.

Measuring Supply Chain Performance

Inventory Turnover

Key Performance Indicators are measurements used to evaluate supply chain performance. One of the ways to evaluate the supply chain performance is to calculate inventory turnover (inventory turns):

Figure 4.5: Inventory turnover formula (cost of goods sold divided by average aggregate inventory value).

“Average aggregate inventory value” is a term used to describe all of the inventory held in stock, which includes raw materials, work in process and finished goods, all valued at cost.

Inventory turnover is an indicator of the policies and practices of an organization. It represents their ability to purchase materials, produce and sell their products in a timely manner. A higher value for the inventory turnover means that the organization has been capable of replenishing and selling its inventory more number of times in any particular amount of time, and as a result, have a better cash flow.

It is important to keep in mind that high or low value of inventory turnover for each company is relative to its own industry. For example, dairy (milk) manufacturing has an annual inventory turnover of around 23, while this number is 14.7 for the grocery supermarkets, and 4.8 for the automotive industry.[9] Industries with higher volume, but lower margin, usually have the highest inventory turnovers.

Example

NED’s Food Supply is a supplier to restaurants and institutions for frozen foods, meats, fish, canned and fresh fruits and vegetables.  Here is an analysis from the past two years regarding their inventory management. In which year was their supply chain performance better?

Last year Two years ago
Cost of goods sold 17,550,000 16,255,000
Average aggregate inventory value $1,650,000 $1,763,350

Solution

Inventory turns for last year = 17,550,000 / 1,650,000 = 10.64 turns

Inventory turns for two years ago = 16,255,000 / 1,763,350 = 9.22 turns

Last year, their inventory turnover was faster. If customer service was equivalent in both years, then their performance was better last year than it was two years ago. This may have resulted in customers receiving fresher foods as well.

Days of Supply

Another related performance measure is days of supply:

Figure 4.6: Days of supply formula (average aggregate inventory value divided by annual cost of goods sold, the sum of which is multiplied by 365 [days]).

Example

J’s Custom Automotive Finishing has calculated that his annual cost of goods sold at 45,000,000. His average inventory value in 2019 is:

Production components 2,350,000
Production supplies 450,000
Finished goods 225,600
Total aggregate inventory value: 3,025,600

Solution

Days of supply = (3,025,600 / 45,000,000) x 365 = 24.54

This measure can be thought of as how much inventory is sitting in the building at any one time. In terms of measuring the efficiency of the inventory, a lower number is better. It would imply that goods are purchased more frequently and spend less time in the facility before being converted into sales.

There are other ways to measure supply chain performance as well. In a warehouse or distribution setting, fill rate is an important measure. It is the percentage of customer orders that are filled from on-hand stock. In a manufacturing setting, a measure such as the percentage of orders delivered on time is an important indicator of customer service level.

Socially Responsible Supply Chain Management

Main areas of social responsibility in supply chains are:[10]

  • Organizational practices
  • Ethical practices
  • Environmental practices
  • Practices of human rights and working conditions
  • Practices of occupational health and safety
  • Practices to establish relationship with society

The following table[11] summarizes activities and practices considered good examples for the CSR areas listed above.

Relevant CSR Areas Sample Practices
Organizational Practices • Determining CSR goals for purchasing function
• Determining and defining roles and responsibilities of human resources related to CSR in logistics
• Providing relevant training in CSR to the suppliers
• Sharing of CSR activities and practices with all relevant stakeholders
• Implementing a mechanism to receive feedback from stakeholders regarding CSR practices
Ethical Practices • Not accepting gifts, free services, etc. from suppliers (especially during supplier selection process)
• Not creating illegitimate pressures on suppliers
• Not sharing price and service information about suppliers with other irrelevant stakeholders
• Not favoring any particular supplier just because of managers’ preferences and assuring a fair selection process
• Assuring all departments meet ethical standards in independent purchasing process
• Not creating illegitimate advantage in competition by using contract items
• Not giving out wrong information on purpose
• Not using specific items pointing out specific suppliers in contracts
Environmental Practices • Purchasing and using recycled materials for packaging
• Supporting and encouraging suppliers on reducing waste (especially hazardous waste)
• Putting special emphasis on producing recyclable and reversible materials in production and design
• Meeting standards for protecting environment in the processes of lifecycle management, production, packaging and storing
• Supporting suppliers to implement processes that are appropriate for sustainable environmental protection
Practices of human rights and working conditions • Not keeping some suppliers out of cycle, just because they have managers from different backgrounds
• Having procedures and also having mechanisms to monitor providing equal opportunity for each employee working in all supplier companies
• Having appropriate procedures in place to assure that all employees can benefit from all their legal rights, are working in accordance with rules, regulations and national/ international standards
• Assuring that physical and psychological working conditions comply with all rules and regulations in place
Practices of occupational health and safety • Having appropriate procedures in place to assure that working conditions do not jeopardize human health and safety
• Assuring that all safety, security and protection measures are in place for all activities
• Having procedures in place to assure that sensitive and delicate products are stored under appropriate conditions
Practices to establish relationship with society • Developing and carrying out programs for training and development of local suppliers
• Actively participating into and organizing non-for-profit social activities, such as volunteer work, charities, public auctions, etc.
• Supporting sport activities and public education

Among those aforementioned activities, ensuring that all activities and functions comply with national / international rules, regulations and standards and working with suppliers that fulfill same requirements constitute the most important factors for CSR in supply chains. This issue is also important to stay competitive in market and to have a sustainable growth in terms of strategic perspective.

Video: Business is about purpose


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Introduction to Operations Management by Mary Drane and Hamid Faramarzi is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License, except where otherwise noted.