10.

SCM – Inventory Management Supply Chain Management

As seen under the major objectives of supply chain, one of the basic objectives of SCM is
to make sure that all the activities and functions within as well as across the company
are managed efficiently.

There are instances where efficiency in supply chain can be ensured by efficiencies in
inventory, to be more precise, by maintaining efficiency in inventory reductions. Though
inventory is considered a liability to efficient supply chain management, supply chain
managers acknowledge the need of inventory. However, the unwritten rule is to keep
inventory at a bare minimum.

Many strategies are developed with the objective of streamlining inventories beyond the
supply chain and holding the inventory investment as low as possible. The supply chain
managers tend to maintain the inventories as low as possible because of inventory
investment. The cost or investment related with owning inventories can be high. These
costs comprise the cash outlay that is necessary for purchasing the inventory, the costs
of acquiring the inventories (the cost of having invested in inventories rather than
investing in something else) and the costs related with managing the inventory.

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Role of Inventory
Before understanding the role of inventory in supply chain, we need to understand the
cordial relationship between the manufacturer and the client. Handling clients, coping up
with their demands and creating relationships with manufacturer is a critical section of
managing supply chains.

There are many instances where we see the concept of collaborative relationship being
marked as the essence of supply chain management. However, a deeper analysis of
supply chain relationships, especially those including product flows, exposes that at the
heart of these relationships is inventory movement and storage.

More than half of it relies on the purchase, transfer or management of inventory. As we

know, inventory plays a very important role in supply chains, being a salient feature.

The most fundamental functions that inventory has in supply chains are as follows:

 To supply and support the balance of demand and supply.

 To effectively cope with the forward and reverse flows in the supply chain.

Companies need to manage the upstream supplier exchanges and downstream customer
demands. In this situation, the company enters a state where it has to maintain a
balance between fulfilling the demands of customers, which is mostly very difficult to
predict with precision or accuracy, and maintaining adequate supply of materials and
goods. This balance can be obtained through inventory.

Optimization Models
Optimization models of supply chain are those models that codify the practical or real life
issues into mathematical model. The main objective to construct this mathematical
model is to maximize or minimize an objective function. In addition to this, some
constraints are added to these issues for defining the feasible region. We try to generate
an efficient algorithm that will examine all possible solutions and return the best solution
in the end. Various supply chain optimization models are as follows:

Mixed Integer Linear Programming

The Mixed integer linear programming (MILP) is a mathematical modeling approach used
to get the best outcome of a system with some restrictions. This model is broadly used
in many optimization areas such as production planning, transportation, network
design, etc.

MILP comprises a linear objective function along with some limitation constraints
constructed by continuous and integer variables. The main objective of this model is to
get an optimal solution of the objective function. This may be the maximum or minimum
value but it should be achieved without violating any of the constraints imposed.

We can say that MILP is a special case of linear programming that uses binary variables.
When compared with normal linear programming models, they are slightly tough to
solve. Basically the MILP models are solved by commercial and noncommercial solvers,
for example: Fico Xpress or SCIP.

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Stochastic Modeling
Stochastic modeling is a mathematical approach of representing data or predicting
outcomes in situations where there is randomness or unpredictability to some extent.

For example, in a production unit, the manufacturing process generally has some
unknown parameters like quality of the input materials, reliability of the machines and
competence within the employees. These parameters have an impact on the outcome of
the manufacturing process but it is impossible to measure them with absolute values.

In these types of cases, where we need to find absolute value for unknown parameters,
which cannot be measured exactly, we use Stochastic modeling approach. This modeling
strategy helps in predicting the result of this process with some defined error rate by
considering the unpredictability of these factors.

Uncertainty Modeling
While using a realistic modeling approach, the system has to take uncertainties into
account. The uncertainty is evaluated to a level where the uncertain characteristics of
the system are modeled with probabilistic nature.

We use uncertainty modeling for characterizing the uncertain parameters with probability
distributions. It takes dependencies into account easily as input just like Markov chain or
may use the queuing theory for modeling the systems where waiting has an essential
role. These are common ways of modeling uncertainty.

Bi-level Optimization
A bi-level issue arises in real life situations whenever a decentralized or hierarchical
decision needs to be made. In these types of situations, multiple parties make decisions
one after the other, which influences their respective profit.

Till now, the only solution to solve bi-level problems is through heuristic methods for
realistic sizes. However, attempts are being made for improving these optimal methods
to compute an optimal solution for real problems as well.

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11. SCM – Pricing & Revenue Management Supply Chain Management

Pricing is a factor that gears up profits in supply chain through an appropriate match of
supply and demand. Revenue management can be defined as the application of pricing
to increase the profit produced from a limited supply of supply chain assets.

Ideas from revenue management recommend that a company should first use pricing to
maintain balance between the supply and demand and should think of further investing
or eliminating assets only after the balance is maintained.

The assets in supply chain are present in two forms, namely capacity and Inventory.

Capacity assets in the supply chain are present for manufacturing, shipment, and
storage while inventory assets are present within the supply chain and are carried to
develop and improvise product availability.

Thus, we can further define revenue management as the application of differential

pricing on the basis of customer segment, time of use and product or capacity
availability to increment supply chain surplus.

Revenue management plays a major role in supply chain and has a share of credit in the
profitability of supply chain when one or more of the following conditions exist:

 The product value differs in different market segments

 The product is highly perishable or product tends to be defective.
 Demand has seasonal and other peaks.
 The product is sold both in bulk and the spot market.

The strategy of revenue management has been successfully applied in many streams
that we often tend to use but it is never noticed. For example, the finest real life
application of revenue management can be seen in the airline, railway, hotel and resort,
cruise ship, healthcare, printing and publishing.

RM for Multiple Customer Segments

In the concept of revenue management, we need to take care of two fundamental
issues. The first one is how to distinguish between two segments and design their pricing
to make one segment pay more than the other. Secondly, how to control the demand so
that the lower price segment does not use the complete asset that is available.

To gain completely from revenue management, the manufacturer needs to minimize the
volume of capacity devoted to lower price segment even if enough demand is available
from the lower price segment to utilize the complete volume. Here, the general trade-off
is in between placing an order from a lower price or waiting for a high price to arrive
later on.

These types of situations invite risks like spoilage and spill. Spoilage appears when
volumes of goods are wasted due to demand from high rate that does not materialize.
Similarly, spill appears if higher rate segments need to be rejected due to the
commitment of volume goods given to the lower price segment.

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To reduce the cost of spoilage and spill, the manufacturer can apply the formula given
below to segments. Let us assume that the anticipated demand for the higher price
segment is generally distributed with mean of DH and standard deviation of σH:

CH = F-1(1-pL/pH,DH,σH) = NORMINV(1-pL/pH,DH,σH)

Where,
CH = reserve capacity for higher price segment
pL = the price for lower segment
pH = the price for higher segment

An important point to note here is the application of differential pricing that increments
the level of asset availability for the high price segment. A different approach that is
applicable for differential pricing is to build multiple versions of product that focus on
different segments. We can understand this concept with the help of a real life
application of managing revenue for multiple customer segments, that is, the airlines.

RM for Perishable Assets

Any asset that loses its value in due course of time is considered as a perishable item,
for example, all fruits, vegetables and pharmaceuticals. We can also include computers,
cell phones, fashion apparels, etc.; whatever loses its value after the launch of new
model is considered as perishable.

We use two approaches for perishable assets in the revenue management. These
approaches are:

 Fluctuate cost over time to maximize expected revenue.

 Overbook sales of the assets to cope or deal with cancellations.

The first approach is highly recommended for goods like fashion apparels that have a
precise date across which they lose a lot of their value; for example, apparel designed
for particular season doesn’t have much value in the end of the season. The
manufacturer should try using effective pricing strategy and predict the effect of rate on
customer demand to increase total profit. Here the general trade-off is to demand high
price initially and allow the remaining products to be sold later at lower price. The
alternate method may be charging lower price initially, selling more products early in the
season and then leaving fewer products to be sold at a discount.

The second approach is very fruitful here. There are occurrences where the clients are
able to cancel placed orders and the value of asset lowers significantly after the
deadline.

RM for Seasonal Demands

One of the major applications of revenue management can be seen in the seasonal
demand. Here we see a demand shift from the peak to the off-peak duration; hence a
better balance can be maintained between supply and demand. It also generates higher
overall profit.

The commonly used effective and efficient revenue management approach to cope with
seasonal demand is to demand higher price during peak time duration and a lower price
during off-peak time duration. This approach leads to transferring demand from peak to
off-peak period.

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Companies offer discounts and other value-added services to motivate and allure
customers to move their demand to off-peak period. The best suited example
is Amazon.com. Amazon has a peak period in December, as it brings short-term volume
that is expensive and reduces the profit margin. It tempts customers through various
discounts and free shipping for orders that are placed in the month of November.

This approach of reducing and increasing the price according to the demand of
customers in the peak season generates a higher profit for various companies just like it
does for Amazon.com.

RM for Bulk and Spot Demands

When we talk about managing revenue for bulk and spot demand, the basic trade-off is
somewhat congruent to that of revenue management for multiple customer segments.

The company has to make a decision regarding the quantity of asset to be booked for
spot market, which is higher price. The booked quantity will depend upon the differences
in order between the spot market and the bulk sale, along with the distribution of
demand from the spot market.

There is a similar situation for the client who tends to make the buying decision for
production, warehousing and transportation assets. Here the basic tradeoff is between
signing on long-term bulk agreement with a fixed, lower price that can be wasted if not
used and buying in the spot market with higher price that can never be wasted. The
basic decision to be made here is the size of the bulk contract.

A formula that can be applied to achieve optimal amount of the asset to be purchased in
bulk is given below. If demand is normal with mean µ and standard deviation σ, the
optimal amount Q* to be purchased in bulk is

Q* = F-1 (p*, μ, σ) = NORMINV (p*, μ, σ)

Where,

p* = probability demand for the asset doesn’t exceed Q*

Q* = the optimal amount of the asset to be purchased in bulk

The amount of bulk purchase increases if either the spot market price increases or the
bulk price decreases.

We can now conclude that revenue management is nothing but application of differential
pricing on the basis of customer segments, time of use, and product or capacity
availability to increase supply chain profit. It comprises marketing, finance, and
operation functions to maximize the net profit earned.

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 12. SCM – Integration Supply Chain Management

Supply chain integration can be defined as a close calibration and collaboration within a
supply chain, mostly with the application of shared management information systems. A
supply chain is made from all parties that participate in the completion of a purchase,
like the resources, raw materials, manufacturing of the product, shipping of completed
products and facilitating services.

There are different levels of supply chain integration. We will understand this with the
help of an example of a computer manufacturing company. The initial step in integration
shall include choosing precise merchants to supply certain inputs and ensuring
compliance for them for supplying certain amount of inputs within the year at a set cost.

This assures that the company has the appropriate materials required to produce the
expected output of computers during the year. In the meanwhile, this computer
company may sign a bond with a large supplier of circuit boards; the bond expects it to
deliver a precise quantity at precise times within a year and fix a price that will be
effective during the bond year.

If we move to a higher level, the next step would be to integrate the companies more
closely. The circuit board supplier may construct a plant close to the assembly plant and
may also share production software. Hence, the circuit board company would be able to
see how many boards are required in the upcoming month and can construct them in
time, as the company requires them in order to meet its sales demand.

Further higher level is referred as vertical integration. This level starts when the supply
chain of a company is actually owned by the company itself. Here, a computer company
may buy the circuit board company just to ensure a devoted supply of elements.

Push System
In a push-based supply chain, the goods are pushed with the help of a medium, from the
source point, e.g., the production site, to the retailer, e.g., the destination site. The
production level is set in accordance with the previous ordering patterns by the
manufacturer.

A push-based supply chain is time consuming when it has to respond to fluctuations in

demand, which can result in overstocking or bottlenecks and delays,
unacceptable service levels and product obsolescence.

This system is based on the deliberation of customer’s demand. It tries to push as many
products into the market as possible. As a result, the production is time consuming
because the producer and the retailer struggle to react to the changes in the market.
Forecast or prediction plays an important role in the push system.

Optimum level of products can be produced through long term prediction. This
deliberative nature of the push system leads to high production cost, high inventory cost
as well as high shipment cost due to the company’s desire to halt products at every
stage.

Thus, in the push view of supply chain integration, the manager of a firm may
sometimes fail to satisfy or cope with the fluctuating demand pattern. This system leads
to high inventory and high size of batches.

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Here, the companies focus more on minimizing the cost of supply chain and neglect the
responsiveness. This system models challenges along with demand management and
transportation management.

Pull System
The pull-based supply chain is based on demand-driven techniques; the procurement,
production and distribution are demand-driven rather than predicting. This system
doesn’t always follow the make-to-order production. For example, Toyota Motors
Manufacturing produces products yet do not religiously produce to order. They follow the
supermarket model.

According to this model, limited inventory is kept and piled up as it is consumed. Talking
about Toyota, Kanban cards are used to hint at the requirement of piling up inventory.

In this system, the demand is real and the company responds to the customer demands.
It assists the company in producing the exact amount of products demanded by the
clients.

The major drawback in this system is that in case the demand exceeds than the amount
of products manufactured, then the company fails to meet the customer demand, which
in turn leads to loss of opportunity cost.

Basically in the pull system, the total time allotted for manufacturing of products is not
sufficient. The production unit and distribution unit of the company rely on the demand.
From this point of view, we can say that the company has a reactive supply chain.

Thus, it has less inventories as well as variability. It minimizes the lead time in the
complete process. The biggest drawback in pull based supply chain integration is that it
can’t minimize the price by ranking up the production and operations.

Differences in Push and Pull System

The major differences between push and pull view in supply chain are as follows:
 In the push system, the implementation begins in anticipation of customer order
whereas in the pull system, the implementation starts as a result of customer’s
order
 In the push system, there is an uncertainty in demand whereas in pull system,
the demand remains certain
 The push system is a speculative process whereas the pull system is
a reactive process.
 The level of complexity is high in the push system whereas it is low in the pull
system.
 The push based system concentrates on resources allocation whereas the pull
system stresses on responsiveness.
 The push system has a long lead time whereas the pull system has a
short lead time.
 The push system assists in supply chain planning whereas the pull system
facilitates in order completion.
To conclude, the push based supply chain integrations works with an objective of
minimizing the cost whereas the pull based supply chain integration works with an
objective to maximize the services it provides.

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Push & Pull System

Mostly we find a supply chain as merger of both push and pull systems, where the
medium between the stages of the push-based and the pull-based systems is referred as
the push–pull boundary.

The terms push and pull were framed in logistics and supply chain management, but
these terms are broadly used in the field of marketing as well as in the hotel distribution
business.

To present an example, Wal-Mart implements the push vs. pull strategy. A push and pull
system in business represents the shipment of a product or information between two
subjects. Generally, the consumers use pull system in the markets for the goods or
information they demand for their requirements whereas the merchants or suppliers use
the push system towards the consumers.

In supply chains, all the levels or stages function actively for the push and the pull
system. The production in push system depends on the demand predicted and
production in pull system depends on absolute or consumed demand.

The medium between these two levels is referred as the push–pull

boundary or decoupling point. Generally, this strategy is recommended for products
where uncertainty in demand is high. Further, economies of scale play a crucial role in
minimizing production and/or delivery costs.

For example, the furniture industries use the push and pull strategy. Here the production
unit uses the pull-based strategy because it is impossible to make production decisions
on the basis on long term prediction. Meanwhile, the distribution unit needs to enjoy the
benefits of economy of scale so that the shipment cost can be reduced; thus it uses a
push-based strategy.

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Demand-Driven Strategies
The demand-driven strategies were first developed to understand the impact of inactivity
and collection, as information fertilizes the supply chain from the source of demand to
the suppliers.

Within a mentioned supply lead time, normally the manufacturers manufacture sufficient
goods to satisfy the needs of their clients predicted. But this is only somewhat accurate
at the granular level at which inventory decisions are made.

Anyways, when the actual demand varies from the demand predicted, the first thing to
be done is to adjust the supply levels needed in accordance with each step of the supply
chain. But because of time delay between changing demands and its detection at several
at points along the supply chain, its impact is amplified, resulting in inventory shortages
or excesses.

The inventory levels of the companies are disturbed because of the overcompensation
done by the companies either by slowing down or speeding up production. These
fluctuations prove to be a costly and inefficient affair for all participants.

Basically, the demand-driven strategies or the demand-driven supply chain is completely

based on the demand as well as the supply part of marketing. So it can be uniquely
organized in terms of the demand side and supply side initiatives.

The demand-side initiatives concentrate on efficient methods to acquire the demand

signal closer to the source, observe the demand to sense the latest and most accurate
demand signal and shape the demand by implementing and following promotional and
pricing strategies to gear up demand in accordance with business objectives.

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On the other hand, the supply side initiatives mostly need to do with reducing reliance
on the prediction by developing into an agile supply chain accompanied by faster
response when absolute demand is known.

All the strategies discussed above are addressed under the demand-driven strategy, but
we a company following all of them is rare. In fact, we can conclude that companies
concentrate on different markets on the basis of features of the market and industry.

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