Supply chain management (SCM) is the design and management of ﬂows of products, information, and funds throughout the supply chain. It involves the coordination and management of all the activities of a supply chain. As such, SCM may appear deceptively simple. In fact, it is a complex business concept that is far-reaching in the nature and type of decisions involved. Before we can begin to look at the full complexity of SCM, it is important to first understand the meaning of the term supply chain.
A supply chain is the network of all entities involved in producing and delivering a finished product to the final customer. This includes sourcing raw materials and parts; manufacturing, producing, and assembling the products; storing goods in warehouses; order entry and tracking; distribution; and delivery to the final customer. A simple supply chain is illustrated in Figure 1.1.
The ﬂows through the supply chain beginning with suppliers who supply and transport raw materials and components to producers or manufacturers. Manufacturers transform these materials into finished products that are then shipped either to the manufacturers’ own distribution centers or to wholesalers. Next, the products are shipped to retailers who sell the product to final customers. Consider the Starbucks supply chain we just discussed. At the beginning of the supply chain are coffee farmers at various locations across the globe that grow coffee beans. The coffee beans are picked, packaged in burlap bags, and transported to coffee roasters, entities that roast the beans. The roasted beans are then sent to coffee distributors, who then sort, package, and move the beans to retail outlets such as Starbucks cafés, to be purchased by the consumer.
A typical supply chain may involve many different trading partners, called stages. These supply chain stages may include the following:
Note that every supply chain is different and that these stages are a generic representation of a supply chain. In fact, each stage may not be present in every supply chain. The number of stages that are part of a supply chain and its appropriate design will depend on both the customer’s needs, the roles of the stages involved, and the value each stage provides.
Supply chains are under increasing financial pressure, and stages that do not add value to the supply chain are quickly bypassed or eliminated. For this reason, a supply chain is often called a value chain or a value network. Today’s concept of the supply chain comes from the concept of a “value chain” that was introduced by a Harvard Business School professor, Michael Porter, in the l980s. Michael Porter explained that a company’s competitive advantage cannot be understood by looking at a firm as a whole.
Rather, its competitive advantage comes from the many discrete activities that a firm performs and that each of these activities contributes to the firm’s total cost position. This concept of each activity contributing to the total value has now been extended to the entire supply chain. In fact, it has been often said that it is not companies that compete. Rather, it is their supply chains that compete.
As we look at a supply chain it is important to point out some common terminology used to describe the relationships of supply chain stages to one another. Each company in a supply chain has its suppliers and customers. The stages of the supply chain that comprise the inbound direction toward the company, or the “focal firm,” are called the “upstream” part of the supply chain.
The stages of the supply chain away from the “focal firm” are termed “downstream.” This is shown in Figure 1.2. For example, if the focal firm was a manufacturer, all inbound suppliers would be considered “upstream,” whereas distributors/wholesalers and retailers/customers would comprise the “downstream” part of the supply chain. Being able to refer to parts of the supply chain as either “upstream” or “downstream” provides a convenient point of reference. Similarly, suppliers that directly supply goods or services to a company are termed “first-tier suppliers.” Suppliers that supply to a company’s “first-tier suppliers” are termed “second-tier suppliers,” and so on moving up the chain. This provides a common terminology for companies to understand which suppliers are being referenced.
The term supply chain implies a linear chain of participants from suppliers to final customers. A true supply chain is actually more like a complex network, as shown in Figure 1.3. A producer may receive materials from multiple suppliers. Many distributors and wholesalers receive inventory from many manufacturers, and most retailers receive products from many different distributors. For this reason, a supply chain is often referred to as a supply chain network or supply web, to more accurately describe the nature of these relationships. In fact, many companies are part of multiple supply chains.
The supply chain network can actually take on many different shapes. Some are linear, as shown in Figure 1.3. Others take on the form of hub-and-spoke or a web. Often the type of network can be related to the number of suppliers, their locations, and the type of product being produced. For example, Dell Computer Corporation became famous for mandating that all its first-tier suppliers must be within a 15-minute radius anywhere around its Austin, Texas, manufacturing facility. This is an example of a hub-and-spoke supply network, with the focal firm in the center of the design, and a model that has been followed by many other manufacturers.
Now that we understand what constitutes a supply chain or supply network, we can look at the issues involved in managing it. Recall that SCM involves the coordination and management of all the activities of a supply chain. It is responsible for managing the system of ﬂows between the different entities of a supply chain to satisfy the final customer and maximize total supply chain profitability. SCM is a dynamic and ever-changing process that requires coordinating all activities among members of the supply chain. SCM activities include the following:
SCM involves coordinating the movement of goods and services through the supply chain, from suppliers to manufacturers to distributors to final customers; it also includes movement of goods back up the supply chain, as products may be returned. Coordination also involves the movement of funds through the supply chain as products are purchased and sold. This includes various financial arrangements and terms of purchase between buyers and suppliers.
SCM requires sharing relevant information among members of the supply chain. This includes sharing demand and sales forecasts, point-of-sale data, promotional campaigns planned, and inventory levels. Consider that a manufacturer must know if a retailer is planning an advertising campaign to ensure that enough of the product is being produced. Otherwise, the retailer may run out of stock. Similarly, the manufacturer’s suppliers must be aware of increased production plans to provide sufficient component parts. Sharing this information enables the entire chain to work in unison.
SCM requires collaboration between supply chain members so that they jointly plan, operate, and execute business decisions as one entity. This is important for decisions that range from product design and process improvement to implementing business initiatives or following a particular business strategy. For example, this may include collaborating on ways to cut costs or improve quality standards throughout the entire supply chain.
Managing Flows Through the Supply Chain
Recall that many ﬂows move through a supply chain network. The first is the ﬂow of products through the supply chain, from the beginning of the chain through various stages of production, to the final customer. However, goods also ﬂow back through the chain. This is in the form of returned products that are unacceptable to customers for a variety of reasons, such as damaged or obsolete goods. This is an area of SCM called reverse logistics because the direction of product ﬂow is reversed. The increased focus on customer accommodation has resulted in an increase in the number of goods returned from customers.
The second important ﬂow through the supply chain is that of information that is shared between members of the supply chain. Many simplified supply chains view the product ﬂowing from suppliers to customers and information ﬂowing in the opposite direction, from point-of-sale back to suppliers. In this simplified case, the primary information is demand or sales data, which is used to trigger replenishment and serves as the basis for forecasting. In a more realistic case, sales information is shared on a real-time basis, which leads to less uncertainty and less safety stock. The sharing of real-time information serves to compress or shorten the supply chain from a time standpoint. The result of this more timely and accurate information is a reduction in the amount of inventory carried throughout the supply chain.
The third important ﬂow through the supply chain is that of funds. In a simplified supply chain, financial ﬂow is often viewed as one-directional, ﬂowing backward in the supply chain as payment for products and services received. However, as products ﬂow in both directions so does the transfer of funds. A major impact on fund transfer and the financials of companies has been supplying chain compression. A shorter order cycle time means that customers receive their orders faster. It means that they are billed sooner and that companies receive payment sooner.
This speeding up of the money collection process has had a huge impact on the profitability of certain firms. Consider Dell Computer Corporation, a company that has gained much from the compressed supply chain. Dell turns over its inventory roughly every four days. However, they often receive payment a week in advance, well before Dell pays its suppliers, providing a large financial benefit to Dell.
The key to successful SCM is the management of these ﬂows through the chain. SCM is a dynamic process and provides many opportunities to reduce the cost of doing business and improve customer service. At the same time, the challenges of SCM are often underestimated. In fact, the reason for the failure of many online businesses is due to their inability to manage supply chain ﬂows effectively. Many have excellent business concepts and marketing strategies but are unable to make products available to customers in a cost-effective manner. For example, Webvan, an online grocery delivery company, was unable to bring the cost of grocery picking and delivery to a competitive level and went out of business. The success of Internet retailers such as Amazon.com has been primarily driven by the improvements in their supply chains.
The Bullwhip Eﬀect
A supply chain is composed of many different companies, or stages, each with its own objectives. For a supply chain to be highly competitive, it is critical that its members engage in the activities of coordination, information sharing, and collaboration. Otherwise, each stage of the supply chain will have differing and possibly conﬂicting objectives and may focus on simply maximizing their own profits. Similarly, if the information is not shared between stages, but is delayed or distorted, each stage may have a distorted view of final customer demand. As a result, they will likely not produce the right quantities of items needed, resulting in either shortages or excess inventory. Both situations result in lowered profitability of the entire supply chain.
It has been observed that ﬂuctuation and distortion of information increase as it moves up the supply chain, from retailers, to manufacturers, and to suppliers. This is called the bullwhip effect, as inaccurate and distorted information travels up the chain like a bullwhip uncoiling. In response, each stage of the chain carries progressively more inventory to compensate for the lack of information. The bullwhip effect has been well documented in many industries and is costly for all supply chain members.
One of the best-known examples of the bullwhip effect was observed by Proctor & Gamble (P&G) in the supply chain of its Pampers diapers. The company discovered that even when demand for diapers was stable at the retail store level, orders for diapers from P&G ﬂuctuated significantly. Even greater ﬂuctuation was observed in orders for raw materials from suppliers over time. Although consumption of the final product was stable, orders for raw materials were highly variable.
A similar example was observed at Hewlett Packard (HP). HP observed that ﬂuctuations of orders increased significantly as they moved from the resellers up the supply chain to the printer division to the integrated circuit division. Like P&G, HP observed that although final product demand was fairly stable, orders placed at every stage up the supply chain significantly increased in variability. Both P&G and HP found that the result of the bullwhip effect was an increase in cost and difficulty in filling orders on time.
The longer the supply chain, the greater the opportunity for the bullwhip effect, as manufacturers and suppliers are further away from final customer demand. If there is no coordination or sharing of information, these stages do not know the final customer demand or when a replenishment order might arrive. As a result of this higher uncertainty, they stockpile inventory. The way to combat the bullwhip effect is to share point-of-sale information, available from most cash registers, with all members of the supply chain. This allows all stages of the supply chain to make replenishment decisions from the same information source. In addition to information sharing, coordination and collaboration will enable stages of the supply chain to work toward the same goals.
The final customer is the driving force of the supply chain. In fact, the primary purpose for the existence of a supply chain is to respond to customer demands and generate profits for companies that are members of the chain. Therefore, meeting customer demands is the primary objective. The process is driven by a customer having a particular product need. The retailer tries to satisfy the customer by ensuring that the product is available. As customers continue to purchase products, the retailer requests additional products from its suppliers to replenish those sold. These suppliers then purchase materials from their suppliers, and the process “pulls” raw materials through the rest of the chain needed to produce more quantities of the product.
Consider a customer walking into a Wal-Mart store to buy laundry detergent, as shown in Figure 1.4. The process that drives the supply chain starts with the need of the customer to buy detergent. The customer visiting Wal-Mart takes detergent off the shelf that Wal-Mart stocked from an inventory supplied from its finished-goods warehouse or by a distributor. Sales of the detergent trigger the warehouse or distribution center to replenish the sold items.
The items “pulled” out of the warehouse or distribution center trigger the manufacturer, such as Proctor & Gamble (P&G), to produce more and fill the warehouse with more items. To produce more items, in turn, P&G has to request more raw materials from their suppliers, such as those that supply packaging and chemical components. As P&G requests more raw materials from their suppliers, their first-tier suppliers request more material from lower-tier suppliers. In this manner, products are moved through the supply chain.
SCM is a dynamic process and involves the constant ﬂow of information, products, and funds between different entities of the supply chain. To see how this works, once again consider the example of Wal-Mart. Wal-Mart provided the product (detergent in this case) to the customer, and the customer transferred their funds to Wal-Mart. Using point-of-sale data, Wal-Mart then conveyed the need to replenish orders to the warehouse or distributor, who transferred the replenishment order via trucks back to the store. After the replenishment was made, Wal-Mart transferred funds to the distributor. Wal-Mart, the distributor, and the manufacturer shared pricing information, delivery schedules, and forecasts of future sales. This type of ﬂow of information, products, and funds takes place across the entire supply chain.
This example illustrates that to provide timely product availability, all the participants in the chain need to coordinate their plans and respond to the same information. Also, notice that there are many ﬂows moving through the supply chain. The process is driven by customer order and ends when a customer has paid for their purchase. SCM is the coordination and orchestration of all the activities necessary for this process to occur in the most efficient, cost-effective, and timely manner.
The Service Supply Chain
SCM is just as relevant to companies in the service industry, ranging from healthcare to real estate to banking, as it is to manufacturing companies that produce tangible products. However, service supply chains differ from manufacturing in the role of the customer and the direction of ﬂow of the delivery process. Unlike manufacturing supply chains that focus on the production and delivery of a tangible product, service supply chains tend to focus more on the interaction between the customer and provider.
For this reason, the role of the customer is even greater in driving the service supply chain than it is in manufacturing. In service organizations, the customer is also a supplier of inputs and information, which can change the service delivery. Consider the legal environment, where the course of legal action greatly depends on the information provided by the client to the attorney. Similarly, a university student may have the option to conduct an independent study under the supervision of a faculty member, changing the set course of study.
Service supply chains tend to be considerably shorter than manufacturing supply chains. The provider typically interacts directly with customers, without the buffer of retailers and distributors, enabling easier sharing of information. Service supply chains also tend to look more like hubs than chains. One of the disadvantages is that they do not have the buffers of inventory as seen in manufacturing. This means that they need to have other organizational mechanisms that give them ﬂexibility when handling the variation of customer-supplied inputs and demands. This also makes information sharing with customers much more critical.
Even service companies that provide pure content to customers, such as those in the entertainment industry, rely heavily on their supply chains to deliver customer value and remain competitive. This includes industries such as film, computer games, and sports and includes companies such as Disney, Warner Bros., and Ticketmaster. These companies are increasingly relying on SCM processes and technology improvements to ensure coordination of information and maintain competitiveness.