Tuesday, December 15, 2009

The Push Pull Interface: the Optimal Point

A while ago, we talked about the basic characteristics of push or pull based supply chains. We also discussed how push or pull concept should be interpreted within a single supply chain as well as across multiple supply chains supporting the product life cycle from raw material to finished goods to purchase by a customer.

All that raises a question: how can one decide what will be the best point in the supply chain where the order-inventory interface must be located? Just to refresh, the order-inventory interface is the point in the supply chain where the demand fulfillment process changes from “fulfilling from inventory” to “fulfilling from orders”. While the article on considerations for push or pull provided a good view of attributes to be considered, they do not necessarily help in deciding where in supply chain the nature of demand fulfillment must change from inventory to orders. This is the question, I wish to address today in this article.

To answer the question, let us establish some basic facts. Supply chain for this discussion is represented as a chain of activities and nodes connecting supply with demand. Keeping with the convention, we represent the “supply” end upstream of the “demand” end. The Order-Inventory interface can then be located anywhere along the length of the supply chain. It can be closer to the demand end or closer to supply end or mid-way between the two. The question we are trying to answer is how to objectively decide the optimal point where this should be located for optimal supply chain performance.


Next, let us explore through logic what happens when the order-inventory (OI) interface point moves along the supply chain? We will explore the impact of such movement from the point of what happens to demand as this point moves along the chain. For example, if we move the order-inventory (OI) interface closer to demand, it follows logically that the demand fulfillment lead-time will be lowest, while the flexibility to customize products to the order will be lowest as all demand is fulfilled from available stock.

The following table summarizes the observations.


In Managing the Fickle: The True Nature of Supply Chains, we identified that a supply chain’s primary purpose in life was to combat variability in supply, demand, and lead-time. We had also established that supply chains achieve this objective by creating and managing buffers. Buffers can exist for inventory, resources, and time. The observations in the table above enable us to see how the movement of OI point along the supply chain affects these buffers. As the OI point moves closer to the supply end, the supply-chain’s ability to keep inventory buffers reduces, therefore it must compensate by establishing larger resource and time buffers to accommodate demand variance. Conversely, when the OI point moves closer to the demand end, the supply-chain’s ability to keep inventory buffers is enhanced, therefore it can make do with smaller resource and time buffers. Of course, the supply chains must maintain the smallest possible buffers to provide the desired cost performance for the target service levels. This is shown in the picture below.


The point of evaluating the impact of moving OI point on the supply chain’s ability to create and manage buffers is simple. It allows us to see how supply chains will react to such a change and provides us with an objective view of how supply chain performance may get affected as a result. Higher inventories provide shorter fulfillment time, but come at the cost of higher carrying costs and obsolescence costs. On the other hand, higher inventories generally allow mass-production, thus increasing the resource utilization and reducing the cost of resource buffers because they can now be planned and utilized well to their capacity.

As creation and maintenance of all buffers needs capital, eventually the decision to place the OI point at a certain point in the supply chain gets reduced to balancing the cost of these buffers against the cost of stock-outs and lost sales revenue. If the costs of maintaining inventory is relatively higher when compared to the costs of resources and time, then the equation will tilt in favor of the OI point towards the supply side of the chain. On the other hand, when cost of inventory is low compared to the costs of resources and time, then the equation will favor moving the OI point closer to demand. Of course, these considerations are in addition to the basic nature of the products and demand which must determine the suitability of such analysis. But assuming that a supply chain type has been established (for example, commodities versus personalized versus engineered products), this analysis can help in establishing which echelon in the supply chain is the best for placing the OI point.

Here is a summary of the opposing costs to balance when making decisions about the OI point:

  • Costs related to creation and maintenance of Inventory buffers: Balance the costs of maintaining inventory with the costs of obsolescence and clearance of unwanted/excess inventory against the cost of stock-outs and lost sales.
  • Costs related to creation and maintenance of Resource buffers: Balance the costs of maintaining resource flexibility (ramping up/down as required, adding sub-contract capacity at short notice, etc.) against the cost of stock-outs and lost sales if resources cannot be ramped up to meet demand.
  • Costs related to creation and maintenance of Time buffers: Balance the costs of maintaining time buffers (cost of extra capital to maintain additional operations and inventory to hedge against variability in lead-time) against the cost of stock-outs and lost sales.


These costs vary at every echelon of the supply chain network. If they can be modeled and evaluated at various potential echelons of the supply chain, the location for the OI interface can be determined in a more objective fashion. While some of these costs are hard to determine, judicious approximation would be better than making a decision that is completely subjective. Most likely, the optimal echelons will differ by the product’s demand and supply characteristics. Fast moving products will require inventories closer to the end-demand, while the inventories of the slow-moving products can be moved upstream. Similarly, inventories for commodities will be closer downstream, while personalized products must be maintained upstream and typically as sub-assemblies that can be configured to final customer demand.

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Friday, December 11, 2009

Book Review: Enterprise SCM

Jan Husdal has since 2005 been a Researcher with the Transport Economics Research Group at Møreforsking Molde/Molde Research Institute in Molde, Norway, where he is engaged in transport modelling, and cost-benefit evaluations of infrastructure projects.

Jan routinely reviews supply chain books. Though supply chain risk is his specialization, he has a deep understanding of the supply chains in general. Jan recently took time out to review my book and write a detailed review on his site, which I would like to share.

Click here to read Jan's review of my book: Book Review: Enterprise SCM

Clisk here to read more about Jan: About Jan Husdal « husdal.com

Commerce says Retail Sales up by 1.2% Without Autos

Well, that is really good news. On Nov. 13, I wrote that there is a very good likelihood that retail holiday sales this year will be better this year than last. This is a view not shared by NRF, though I would stick to it. That has been the trend so far and I think it is going to continue through the rest of the season. When compared to November, 2008, this month’s numbers are up by 1.9%! Click here for the news release from the bureau.

The best part is that while the total retail sales rose by 1.3%, most of the rise happens to be the real retail, as in without the autos. Autos did not contribute heavily to this number so that the retail without autos rose 1.2%. However, autos sales rose as well by 2.0% (6.7% over November 2008 numbers).

All in all, a definite up-trend.

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Tuesday, December 8, 2009

Strategy Alignment: Poor State of Affairs

While there is a lot of common sense talk about aligning strategies, it seems that it is easier said than done. I am sure that all of us have across situations in our careers where we have gone through this conflict ourselves – when the business strategy did not quite align with the IT strategy. The results range from less than desirable to disastrous.

Now a survey by McKinsey finds that the situation is continuing (see exhibit 6 in the linked article). That is despite the recession. This is surprising and disappointing because such market pressures generally lead to the kind of organizational transformations that drive greater alignment to increase the efficiency of capital investments. The survey found that only 16% of the 444 respondents agreed their business and IT strategies were integrated and affected each other. Other 19% found no relationship between their business and IT strategies.

Misaligned business and IT strategy can lead to several undesirable consequences including the following:

  • Misdirected capital investments: Since almost all functional capabilities are enabled through technology, misalignments between the business and IT strategies leads to capital investments that are simply not compliant with the long term IT strategy and therefore just not sustainable. Examples of such investments may be technology platforms that are obsolete, not mainstream, require skills that are not abundantly available or unavailable in-house, or are not supported adequately by the suppliers. However, once established, such technologies must be maintained at the cost of business continuity or replaced with more compliant solutions at the cost of additional investments.
  • Unsustainable technology solutions: When business and IT strategies are independent of each other, the resulting technology solutions may be unsustainable as they simply do not support any direct business requirements and therefore do not add value.
  • Siloed solutions: Misaligned strategies typically result in siloed solutions that do not adequately support business processes. Integration, when possible adds complexity, cost, and ongoing maintenance to the solutions.
  • Organizational friction: When the business and IT strategies are established in isolation from each other, the resulting conflict affects the business and technology solution deployment teams, reducing the organizational efficiency, affecting project timelines and costs.
  • Cost and functionality compromises: As the misalignment between the business and IT strategies inevitably leads to multiplicity of solutions, it adds to the cost of technology, complexity of solution landscape, multiple vendor relationships, and sometimes compromised business functionality if the solutions cannot be integrated effectively.

Getting the strategies aligned is not hard, but it does require an organizational resolve to do that. Executive understanding helps and is a critical factor in bringing together the two teams in business and technology. It is tough, but worth every penny invested in the effort!

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Monday, December 7, 2009

Managing the Fickle: The True Nature of Supply Chains

The essential nature of the supply chains is to master the change, the variable, the fickle. Quoting the compact oxford dictionary:


adjective 1 not consistent or having a fixed pattern; liable to vary. 2 able to be changed or adapted. 3 Mathematics (of a quantity) able to assume different numerical values.

noun 1 a variable element, feature, or quantity. 2 Astronomy a star whose brightness changes, either regularly or irregularly. 3 (variables) the region of light, variable winds to the north of the NE trade winds or (in the southern hemisphere) between the SE trade winds and the westerlies.

— DERIVATIVES variability noun variably adverb.

Variability or statistical variability or dispersion is the spread of a variable. Supply chains have a lot of variables. And supply chain management is essentially the management of the variability of these variables while maintaining predictably stable business operations of a firm. There are three main variables to manage: demand, supply, and lead-times. These are the three independently changing variables that supply chain managers cannot directly control. All supply chain processes are designed to manage these three variables with the objective of optimizing stability of operations, reducing the cost of changes (or volatility), and increasing the efficiency of asset/resource utilization in spite of the changes.

How do supply chains manage variability? Through buffers. In the supply chain context, the buffers provide the ability to absorb the shocks in the supply chain due to changes in these variables. Again, there are three types of buffers that a supply chain can create. These are inventory, resource, and time. Creating and maintaining these buffers costs significant amount of capital, but provides hedging against the variables of demand, supply and lead-time.

An Optimized Supply Chain

Supply chain management, then, essentially means managing the variability in demand, supply, and lead-time through creation and maintenance of buffers using inventory, resource, and time. Supply chain optimization is the science of optimizing the costs of maintaining these buffers for the best supply chain performance that could mean minimizing the volatility or cost operations, or maximizing the utilization of assets or resources.

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Thursday, December 3, 2009

Who is Your CFO’s Best Friend?

Look at your P&L closely and you will find it in the first two lines. After sales is the cost of sales. And their difference is the gross profit. So what is the big deal? Big deal is that cost of sales determines the gross profit and gross profit is the starting point for the famous bottom-line.

Cost of sales has aliases. It may be called cost of goods sold, cost of products, cost of products sold or something else similar in connotation. That is not important. What is important is what constitutes the cost of sales. Here are some explanations from the annual reports:

  • From P&G’s annual report 2009: “Cost of products sold is primarily comprised of direct materials and supplies consumed in the manufacture of product, as well as manufacturing labor, depreciation expense and direct overhead expense necessary to acquire and convert the purchased materials and supplies into finished product. Cost of products sold also includes the cost to distribute products to customers, inbound freight costs, internal transfer costs, warehousing costs and other shipping and handling activity.”
  • From Wal-mart’s annual report 2009: “Cost of sales includes actual product cost, the cost of transportation to the Company’s warehouses, stores and clubs from suppliers, the cost of transportation from the Company’s warehouses to the stores and clubs and the cost of warehousing for our Sam’s Club segment.”
  • From Target’s annual report 2009: “Total cost of products sold including Freight expenses associated with moving merchandise from our vendors to our distribution centers and our retail stores, and among our distribution and retail facilities; Vendor income that is not reimbursement of specific, incremental and identifiable costs; Inventory shrink, Markdowns, Outbound shipping and handling expenses associated with sales to our guests, Terms cash discount, Distribution center costs, including compensation and benefits costs.”

Typically, almost all the components of cost of goods sold (COGS) fall within the scope of supply chain processes. COGS also makes the largest part of company’s costs. The COGS compares to 50% of 2009 sales for P&G, 76% for Wal-mart, and 70% of sales at Target for FY2009. Therefore, if you had to start looking at reducing costs, COGS fits the bill nicely. This is the largest pie of expense in an organization and even a small reduction in this will naturally generate a large impact on the firm’s bottom-line. Following are some of most common expenses included in the COGS and the supply chain process that can potentially optimize it.


So who is your CFO’s best friend? If the answer is chief supply chain officer (CSCO), you are already ahead of the pack. However, AMR reports that from about 90 organizations that they surveyed, only 38% of respondents identified a chief supply chain officer (CSCO) or equivalent executive vice president as their highest ranking official. Furthermore, of the 38% that stated they had a CSCO or equivalent, only 33% of them report directly to the CEO. This means only about 12.5% of the organizations they surveyed have a CSCO that reports directly to the CEO. (Read the AMR article: Driving Supply Chain Transformation Through the Chief Supply Chain Officer).

Perhaps, time to rethink the organization!

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Clicks Win Over Bricks

Here are the final tallies for the holiday retail sales so far:

Black Friday Weekend Sales Rise 1.6 Percent as Compared to 2008 (links back to the ShopperTrak’s news article).

  • Black Friday weekend retail sales increased a marginal 1.6 percent to a total of $20.5B.
  • Black Friday began the season with a large spend as retail sales totaled $10.66 billion, equaling just a 0.5 percent increase over Black Friday 2008 but representing the largest dollar amount ever spent on the day.
  • Black Saturday posted a slight 0.9 percent rise over last year with $6.107 billion spent.
  • Sunday retail sales increased a seemingly impressive 5.2 percent at $3.73 billion.

Online Cyber Monday sales up 5 pct and number of Web shoppers up 6 percent (links back to the Reuters story).

  • Online shoppers spent 5 percent more this Cyber Monday than they did last year.
  • More consumers flocked to the Web for holiday shopping though they spent slightly less per person.
  • Monday, Nov. 30 was the strongest Cyber Monday in terms of sales since the term was coined five years ago.

Now, some more data from the US Census Bureau: when you compare the rates of decline and rise for total retail and online retail, the online retail help up much better that the total retail. The chart below shows the quarterly change year-over-year for the two time-series. Focus specifically on the data from Q3-2008, the declines in the online retail have been smaller and the improvements in online retail stronger. Few points of note:

  • Online retail seems to have started growing again at growth rates stronger than the total retail. This is not surprising since that has been the trend all along with few exceptions during the recent recession.
  • Notice the trend of the green-line in the second chart – it shows the E-commerce as percent of total retail has a positive trend. The trend has held even during the last two years.



Lessons for retailers:

  • Build your online stores if you have not yet!
  • When you do, pay attention to the bold new world of multi-channel retailing that you can leverage as a conventional retailer!

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Tuesday, December 1, 2009

Can Your Supply Chain do That?

What are the objectives of your supply chain management? What should they be? In short, the following four capture all that an optimally run supply chain can achieve.

  1. Cost (Lean): The supply chain management processes cover a wide scope of execution operations from managing replenishment orders to transportation and warehousing activities. Depending on the industry, the percentage of these operational costs towards the cost of goods sold can be anywhere up to 20%. Following the processes based on supply chain best practices can directly reduce these costs through better planning, optimization, and execution. Some of the supply chain planning processes also impact costs such as inventory planning. Well planned inventories can not only reduce the amount of inventory in the system thus reducing operational cash-flow requirements, they can also reduce costs by reducing obsolescence, having the right product at the right place, and by reducing the need for clearance pricing. In fact, all supply chain processes either directly impact the COGS or impact the operating cash requirements. And, in most cases, the impact of a better deployed process, automation, or optimization can be specifically calculated for obtaining financial return on the investments made.
  2. Flexibility (Agile): This is the second objective for the supply chain processes. Agility provides a supply chain the capability to react to the changes in demand or supply in an optimal fashion so as to maintain the service-levels and therefore, the top-line revenues. There are several processes that create such agility in the supply chains: cross-docking made famous by Wal-mart is one of them. Ability to push the selection of the destination of the inventory-in-transit to the last possible minute is the underlying concept that enables agility in a flow-based supply chain. This can manifest itself through several possible processes such as consolidation and de-consolidation centers, regional and local distribution centers, cross-docking and so on. Other processes that add to the capability of agility are sourcing and replenishment where the agility can be achieved through better visibility and collaboration among the partners in the inter-company supply chains.
  3. Risk: Supply chains must manage the uncertainties beyond the volatility of demand and supplies. Risk is primarily the disruption in the supply chain that is not attributable to the natural demand/supply volatility. While the probability of such disruptions is low, their consequences remain disastrous. Risk increases as the supply chains become longer, global, and need several independent corporate partners. Supply chains typically manage risk through better collaboration, visibility, and finally by developing backup plans for alternate sources of supplies if the primary supplies fail.
  4. Visibility: While visibility for its own sake is not an objective of supply chain management -- this is a capability that must be developed to support the three primary objectives mentioned above. Visibility can help reduce costs by detecting the most inefficient processes, provide agility through showing available alternatives, and manage risk better by identifying the most critical supply paths and the impact of their failure.

Evaluating your supply chain processes can expose inefficiencies and gaps that can help achieve or enhance the results in any of above four categories. Metrics can be set to measure the improvements: while the cost reductions can be measured more precisely, the impact of improvements due to increased agility and reduced risk can also be measured by comparing the results to the historical performance of the supply chain.

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.