Supply Chain Management

Subject Code: 18ME653

Module-1: Introduction to Supply Chain Management
What is Supply Chain Management?
The supply chain encompasses all activities involved in the transformation of goods from the raw
material stage to the final stage, when the goods and services reach the end customer. Supply chain
management involves planning, design and control of flow of material, information and finance
along the supply chain to deliver superior value to the end customer in an effective and efficient
manner. A typical supply chain is represented in Figure 1.1.

As can be seen from the definition, the supply chain not only includes manufacturers, suppliers
and distributors but also transporters, warehouses and customers themselves. Of late, firms have
realized that it is not the firms themselves but their supply chains that vie with each other in the
marketplace. Thus, it is not Hindustan Unilever (HUL) versus Procter & Gamble (P&G). Rather,
the supply chains of both these firms compete against each other. The customer is interested only
in the price, availability and quality of the product at the neighborhood retail outlet, where they
actually come into contact with products supplied by HUL and P&G. If customers observe
inefficiency on account of non-availability, damaged packaging, etc. at the retail end with regard
to HUL’s products, they attribute inefficiency to HUL and not to its chain partners. The customer
is only interested in getting the desired product at the right place, at the right time and at the right
price. For a simple product like soap, the HUL supply chain involves ingredient suppliers,
transporters; the company’s manufacturing plants, carrying and forwarding agents, wholesalers,
distributors and retailers. Obviously, HUL does not own all these entities, but the HUL brand name
is at stake and it has to be ensured that the entire chain delivers value to the end customer. HUL
cannot afford to focus only on those parts of the chain that are owned by it and ignore the other
parts of chain. Firms need to realize that the performance of the chain is determined by its weakest
link.
The supply chains of automobile companies (Maruti, Tata Motors and TVS) and other companies
like BPL, LG and Whirlpool, dealing in consumer durables, will be very similar to the one depicted
in Figure 1.1. On the other hand, companies in the consumer non-durables business—for example,
HUL, P&G, Godrej Soaps and Nestlé—have to work with supply chains that are likely to be much
longer and more complex. The term chain is a little misleading because it gives the impression
that there is only one entity at each stage of the supply chain. In reality, as seen in Figure 1.1,
multiple entities are involved at each stage: a manufacturer receives material from several suppliers
and, in turn, distributes the products through multiple distributors. The more appropriate term
probably will be either supply networks or supply web. However, the term supply chain has been
widely accepted by both practitioners and academicians; hence, we will continue to use the same
throughout the book.

Evolution of Supply Chain Management

The First Revolution (1910–1920): Vertical Integrated Firms Offering Low
Variety of Products
There have been three major revolutions along this journey, and we examine each of them in the
context of the broader evolution in the economic environment.
The first major revolution was staged by the Ford Motor Company where they had managed to
build a tightly integrated chain. The Ford Motor Company owned every part of the chain— right
from the timber to the rails. Through its tightly integrated chain, it could manage the journey from
the iron ore mine to the finished automobile in 81 hours. However, as the famous saying goes, the
Ford supply chain would offer any colour, as long as it was black; and any model, as long as it was
Model T. Ford innovated and managed to build a highly efficient, but inflexible supply chain that
could not handle a wide product variety and was not sustainable in the long run. General Motors,
on the other hand, understood the demands of the market place and offered a wider variety in terms
of automobile models and colours. Ford’s supply chain required a long time for set-up changes
and, consequently, it had to work with a very high inventory in the chain.
Till the second supply chain revolution, all the automobile firms in Detroit were integrated firms.
Even traditional firms in India, like Hindustan Motors, were highly integrated firms where the bulk
of the manufacturing was done in-house.

The Second Revolution (1960–1970): Tightly Integrated Supply Chains

Offering Wide Variety of Products
Towards the end of the first revolution, the manufacturing industry saw many changes, including
a trend towards a wide product variety. To deal with these changes, firms had to restructure their
supply chains to be flexible and efficient. The supply chains were required to deal with a wider
product variety without holding too much inventory. The Toyota Motor Company successfully
addressed all these concerns, thereby ushering in the second revolution.
The Toyota Motor Company came up with ideas that allowed the final assembly and
manufacturing of key components to be done in-house. The bulk of the components was sourced
from a large number of suppliers who were part of the keiretsu system. Keiretsu refers to a set of
companies with interlocking business relationships and shareholdings.
The Toyota Motor Company had long-term relationships with all the suppliers. These suppliers
were located very close to the Toyota assembly plants. Consequently, set-up times, which
traditionally used to take a couple of hours, were reduced to a couple of minutes. This combination
of low set-up times and long-term relationships with suppliers was the key feature that propelled
the second revolution—and it was a long journey from the rigidly integrated Ford supply chain.
The principles followed by Toyota are more popularly known as lean production systems.
The Toyota system, involving tight linkages, did get into some problems in the later part of the
century. Gradually, when Toyota and other Japanese firms tried to set up assembly plants in
different parts of the world, they realized that they would have to take their suppliers also along
with them. Further, they found that some of the suppliers in keiretsu had become com-placent and
were no longer cost competitive. With the advent of electronic data interchange (EDI), which
facilitated electronic exchange of information between firms, it was possible for a firm to integrate
with the suppliers without forcing them to locate their plants close to the manufacturers’ plant.
In actual practice, the Toyota supply chain also had certain rigidities, such as a permanent relation
with suppliers, which could become a liability over a period of time. This, in turn, led to the third
revolution spearheaded by couple of progressive companies like Dell Computers, Apple Inc., and
Bharti Airtel, which offered, its customers the luxury of customization with loosely held supplier
networks.

The Third Revolution (1995–2020): Virtually Integrated Global Supply

Networks Offering Customized Products and Services
Technology, especially information technology, which is evolving faster than enterprises can find
applications for some of the innovations, is the fuel for the third revolution in supply chain. It will
probably take at least couple of years before we can fully understand the IT-enabled model that
has emerged and begin to apply it to all industries. However, we have enough information to get a
reasonably good understanding of the contours of the third revolution. We will illustrate key
characteristics of the third revolution using the example of Dell computers, Apple Inc., and Bharti
Airtel. The first is a product company, the second combines product and service, and third is a
pure service organization. In each of these organisations, we will see different aspects of the third
revolution.
Dell computers allows customers to configure their own laptops (in terms of processors, video
cards, screen sizes, memory, etc.) and track the same in their production and distribution systems.
Apple offers personal digital devices to its customers and iPod is a classic example. However, it
is not just about the product. Apple allows the consumer to have a personalized user experience
through the features and services. Users can personalize the music and other media content on their
device through the various features available on iPod. Similarly, Bharti Airtel allows services like
My Airtel through which customer can have unique personalized experience.
As one can see we have moved to the stage where firms offer a bundle of goods that leads to
personalized experiences, which would be of great value to individual customer. Value is unique
to each customer, and therefore, each customer would wish a customized experience to be fully
satisfied with the value delivered to him or her. In summary, we have moved from single product
(Model T black colour) to wide variety as offered by Toyota to customization as offered by
companies such as Dell computers, Apple, and Bharti Airtel. Businesses can no longer be content
in providing select product variety to customers.
Organizations have moved from offering products to offering user experiences, which are a bundle
of goods and services selected by the user. This has changed the way supply chains are configured
to deliver value.
Let us begin with Dell. To make sure its customers get the completely customized product, Dell
has built a strong network of vendors who are cost and technology leaders. These medium term
relationships are based on the understanding that the vendors will adhere to a high benchmark on
cost and technology leadership which in turn will reflect in Dell’s products.
Apple Inc. brings together a product and a user experience in a revolutionary new way. Similar to
Dell, Apple has global partners with which it maintains medium term relationships based on cost
and technology benchmarking to fulfil its product manufacturing requirements. However, for
creating a better user experience, it has gone a step further by creating a platform that enables
anyone to contribute to the Apple user experience. Take the example of Apple iTunes and App
Store. At the first level, iTunes made it possible for Apple to provide all the music in the world to
its users through a seamless and tightly integrated platform. While this was only about
entertainment, the App Store took it to the next level

Decisions in a Supply Chain

Successful supply chain management involves several decisions with varying time frames. We can
broadly classify them as design decisions and supply chain operations decisions.
Design Decisions
Supply chain design (network design) or strategic decisions involve the following critical issues:

• What activities should be carried out by the nodal firm and what should be outsourced?
• How to select entities/partners to perform outsourced activities and what should be the nature of
the relationship with those entities? Should the relationship be transactional in nature or should it
be a long-term partnership?

• Decisions pertaining to the capacity and location of the various facilities. The decisions
pertaining to location and capacity are for those facilities that are owned by the nodal firm. In
addition to manufacturing locations and capacities, the firm has also to worry about locations and
capacities for warehouses (depots). Supply chain design decisions are made for the long term
(usually a couple of years) and are very expensive to alter at short notice.
Operations Decisions
Once supply chain design decisions are in place, the firm has to take decisions regarding the
management of supply chain operations for shorter horizons. This involves tactical decisions,
which have a horizon of about three months to a year; and operations decisions, which usually
have a horizon ranging from a day to a month. Both tactical and operations decisions involve the
following areas:

• Demand forecasting
• Procurement planning and control
• Production planning and control
• Distribution planning and control
• Inventory management
• Transportation management
• Customer order processing
• Relationship management with partners in the chain
Given the demand forecast and the business strategy of the firm, decisions related to procurement,
production, planning, distribution and transportation have to be integrated with customer order
processing and inventory management decisions. Relationship management essentially involves
the alignment of incentives to the various entities in the chain so that the overall supply chain
performance meets customer requirements at the lowest cost. Though not so obvious, the supply
chain has also to be integrated with other important functions of the firm, for example, customer
relationship management and new product development. Since customer relationship creates
demand, the supply chain must ensure that it is in a position to fulfil the demand created by
customer relationship management in a profitable way. Well-managed firms integrate their
customer relationship and supply chain activities. Similarly, while designing new products, well-
managed firms ensure that supply chain issues are kept in mind at the design stage. Firms have to
find a way in which the new products can use the existing product platforms and components, so
as to minimize the supply chain costs for the product family as a whole. Traditionally, terms like
integrated logistics or business logistics have been used synonymously with the term supply chain
management. In some firms, traditional logistics professionals have taken up the responsibility of
integrating supply chain activities within the firm under the banner of integrated logistics. In some
other firms where this integration is quite weak, the top management has taken on the responsibility
of developing the supply chain culture within the organization. Since both these approaches are
prevalent in the industry, a lot of practitioners and academicians refer to this body of knowledge
as logistics and supply chain management.

The Importance of the Supply Chain

In the past, customers were not very demanding and competition was not really intense. As a
result, firms could afford to ignore issues pertaining to the supply chain. Today, firms that do
not manage their supply chain will incur huge inventory costs and eventually end up losing a lot
of customers because the right products are not available at the right place and time. The following
are the five major trends that have emerged to make supply chain management a critical success
factor in most industries.
Proliferation in product lines. Companies have realized that more and more product variety is
needed to satisfy the growing range of customer tastes and requirements. This is evident from the
fact that every time a customer walks into a neighbourhood store, he or she is bound to discover a
couple of items on the shelf that he or she had not seen during his or her last visit and that he or
she has more varieties to choose from now. Every time you walk into a neighbourhood store, do
not be surprised to find that even a simple product like toilet soap has 50-odd varieties. We define
stock-keeping unit (SKU) as a unit of variety. For example, the same brand of soap may be offered
in varying colours and sizes. Each variety is treated as a separate SKU. Companies like HUL, in
their personal care products, manage, on an average, 1,200 SKUs. Chains like Foodworld manage
about 6,000 SKUs. With increasing product variety, it becomes rather difficult to forecast
accurately. Hence, retailers and other organizations involved in the business are forced to either
maintain greater amount of inventories or lose customers.

• Shorter product life cycles. With increased competition, product life cycles across all industries
are becoming shorter. For example, technology leaders like Apple works with a life cycle as short
as 6 months. So a firm like Apple , which has, on an average, just 5 days of inventory, as compared
to the industry average of 35 days, does not have to worry about product and component
obsolescence. Its competitors with higher inventories end up writing off huge amounts of stocks
every year as obsolete. In the past, in developing countries where inflation was a way of life, higher
inventories used to be a major source of profits for the firm. With inflation in control and shorter
product life cycles, firms have had to change the way they manage their inventories. Also, with
shorter product life cycles, there is not much data available for demand forecasting. Most of the
technology firms find that 50 per cent of their revenue comes from products that were introduced
in the last three years.

• Higher level of outsourcing. As discussed in the section on “Evolution of Supply Chain

Management”, firms increasingly focus on their core activities and outsource non-core activities
to other competent players. Michael Dell, the CEO of Dell Computers, had mentioned that if his
company was vertically integrated, it would need five times as many employees and would suffer
from a drag effect. Apart from primary activities in the value chain, even support activities that
were usually done inhouse are outsourced in a big way now. Bharti Tele-Ventures, India’s number
one private telecom service provider, has outsourced network-management services, IT services
and call centre operations. This trend towards outsourcing is irreversible but a higher level of
outsourcing makes supply chains more vulnerable, thereby forcing firms to develop different types
of supply chain capabilities within the organization.
Shift in power structure in the chain. In every industry, the entities closer to customers are
becoming more powerful. With increasing competition, a steadily rising number of products are
chasing the same retail shelf space. Retail shelf space has not increased at the pace at which product
variety has increased. So there have been cases of retailers asking for slotting allowance when
manufacturers introduce new products in the market place. Savvy firms have started talking about
trade marketing and treating dealers and retailers as their customers while simultaneously trying
to woo the retailers aggressively. There is a clear shift in the power structure. Retailers have
realized that they are powerful entities in the chain and hence expect the manufacturers to be more
responsive to their needs and demands. Discount retailers like Wal-Mart have been asking their
suppliers to replenish the supplies on a daily basis based on actual sales data from their point-of-
sales systems. In general, manufacturers are forced to respond more quickly to the customers’
demands, because of changes in the power structure within the chain.

• Globalization of manufacturing. Over the past decade, tariff levels have come down significantly.
Many companies are restructuring their production facilities to be at par with global standards.
Unlike in the past, when firms use to source components, produce goods and sell them locally,
now firms are integrating their supply chain for the entire world market. For example, companies
like ABB have developed some global centres of excellence for each of their product lines that
take care of the global market. General Motors is talking about a world car and has been designing
a few cars for global markets. In the telecommunications and electronics industry, companies
usually get their chips from Taiwan, test them in Europe and finally integrate them with other
products in the United States of America to sell in the international market. This has made
managing supply chains extremely complicated. Unlike information and finance flow, which can
be managed electronically, materials and products have to move physically, and as this movement
can even be across continents, managing supply chains is now an extremely complex issue.

Enablers of Supply Chain Performance

As mentioned in the previous section, managing supply chains is becoming increasingly complex.
Despite this, firms have actually managed to reduce their logistics costs. For example, in a country
like the United States of America, logistics costs used to account for 15 per cent of the gross
domestic product (GDP) in the 1980s. Today, because of innovations in technology and
management practices, logistics costs account for about 8.5 per cent of their GDP. Three major
enablers that have helped firms and nations in reducing supply chain costs are briefly discussed
below.

Improvement in Communication and IT

Computing power has become cheaper and communication costs too have come down. This has
helped firms in coordinating global supply chains in a cost-effective manner. Advances in
enterprise resource planning (ERP) systems have helped firms in automating several business
processes resulting in seamless information flow throughout the company across different
functions. The way ERP systems have changed the nature of information flow within organization,
Internet technology is likely to change the nature of information flow in interfirm transactions. In
the past, only large companies could integrate with partner firms using expensive EDI
technologies. Now, even small firms can communicate with their chain partners using the
worldwide web at a fraction of the earlier cost. Companies are realizing that they can replace
physical inventory by information. To really exploit their IT investments, companies need to re-
engineer their supply chain and other supporting organizational processes and try to replace
physical inventory with information. Unfortunately, many Indian companies have invested in
information systems but have not made the corresponding changes in their supply chain systems
and processes, which has resulted in the company failing to exploit the information system to its
full potential. For example, a company with multiple plants can work with a common pool of
safety stock of raw materials and does not need to have safety stocks for each individual plant.
Similarly, on the order-processing side, companies can offer greater customization as compared to
the past because their order-processing system can be designed to handle customized orders and
their manufacturing and distribution system would allow them to track these customized products
in the system. In the absence of an information system, this would not have been possible at all.
But unfortunately a significant number of companies have used IT to just automate the existing
supply chain systems and processes. Companies that have successfully exploited IT have made
major changes in their supply chain structure, systems, processes and strategy.

Emergence of Third-party Logistics Providers

Traditionally, many firms have been managing their logistics activities internally. Lately,
companies have realized that they need to focus their energies on managing core business
activities, and hence have been exploring the possibility of outsourcing logistics activities to third-
party logistics (3PL) service providers. In developed countries, almost 90 per cent of the logistics
activities are outsourced and are managed by 3PL companies. Apart from bringing in the much
needed professionalism to the field, 3PL companies have economies of scale as they are able to
pool demand across customers. In developed markets, global firms would like leading 3PL
companies to go beyond the traditional role and play the role of a fourth-party logistics (4PL)
company that can integrate the capabilities, resources and technology so as to provide
comprehensive supply chain solutions to its customers. Currently, the 3PL industry in India is still
evolving. Two sets of companies have emerged in this field. One set of companies involves
traditional transporters, shippers, warehouse service providers and freight forwarders, who want
to offer value-added services and would like to see if they can develop competencies and become
a 3PL company. The second set of service providers comprises international 3PL companies that
have come to India along with their global MNC customer. For example, when Toyota wanted to
set up a manufacturing plant in India, it asked its logistics service provider Mitsui and Co. to come
to India to take care of its logistics requirements. Currently, not many companies in India employ
the services of other 3PL companies. However, with the evolution of the Indian market, new MNCs
and progressive Indian companies operating in the mid-volume, mid-variety segment have started
using the services of 3PL companies. Over a period, the 3PL companies would not only develop
the competence required to function smoothly in the Indian context but also take care of the
logistics requirements of the bulk of the industries in India as well.
Enhanced Inter-firm Coordination Capabilities
Successful coordination across a global network of companies has been a comparatively new
phenomenon in the corporate world. It has been realized that for a network to function
meaningfully one needs a firm to play the role of the strategic centre. Many companies, like Apple,
Nike, Benetton, Nintendo, Sun and Toyota, have successfully managed complex networks, played
the part of the strategic centre and, hence, have emerged as role models to other companies. While
each company in the network focuses on its core competencies, the strategic centres function as a
leading and orchestrating system. Consequently, supply chains become more efficient and
responsive. However, there have been a large number of failures also, where firms within the chain
could not align their interests, and as a result, the network could not function effectively. The
industry is still on the learning curve in this matter, but better understanding and coordination of
issues would greatly help in diffusing the third supply chain revolution across all industries.

Supply Chain Performance in India

Supply chain performance measures involve multiple dimensions and they are discussed in detail
in the subsequent chapters. In this section, the focus is on performance, both in terms of inventory
turnover ratio at the organizational level and logistics costs at the economy level. Logistics costs
include inventory-carrying costs, transportation costs and logistics administration costs. As can be
seen in Table 1.1, logistics costs in India are quite high when compared with other countries. Of
course, one could argue that since customer service expectations are not the same across countries,
logistics costs may not be strictly comparable. However, as tariff levels have been coming down
with globalization, logistics costs do become comparable to a significant extent. Higher logistics
costs definitely affect the competitiveness of the Indian industry. Firms often argue that
inefficiency in the transport and warehousing sector makes it difficult for them to compete in the
global market. For example, the cost of sending an export cargo to Mumbai from Punjab and that
of shipping it further to London from Mumbai are the same. Further, variable transit time and in-
transit damages make transportation in India a very expensive affair We now analyse the
performance of the supply chains of Indian firms using inventory turnover ratio as a measure of
performance. When we look at the performance of the Indian manufacturing sector in last decade
(Figure 1.2), we find that performance has gradually improved in the time period between 2003
and 2008. After 2008, the inventory turn has dropped significantly and subsequently improving
gradually. Impact of global financial crisis had deep impact on Indian manufacturing, and even
after five years, Indian manufacturing has not reached level of performance achieved in 2008. Over
a decade, Indian manufacturing industry has more or less maintained the performance and has
shown only marginal improve-ment.

Though there is evidence of moderate improvement, this rate of improvement has to be sustained.
On the other hand, the best international firms have improved at much faster rates in the past
decade when compared to the best Indian firms. The sector-wise performance of Indian firms is
shown in Figure 1.3.

We find that most sectors show performance trend similar to the overall manufacturing sector
except consumer goods, construction, and chemicals. Unlike other sectors, consumer goods and
construction sector have maintained inventory levels in last decade, whereas chemical industry
had shown significant improvements in the last few years. To compete successfully in the global
market the Indian firms need to improve their performance in managing their inventory and keep
their logistics costs low. Let us now look at the challenges that Indian firms face when it comes to
supply chain management. Many of these challenges—which arise due to the economic
environment; taxation structures and the geography of India—are unique to the Indian scenario.
Supply Chain Strategy and Performance Measures
A firm’s supply chain strategy should ensure that its supply chain provides superior value to
the end customer in an efficient manner. Value offering (bundling of goods and services) to a
customer should be available at a reasonable price. In almost all product categories, customers
want more variety and quicker services at lower prices. Firms must recognize the nature of
trade-offs between customer service and costs and arrive at an optimal decision on this front. If
various processes and decisions within the chain are not aligned to suit a company’s business
strategy, it obviously cannot remain competitive in the long run. The firm has to understand
the relationship between business strategy and supply chain decisions and how different business
environments pose different kinds of challenges to the supply chain.

Although at any given point managers need to understand customer service and cost tradeoffs, in
the long run firms will have to find a way of improving performance on both cost and
service fronts. Because of the nature of competition, customers will demand better services
at lower prices over a period of time. Progressive firms resolve this paradox through various
supply chain innovations. To enhance supply chain performance, firms have to identify the
right kind of initiatives to help improve both costs and customer service simultaneously on an
ongoing basis.

Customer Service and Cost Trade-offs

A firm must ensure a smooth fit between its business strategy and supply chain strategy. As a
part of its business strategy, the firm decides the market segment in which it wants to operate
and the level of customer service it wants to offer. The supply chain strategy includes issues of
cost that the firm has to incur to provide the targeted level of customer service.
Well-managed firms identify and develop external market opportunities and internal supply chain
capabilities until the two are mutually consistent.

To understand the relationship between the supply chain strategy and the business strategy, we
need to understand cost versus service trade-offs in business. As discussed earlier,
the supply chain must provide superior value to the end customer in an effective and efficient
manner. For a given supply chain design, firms generally have an efficient frontier, which
defines the nature of trade-offs between supply chain costs and customer service. Ideally,
firms prefer to provide a very high level of customer service (high variety, short delivery time,
etc.) at very low cost. However, as illustrated in Figure 2.1, firms must recognize the nature
of trade-offs between the supply chain cost (marginal cost) and customer service. If a firm
wants to improve its performance on the customer service front, it must accept deterioration
in performance on the cost front and vice versa. For example, if a pizza company delivering
pizzas in 40 minutes wants to deliver in 20 minutes, its costs would increase. An efficient
frontier, shown in Figure 2.1, provides a lower envelope, below which a firm cannot choose
to operate. Efficient firms can choose to operate on any point of the efficiency frontier. For
example, a firm may choose to provide lower service levels at lower costs or higher service
levels at higher costs, but it cannot hope to provide higher levels of customer service at low
cost. In other words, if a firm is on the efficiency frontier, it represents the best attainable
compromise between the two dimensions at any given point in time. The efficiency frontier
is an upper ceiling on performance and is an outcome of the supply chain structure and processes
of the firm.

If the supply chain operations of a typical firm are to be mapped, the firm will lie somewhere above
the efficiency frontier curve, as shown in Figure 2.1. This is because most firms
do not operate their supply chains efficiently. Inefficient executions of supply chain processes
result in gaps between existing and potential performance, as defined by the efficiency frontier.
Of course, by implementing several innovative ideas a firm can shift its overall supply chain
efficiency frontier.

In order to keep things simple, the discussions so far have dealt with only two dimensions—cost
and customer service. However, customer service in itself has multiple dimensions.
From a supply chain perspective, customer service consists of the following four dimensions:

• Order delivery lead time

• Responsiveness
• Delivery reliability
• Product variety
Shorter lead time, higher responsiveness, higher reliability and higher product variety
lead to better customer service. Improvement in performance on any of these four fronts
will result in higher costs. Depending on customer expectations and product characteristics,
different dimensions of the supply chain have varying levels of impact on the overall value
of customer service.

Order Delivery Lead Time

Order delivery time is the time taken by the supply chain to complete all the activities from
order to delivery. This dimension of customer service has a significant impact on the way a
supply chain is designed and operated. Customer expectations on order delivery time could be
practically zero, as in the case of most of FMCG goods, or could be 1 week for certain consumer
durables. For example, a typical customer might expect pizzas to be served in 15 minutes
at any pizza outlet, or expect delivery in 40 minutes if the order has been placed for home
delivery. E-retailers like Fabmart promise to deliver goods within 48 hours at the doorstep of
customers located in major cities. Caterpillar pledges its commitment to customers: service
within 48 hours at any place on earth. For each of these firms, promised order delivery lead
time has tremendous implications on supply chain design and operations.
As shown in Figure 2.3, a typical firm sources material, manufactures components, assembles the
product and delivers the finished product to the end customer, with each of these
activities having a certain lead time. If we aggregate all the four lead times, we get the supply
chain lead time, which is the total time required for the supply chain to carry out all activities
from the beginning to the end. Unfortunately, for many firms, supply chain lead times and
order delivery lead times usually do not match. Ideally, a firm will prefer to work with a delivery
lead time that is larger than the supply chain lead time. In a competitive market, however,
the order delivery lead time is dictated by competitive offerings and customer needs and the
supply chain lead time is usually much longer than the order delivery lead time. The point at
which the customer enters the supply chain (Figure 2.3) is called the order penetration point.
After the order penetration point, all activities do not face any uncertainties because they are
against specific customer orders. All the activities prior to the customer order must be carried
out against forecast and not on actual orders. For example, one wants pizzas to be delivered
within 40 minutes. Obviously the firm cannot procure the material, make the dough and bake
a base in those 40 minutes. A firm in the pizza home delivery business has to forecast likely
demand and execute most of the activities like procurement, preparing the pizza base and making
all the other ingredients ready before the order so that they can satisfy customer demand
within 40 minutes. As all activities after the penetration point are carried out against an order,
and all activities prior to the penetration point are carried out against forecast, this point is also
known as the decoupling point. Essentially, the firm has to keep a decoupling stock ready at the
customer penetration point and manage both sides, that is, before and after order penetration
point, differently.
A critical characteristic of the supply chain is the customer order penetration point or
decoupling point. There are essentially three types of supply chains characterized by the customer
order penetration point: make to stock (MTS), make to order (MTO) and configure to
order (CTO). Figure 2.4 is a conceptual representation of these three types of supply chains.
If customers expect their order (an order can either be a formal document or even an informal
instruction, e.g., a customer asking a retailer for a tube of tooth paste is treated as an order) to
be fulfilled instantaneously, then the supply chain is in the MTS business. If the supplier gives
enough time to the firm to assemble the product before delivery, it is in the CTO business. If
the customer gives enough time to the manufacturer to carry out the complete set of operations
(source, make, assemble and deliver) after placing the order, it is in the MTO business.
Typically, firms in the consumer products business operate on an MTS basis where the customer
expects the products to be on the shelf at the retailer’s outlet. Equipment manufacturers
typically operate with an MTO supply chain where all the activities are started after getting the
order. A firm in the pizza home delivery business is in the CTO business, because your pizza
is configured the way you want, with the toppings of your choice, using ingredients kept in
readiness, prior to an order. CTO is also known as assemble to order (ATO) or build to order
(BTO) business model.
For a firm operating with a wide variety of products, forecasting is a very difficult exercise.
For such a firm, if the variety explosion takes place during the assembly stage, it can improve
its business performance by moving from the MTS model to the CTO model. By doing so, the
firm has to forecast only at the component level rather than at the end-product level. If the firm
belongs to an industry where, because of modular design, there is an explosion in variety at
the assembly stage, it can significantly improve business performance by carrying out assembly,
based on orders rather than against forecast.
In the PC industry, where most players operate on an MTS basis, Dell Computers has
managed to operate on a CTO basis. This has helped Dell in reducing inventories and operating
with larger margins, as compared to its competitors. Generally, firms operating in a similar
market segment have to operate with similar order penetration points. If all the competitors
choose the MTS model, it will be difficult for a firm to choose the MTO model. Naturally, this
raises the question: Why is that even though its competitors offer practically zero delivery lead
time, the customers are willing to give about one week of order lead time to Dell computers?
The answer lies in the value offerings made by Dell computers: Since customers are allowed to
customize their PCs, they see a value in customization and therefore are willing to allow longer
order delivery time to Dell, compared to its competitors. Dell also has invested in building a
flexible and efficient assembly and delivery system that allows it to carry out assembly and
delivery activities in less than a week’s time.

Push–Pull Boundary of the Supply Chain

Order delivery lead time also can be used for drawing a push–pull boundary of the supply
chain. All the processes in the supply chain are divided into two categories based on their
position in a supply chain with respect to the customer order point. As shown in Figure 2.5,
all the processes carried out before the customer order point are managed through the push
approach, and all the processes carried out after the customer order are managed through the
pull approach. The interface between the push-based processes and the pull-based strategy
is known as the push–pull boundary. All the processes managed by pull approaches do not
face any uncertainty because they are carried out against specific orders. As they are executed
against specific customer orders, they operate on customer pull and, hence, are known as pull based
processes. On the other hand, processes prior to the customer order are executed based
on forecast, and as there is no known customer pull in this case, these activities are pushed
within the chain; thus, they are known as push-based processes.
The inventory at the push–pull boundary is used to decouple the push and the pull processes. Firms
like Asian Paints and Dell Computers are able to assemble and deliver a wide
variety of finished goods demanded by the end customer from relatively few components
stocked at the push–pull boundary. In MTS supply chains, the push–pull boundary is at the
end of chain and all processes are managed using the push approach. In MTO supply chains,
all processes are managed using the pull approach and the push–pull boundary is located at the
beginning of the chain. In CTO supply chains, the push–pull boundary is usually positioned
after component manufacturing.

Supply Chain Responsiveness

Responsiveness captures the firm’s ability to handle the uncertainty of market demand. In
addition to delivery lead time, supply chains have also been characterized on the basis of the
nature of demand uncertainty faced by products in the market place. Based on the nature of
demand uncertainty, products can be classified as functional products or innovative products.
Functional products (grocery) are those that satisfy the basic needs of a customer and
therefore have low variety, stable and predictable demand, long life cycles and low profit margins.
Innovative products (fashion and technology products) are those that try to satisfy a
broad range of customers’ wants and have the following features: high variety, unstable and
very-hard-to-predict demand, short life cycles, high profit margins and frequent stock-outs and
markdowns.
Delivery Reliability
As discussed in the earlier section, delivery lead time is an important dimension of customer
service, and delivery reliability essentially captures the degree to which a firm is able to service its
customers within the promised delivery time. Delivery reliability measures the fraction of
customer demand that is satisfied within the promised delivery lead time.
For firms operating on an MTS model, the percentage of orders getting served from the
stock is known as product availability, also commonly referred to as service level in supply
chain literature. Similarly, for companies offering products based on the CTO or MTO
model, delivery reliability captures the percentage of orders that are delivered within the
promised delivery lead time. Given the nature of demand and supply uncertainty, it is obviously
more expensive to provide higher levels of service. Essentially, firms have to tradeoff inventory
costs and stock-out costs to arrive at the optimum service level. In the MTS
business, a firm has to keep higher inventory if it is to offer higher levels of service.

Product variety
The quantum of variety offered by a firm is an important dimension of customer service. In the
past couple of years, a “variety explosion” has taken place in most product categories. Higher
product variety offers greater choices to the customer who is likely to get a product that fits closest
to his or her actual requirements. Some firms like Dell Computers and National Panasonic
go to the extent of allowing their customers to design their own products. Obviously, higher variety
would lead to greater complexity, resulting in higher supply chain costs. Some firms
have found that variety explosion has affected firm profitability in an adverse way. Firms like
P&G have worked on product rationalizations and have reduced overall product variety. While
deciding the optimum level of product variety, a firm has to manage trade-offs with other
dimensions of customer service like order lead-time. For example, if you go to a fast food outlet,
you know there is less variety but expect food to be served in a few minutes; in a restaurant,
you are ready to wait for 15–20 minutes but do expect a greater variety.

Supply Chain Performance Measures

Among various sets of supply chain performance measures discussed in the literature, we
focus on a set of performance measures that have been most widely accepted in the industry.
The Supply-Chain Council is an independent, non-profit, global corporation interested in getting
the industry to standardize supply chain terms so that meaningful supply chain benchmarking
can be carried out. It has developed the Supply Chain Operations Reference (SCOR) model as
the industry standard for supply chain management. Several supply chain software vendors have
adopted the SCOR performance measures in their performance management module. SCOR
recognizes six major processes: Plan, Source, Make, Delivery, Return, and Enable. As per the
SCOR model, supply chain performance measures fall under the following five broad categories:
Cost
Assets (Asset Management Efficiency)
Reliability
Responsiveness
Agility
Further, the SCOR model develops 10 performance measures as shown in Figure 2.7. The
Supply-Chain Council refers to measures related to costs and assets as internal-facing measures,
while reliability, responsiveness, and agility are termed as customer-facing measures. Typically,
a firm offers a bundle consisting of price, delivery and flexibility to its customers. Price, in
competitive markets, is dictated by the market place. Thus, only delivery- and response-related
measures are termed as customer-facing measures. The performance measures related to assets
and costs affect the profitability of the firm and are, thus, termed as internal-facing measures.
The use of standard measures allows firms to carry out meaningful benchmarking studies.

benchmarking Supply Chain performance using financial Data

Though supply chain benchmarking has received much attention, we have found that firms
face multiple sets of problems while carrying out this exercise. Unlike Western countries,
most countries in Asia suffer from the problem of data availability. Even if the relevant
data are available, one is not sure of the validity and reliability of the data. In this section,
we present a set of supply chain performance measures that can be collected from financial
statements of listed companies. In most countries, it is not difficult to get financial databases
that are reliable. All the listed companies maintain their data on their Web sites and most
countries have an agency that compiles these data and makes it available to interested parties at a
nominal price. For example, India has the “Prowess” databases, maintained by the
Centre for Monitoring Indian Economy (CMIE), compiled using publicly disclosed financial
performance data.
The relevant expressions (data for which are usually available in databases like Prowess)
that are used in this section are shown in Table 2.2.
Using the data presented in Table 2.2, one can calculate the following three performance
measures:
Total length of the chain. The total length of the chain is arrived at by adding up the
days of inventory for raw materials, work in progress and finished goods. The firm that
has the minimum total length of the chain is said to have the best performance.

Supply chain inefficiency ratio. This ratio measures the relative efficiency of internal
supply chain management. The ratio will be low for the firms with better performance.

Supply chain working capital productivity. The analysis of firms on this metric will
also be based on the levels of inventory, accounts receivable and accounts payable.
Firms with efficient supply chains will usually have high supply chain working capital
productivity
Calculating the length of various Stages of the Chain

The following formulae (terms defined in Table 2.2) are used to calculate the length of the
various stages in the supply chain:
DRM, DWIP, DFG = Days of raw material, work in process and finished goods, respectively
DRM = RM × 365/C

DWIP = SFG 365/CP,

DFG = FG 365/CS
Total length of chain in days = DRM + DWIP + DFG
The duration of time taken by the material flow is captured by this measure. Firms like Dell
Computers perform very well on this dimension.
Evaluating the efficiency of Supply Chain Management

The internal supply chain inefficiency ratio is a measure of the efficiency of internal supply
chain management. To calculate this ratio, we consider total inventory carrying costs and the
distribution costs to be components of the internal supply chain management costs. We calculate
the internal supply chain inefficiency ratio as follows:
SCC = DC + INV ICC and SCI = SCC/NS

Where SCC is the supply chain management costs, ICC is the inventory carrying cost and SCI is
the supply chain inefficiency ratio.
The inventory carrying cost for most firms is estimated to be in the range of 0.15–0.25. The
methodology for estimating inventory carrying costs is presented in Chapter 4. In the absence
of any data, one can work with an inventory carrying cost of 0.2.
The supply chain inefficiency ratio (the lower the better) provides an insight into the internal
supply chain management efficiency of the firm. This measure is termed the supply chain
inefficiency ratio since the supply chain cost will be higher if there are inefficiencies in the
system. Firms with efficient supply chain systems will have relatively lower scores on this
performance measure.
Supply Chain working Capital Productivity

The supply chain working capital productivity is calculated using the following formula:

SWC = INV + AR - AP
where SWC is the supply chain working capital.
SWCP = NS/SWC
where SWCP is the supply chain working capital productivity.
A firm can compare its own performance with that of its competitors and the industry aggregate
in order to ascertain where it stands in terms of supply chain performance. Using benchmarking
data, a firm can also map a supply chain profile that allows it to effectively capture both the
dimensions of time and cost in one diagram. Further, a firm can also compare its own profile with
that of its competitors in order to ascertain where it stands in terms of costs and length of time in
the chain. Benchmarking is a useful tool for comparing the performance of competing firms so as
to identify areas of improvement for further detailed investigation, which may lead to process
improvements. In this section, we have focused on financial benchmarking, which can help a firm
in comparing its supply chain performance with competitors using financial data. Once a firm has
identified performance gaps, it should try and carry out a process benchmarking exercise. Process
benchmarking focuses on the investigation of business processes of leading firms with the
objective of identifying and observing the best practices from one or more benchmark firms.