Supply Chain Management: Strategy, Planning and Operation

THIRD EDITION -------·----·---------

SUPPLY CHAIN

MANAGEMENT

Strategy, Planning, and Operation

Sunil Chopra

Kellogg School of Management

Northwestern University

Peter Meindl

Stanford University

PEARSON

--------- Prentice

I-I all

Upper Saddle River, New Jersey

·--· -- ·-·---

"ibrary of Congress Cataloging-in-Publication Data

:::hopra, Sunil

Supply chain management: strategy, planning, and operation I Sunil Chopra,

>eter Meind!.-3rd ed.

p. em.

Includes bibliographical references and index.

ISBN: 0-13-208608-5

1. Marketing channels-Management. 2. Delivery of goods-Management.

i. Physical distribution of goods-Management. 4. Customer services￾vfanagement. 5. Industrial procurement. 6. Materials management. I.

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DEDICATION

~

I would like to thank my colleagues at Kellogg for all that I have learned from them about

logistics and supply chain management. I am grateful for the love and encouragement my

parents, Krishan and Pushpa, and sisters, Sudha and Swati, have always provided during

every endeavor in my life. I thank my children, Ravi and Rajiv, for the joy they have

brought me. Finally, none of this would have been possible without the constant love,

caring, and support of my wife, Maria Cristina.

Sunil Chopra

I would like to thank three mentors-Sunil Chopra, Hau Lee, and Gerry Lieberman-who

have taught me a great deal. Thank you also to my parents and sister for their love,

and to my sons, Jamie and Eric, for making me smile and teaching me what life is

truly all about. Most important, I thank my wife, Sarah, who makes life wonderful

and whom I love with all of my heart.

Pete Meindl

SUNIL CHOPRA

ABOUT THE AUTHORS

~

Sunil Chopra is the IBM Distinguished Professor of Operations Management

and Information Systems at the Kellogg School of Management. He is also the

Codirector of the Masters of Management and Manufacturing program, a joint

dual-degree program between the Kellogg School of Management and the

McCormick School of Engineering at Northwestern University. He has a PhD

in Operations Research from SUNY at Stony Brook. Prior to joining Kellogg,

he taught at New York University and spent a year at IBM Research.

Professor Chopra's research and teaching interests are in supply chain and

logistics management, operations management, and the design of telecommuni￾cation networks. He has won several teaching awards at the MBA and Executive

programs of Kellogg. He has authored more than 35 papers and two books.

He has been a Department Editor for Management Science and an Associate

Editor for Manufacturing & Service Operations Management, Operations Research,

and Decision Sciences Journal. His recent research has focused on supply chain risk to

understand sources of risk and devise mitigation strategies that buffer risk effectively

at low cost. He has also consulted for several firms in the area of supply chain and

operations management.

PETER MEINDL

Peter Meindl is a Finance and Economics PhD candidate in Stanford

University's Management Science & Engineering Department. His research

focuses on portfolio optimization and dynamic hedging using stochastic pro￾gramming, receding horizon control, and Monte Carlo simulation. He was pre￾viously a strategy consultant with the Boston Consulting Group and the

Director of Corporate Strategy for i2 Technologies, a software firm. He holds

an MBA from Northwestern University's Kellogg School and three degrees

from Stanford University.

The first edition of this book won the prestigious Book of the Year award in 2001 from

the Institute of Industrial Engineers.

Preface xiii

BRIEF C 0 NT E ~-T S

~

PART I BUILDING A STRATEGIC FRAMEWORK

TO ANALYZE SUPPLY CHAINS 1

Chapter 1 Understanding the Supply Chain 3

Chapter 2 Supply Chain Performance: Achieving Strategic Fit and Scope 22

Chapter 3 Supply Chain Drivers and Metrics 44

PART II DESIGNING THE SUPPLY CHAIN NETWORK 73

Chapter 4 Designing Distribution Networks and Applications toe-Business 75

Chapter 5 Network Design in the Supply Chain 114

Chapter 6 Network Design in an Uncertain Environment 152

, PART Ill PLANNING DEMAND AND SUPPLY IN A SUPPLY CHAIN 185

Chapter 7 Demand Forecasting in a Supply Chain 187

Chapter 8 Aggregate Planning in a Supply Chain 218

Chapter 9 Planning Supply and Demand in a Supply Chain: Managing Predictable Variability 241

PART IV PLANNING AND MANAGING INVENTORIES IN A SUPPLY CHAIN 259

Chapter 10 Managing Economies of Scale in a Supply Chain: Cycle Inventory 261

Chapter 11 Managing Uncertainty in a Supply Chain: Safety Inventory 304

Chapter 12 Determining the Optimal Level of Product Availability 346

PART V DESIGNING AND PLANNING TRANSPORTATION NETWORKS 383

Chapter 13 Transportation in a Supply Chain 385

PART VI MANAGING CROSS-FUNCTIONAL DRIVERS

IN A SUPPLY CHAIN 415

Chapter 14

Chapter 15

Chapter 16

Chapter 17

Sourcing Decisions in a Supply Chain 417

Pricing and Revenue Management in a Supply Chain

Information Technology in a Supply Chain 482

Coordination in a Supply Chain 497

Name Index 528

Subject Index 530

459

v

CONTENTS

Preface xiii

PART I BUILDING A STRATEGIC FRAMEWORK

TO ANALYZE SUPPLY CHAINS 1

CHAPTER 1 Understanding the Supply Chain 3

1.1 What Is a Supply Chain? 3

1.2 The Objective of a Supply Chain 5

1.3 The Importance of Supply Chain Decisions 6

1.4 Decision Phases in a Supply Chain 9

1.5 Process View of a Supply Chain 10

1.6 Examples of Supply Chains 16

1.7 Summary of Learning Objectives 20

Discussion Questions 20

Bibliography 21

CHAPTER 2 Supply Chain Performance: Achieving Strategic Fit and Scope 22

2.1 Competitive and Supply Chain Strategies 22

2.2 Achieving Strategic Fit 24

2.3 Expanding Strategic Scope 38

2.4 Summary of Learning Objectives 42

Discussion Questions 43

Bibliography 43

CHAPTER 3 Supply Chain Drivers and Metrics

3.1 Drivers of Supply Chain Performance

3.2 Framework for Structuring Drivers

3.3 Facilities 48

3.4 Inventory 50

3.5 Transportation 53

3.6 Information 55

3.7 Sourcing 58

3.8 Pricing 60

3.9 Obstacles to Achieving Fit 62

44

44

46

3.10 Summary of Learning Objectives 64

vii

viii Contents

Discussion Questions 65

Bibliography 65

Case Study Seven-Eleven Japan Co. 66

PART II DESIGNING THE SUPPLY CHAIN NETWORK' 73

CHAPTER 4 Designing Distribution Networks and Applications to e-Business 75

4.1 The Role of Distribution in the Supply Chain 75

4.2 Factors Influencin.g Distribution Network Design 76

4.3 Design Options for a Distribution Network 80

4.4 e-Business and the Distribution Network 94

4.5 Distribution Networks in Practice 110

4.6 Summary of Learning Objectives 112

Discussion Questions 112

Bibliography 113

CHAPTER 5 Network Design in the Supply Chain 114

5.1 The Role of Network Design in the Supply Chain 114

5.2 Factors Influencing Network Design Decisions 115

5.3 Framework for Network Design Decisions 121

5.4 Models for Facility Location and Capacity Allocation 124

5.5 The Role of IT in Network Design 140

5.6 Making Network Design Decisions in Practice 141

5.7 Summary of Learning Objectives 143

Discussion Questions 143

Exercises 143

Bibliography 149

Case Study Managing Growth at SportStuff.com 150

CHAPTER 6 Network Design in an Uncertain Environment 152

6.1 The Impact of Uncertainty on Network Design 152

6.2 Discounted Cash Flow Analysis 153

6.3 Representations of Uncertainty 154

6.4 Evaluating Network Design Decisions Using Decision Trees 156

6.5 AM Tires: Evaluation of Supply Chain Design Decisions Under Uncertainty 164

6.6 Risk Management and Network Design 175

6.7 Making Supply Chain Decisions Under Uncertainty in Practice 177

6.8 Summary of Learning Objectives 178

Discussion Questions 178

Exercises 179

Bibliography 181

Case Study BioPharma, Inc. 182

Contents ix

PART Ill PLANNING DEMAND AND SUPPLY IN A SUPPLY CHAIN 185

CHAPTER 7 Demand Forecasting in a Snpply Chain 187

7.1 The Role of Forecasting in a Supply Chain 187

7.2 Characteristics of Forecasts 188

7.3 Components of a Forecast and Forecasting Methods 189

7.4 Basic Approach to Demand Forecast1ng 191

7.5 Time-Series Forecasting Methods 193

7.6 Measures of Forecast Error 203

7.7 Forecasting Demand at Tahoe Salt 204

7.8 The Role of IT in Forecasting 210

7.9 Risk Management in Forecasting 211

7.10 Forecasting in Practice 212

7.11 Summary of Learning Objectives 213

Discussion Questions 213

Exercises 214

Bibliography 215

Case Study Specialty Packaging Corporation, Part A 216

CHAPTER 8 Aggregate Planning in a Supply Chain 218

8.1 The Role of Aggregate Planning in a Supply Chain 218

8.2 The Aggregate Planning Problem 220

8.3 Aggregate Planning Strategies 221

8.4 Aggregate Planning Using Linear Programming 222

8.5 Aggregate Planning in Excel 230

8.6 The Role of IT in Aggregate Planning 232

8.7 Implementing Aggregate Planning in Practice 233

8.8 Summary of Learning Objectives 234

Discussion Questions 235

Exercises 235

Case Study Specialty Packaging Corporation, Part B 238

CHAPTER 9 Planning Supply and Demand in a Supply Chain:

Managing Predictable Variability 241

9.1 Responding to Predictable Variability in a Supply Chain 241

9.2 Managing Supply 242

9.3 Managing Demand 244

9.4 Implementing Solutions to Predictable Variability in Practice 252

9.5 Summary of Learning Objectives 252

Discussion Questions 253

Exercises 253

Bibliography 256

Case Study Mintendo Game Girl 257

x Contents

PART IV PLANNING AND MANAGING INVENTORIES

IN A SUPPLY CHAIN 259

CHAPTER 10 Managing Economies of Scale in a Supply Chain: Cycle Inventory 261

10.1 The Role of Cycle Inventory in a Supply Chain 261

10.2 Economies of Scale to Exploit Fixed Costs 264

10.3 Economies of Scale to Exploit Quantity Discounts 275

10.4 Short-Term Discounting: Trade Promotions 285

10.5 Managing Multiechelon Cycle Inventory 290

10.6 Estimating Cycle Inventory-Related Costs in Practice 294

10.7 Summary of Learning Objectives 296

Discussion Questions 296

Exercises 297

Bibliography 300

Case Study Delivery Strategy at MoonChem 301

Appendix lOA: Economic Order Quantity 303

CHAPTER 11 Managing Uncertainty in a Supply Chain: Safety Inventory 304

11.1 The Role of Safety Inventory in a Supply Chain 304

11.2 Determining Appropriate Level of Safety Inventory 306

11.3 Impact of Supply Uncertainty on Safety Inventory 316

11.4 Impact of Aggregation on Safety Inventory 318

11.5 Impact of Replenishment Policies on Safety Inventory 329

11.6 Managing Safety Inventory in a Multiechelon Supply Chain 332

11.7 The Role of IT in Inventory Management 333

11.8 Estimating and Managing Safety Inventory in Practice 334

11.9 Summary of Learning Objectives 335

Discussion Questions 336

Exercises 336

Bibliography 340

Case Study Managing Inventories at ALKO Inc. 341

Appendix 11A: The Normal Distribution 343

Appendix 11B: The Normal Distribution in Excel 344

Appendix 11C: Expected Shortage Cost per Cycle 345

CHAPTER 12 Determining the Optimal Level of Product Availability 346

12.1 The Importance of the Level of Product Availability 346

12.2 Factors Affecting Optimal Level of Product Availability 347

12.3 Managerial Levers to Improve Supply Chain Profitability 356

12.4 Setting Product Availability for Multiple Products Under Capacity Constraints 367

12.5 Setting Optimal Levels of Product Availability in Practice 370

12.6 Summary of Learning Objectives 370

Discussion Questions 371

Exercises 371

"'--------------------~-~--- - ----- -- -~----

Contents xi

Bibliography 375

Appendix 12A: Optimal Level of Product Availability 376

Appendix 12B: An Intermediate Evaluation 377

Appendix 12C: Expected Profit from an Order 378

Appendix 12D: Expected Overstock from an Order 379

Appendix 12E: Expected Understock from an Order 380

Appendix 12F: Simulation Using Spreadsheets 381

PART V DESIGNING AND PLANNING TRANSPORTATION NETWORKS 383

CHAPTER 13 Transportation in a Supply Chain 385

13.1 The Role of Transportation in a Supply Chain 385

13.2 Modes of Transportation and Their Performance Characteristics 387

13.3 Transportation Infrastructure and Policies 392

13.4 Design Options for a Transportation Network 395

13.5 Trade-Offs in Transportation Design 399

13.6 Tailored Transportation 406

13.7 The Role of IT in Transportation 408

13.8 Risk Management in Transportation 409

13.9 Making Transportation Decisions in Practice 410

13.10 Summary of Learning Objectives 411

Discussion Questions 412

Exercises 412

Bibliography 413

PART VI MANAGING CROSS-FUNCTIONAL DRIVERS

IN A SUPPLY CHAIN 415

CHAPTER14 Sourcing Decisions in a Supply Chain 417

14.1 The Role of Sourcing in a Supply Chain 417

14.2 In-House or Outsource 419

14.3 Third- and Fourth-Party Logistics Providers 426

14.4 Supplier Scoring and Assessment 428

14.5 Supplier Selection-Auctions and Negotiations 432

14.6 Contracts and Supply Chain Performance 436

14.7 Design Collaboration 447

14.8 The Procurement Process 448

14.9 Sourcing Planning and Analysis 451

14.10 The Role of IT in Sourcing 452

14.11 Risk Management in Sourcing 453

14.12 Making Sourcing Decisions in Practice 454

14.13 Summary of Learning Objectives 454

Discussion Questions 456

Exercises 456

Bibliography 458

xii Contents

CHAPTER 15 Pricing and Revenue Management in a Supply Chain 459

15.1 The Role of Pricing and Revenue Management in a Supply Chain 459

15.2 Pricing and Revenue Management for Multiple Customer Segments 461

15.3 Pricing and Revenue Management for Perishable Products 468

15.4 Pricing and Revenue Management for Seasonal Demand 473

15.5 Pricing and Revenue Management for Bulk and Spot Contracts 474

15.6 The Role of IT in Pricing and Revenue Management 476

15.7 Using Pricing and Revenue Management in Practice 477

15.8 Summary of Learning Objectives 478

Discussion Questions 479

Exercises 479

Bibliography 481

CHAPTER 16 Information Technology Jn a Supply Chain 482

16.1 The Role of IT in a Supply Chain 482

16.2 The Supply Chain IT Framework 485

16.3 Customer Relationship Management 488

16.4 Internal Supply Chain Management 489

16.5 Supplier Relationship Management 491

16.6 The Transaction Management Foundation 492

16.7 The Future of IT in the Supply Chain 492

16.8 Risk Management in IT 493

16.9 Supply Chain IT in Practice 494

16.10 Summary of Learning Objectives 495

Discussion Questions 496

Bibliography 496

CHAPTER 17 Coordination in a Supply Chain 497

17.1 Lack of Supply Chain Coordination and the Bullwhip Effect 497

17.2 The Effect on Performance of Lack of Coordination 499

17.3 Obstacles to Coordination in a Supply Chain 501

17.4 Managerial Levers to Achieve Coordination 506

17.5 Building Strategic Partnerships and Trust Within a Supply Chain 511

17.6 Continuous Replenishment and Vendor-Managed Inventories 518

17.7 Collaborative Planning, Forecasting, and Replenishment (CPFR) 519

17.8 The Role of IT in Coordination 523

17.9 Achieving Coordination in Practice 523

17.10 Summary of Learning Objectives 525

Discussion Questions 526

Bibliography 526

Name Index 528

Subjectlndex 530

PREFACE

~

This book is targeted toward an academic as well as a practitioner audience. On the

academic side, it should be appropriate for MBA students, engineering master's stu￾dents, and senior undergraduate students interested in supply chain management and

logistics. It should also serve as a suitable reference for both concepts as well as

methodology for practitioners in consulting and industry.

The book has grown from a course on supply chain management taught to second￾year MBA students at the Kellogg School of Management at Northwestern

University. The goal of this class was to cover not only high-level supply chain strat￾egy and concepts, but also to give students a solid understanding of the analytical

tools necessary to solve supply chain problems. With this class goal in mind, our objec￾tive was to create a book that would develop an understanding of the following key

areas and their interrelationships:

• The strategic role of a supply chain

• The key strategic drivers of supply chain performance

• Analytic methodologies for supply chain analysis

Our first objective in this book is for the reader to learn the strategic importance of

good supply chain design, planning, and operation for every firm. The reader will be

able to understand how good supply chain management can be a competitive advan￾tage, whereas weaknesses in the supply chain can hurt the performance of a firm. We

use many examples to illustrate this idea and develop a framework for supply chain

strategy.

Within the strategic framework, we identify facilities, inventory, transportation,

information, sourcing, and pricing as the key drivers of supply chain performance.

Our second goal in the book is to convey how these drivers may be used on a con￾ceptual and practical level during supply chain design, planning, and operation to

improve performance. We have included a case on Seven-Eleven Japan that can be

used to illustrate how the company uses various drivers to improve supply chain

performance. For each driver of supply chain performance, our goal is to provide

readers with practical managerial levers and concepts that may be used to improve

supply chain performance.

Utilizing these managerial levers requires knowledge of analytic methodologies

for supply chain analysis. Our third goal is to give the reader an understanding of these

methodologies. Every methodological discussion is illustrated with its application in

Excel. In this discussion, we also stress the managerial context in which they are used

and the managerial levers for improvement that they support.

The strategic frameworks and concepts discussed in the book are tied together

through a variety of examples that show how a combination of concepts is needed to

achieve significant increases in performance.

xiii

xiv Preface

CHANGES TO THE THIRD EDITION

The third edition has several changes that we believe significantly improve the book.

• After much thought on how supply chain management has changed and expanded

over the past several years, we have expanded the collection of supply chain drivers

from four to six, with the new additions being the cross-functional drivers of sourc￾ing and pricing. Both sourcing and pricing were covered in the earlier editions, but

we felt that the framework was more complete with each being considered as a

driver. The supply chain drivers are a structure that appears throughout the book,

so making this change-and thus changing much of the structure of the book-is, we

believe, a major improvement. As supply chain management has become more and

more about relationships among different enterprises in the supply chain, we feel it

is only natural to include these two new drivers that encompass significant processes

with both upstream and downstream supply chain partners.

• Along with the expansion of the supply chain drivers comes a fuller treatment of

the two new drivers, sourcing and pricing. The chapters on sourcing and pricing

have increased depth, with particular emphasis on improvement and expansion of

the sourcing chapter. Included in this expansion are new discussions on such

important issues as how to determine whether to perform functions in-house or

to outsource them as well as discussion of the services offered by various types of

logistics providers. This adds a great deal of richness to the discussion of our new

drivers, which we believe is necessary given their importance in the supply chain.

Supply chain metrics are crucial in monitoring a supply chain's performance and in

helping to improve that performance.

• To this end, we have added a significant section to Chapter 3 on supply chain metrics.

Without supply chain metrics, it is very difficult to implement supply chain changes

effectively. With this new material, we hope readers will come away with an under￾standing of what ought to be measured and why it is important to do so. These

metrics show up in the following chapters as we discuss each driver, so the reader

can understand the importance of using the metric and how the metric can be

improved.

In the previous editions, we combined virtually all of our discussion of the use of

information technology into a chapter with that specific focus.

• We still have an IT chapter in this edition, but we have made a significant change

by adding IT-focused sections within individual chapters that address IT issues

specific to the realm on which the particular chapter focuses. We believe this

more integrated view of IT better portrays the importance of IT and its perme￾ation through virtually all supply chain functions.

• Similar to the IT sections within many of the chapters, we have also added sec￾tions in many chapters focused on supply chain risk. In the past, we mentioned

supply chain risk in various discussions, but we believe it is such an important

topic that it deserves more attention than it received. As with the IT sections,

each risk section is focused on risk factors pertaining to the topic on which the

chapter focuses, thus giving readers a more integrated view of all factors affecting

decisions within the area of the chapter topic.

• We have also moved the content from the e-business chapter into other chapters,

most notably into Chapter 4 on distribution networks. As before, we believe this

presents a more integrated view of the supply chain issues one must grapple with

and thus is a worthwhile change.

-~--- ------------·-----·---·-----.--

Preface xv

• Finally, we have added two cases that can be used to discuss the strategic frame￾work as well as supply chain network design.

FOR INSTRUCTORS

For adopters of this edition we have provided the following:

• An instructor Solutions Manual in Word, with solutions spreadsheets provided in

Excel. Each of the end-of-chapter problems has been carefully solved by Srinivas

Talluri of Michigan State University. Where applicable, the Excel and Word solutions

are both provided. These files may be downloaded from http://prenhall.com/irc.

• An Instructor Manual, containing sample syllabi and chapter lecture notes, is

available in Word and may be downloaded from http://www.prenhall.com/irc.

• Power Point Presentation Files for each chapter of the text are available and may

be downloaded from http://www.prenhall.com/irc.

Registration is required before downloading.

ACKNOWLEDGMENTS

There are many people we would like to thank who helped us throughout this process. We

thank the reviewers whose suggestions significantly improved the book, including Daniel

Marrone, SUNY Farmingdale; Jatinder (Jeet) Gupta, University of Alabama, Huntsville;

Srinagesh Gavirneni, Cornell University; Iqbal Ali, University of Massachusetts, Amherst;

Ming Ling Chuang, Western Connecticut State University; Subroto Roy, University

of New Haven; Mehdi Kaighobadi, Florida Atlantic University; Sime Curkovic,

Western Michigan University; Alireza Lari, Fayetteville State University; Bryan Lee,

Missouri Western State College; Richard Germain, University of Louisville; Frenck

Waage, University of Massachusetts, Boston; James Noble, University of Missouri￾Columbia; Effie Stavrulaki, Pennsylvania State University; and James K. Higginson,

University ofWaterloo (Ontario).

We are grateful to the students at the Kellogg School of Management who suffered

through typo-ridden drafts of earlier versions of the book. Specifically, we thank

Christoph Roettelle and Vikas Vats for carefully reviewing several chapters and solv￾ing problems at the end of the chapters in early editions. We thank Srinivas Talluri of

Michigan State University for his tremendous help in preparing the instructor's man￾ual, instructor's solutions manual, and PowerPoint files for the current edition. We

would also like to thank our editors, Mark Pfaltzgraff and Alana Bradley, and the staff

at Prentice Hall, including Melissa Feimer, Production Editor, Debbie Clare, Executive

Marketing Manager, and Barbara Witmer, Editorial Assistant, for their efforts with the

book. Finally, we would like to thank you, our readers, for reading and using this book.

We hope it contributes to all of your efforts to improve the performance of companies

and supply chains throughout the world.

We would be pleased to hear your comments and suggestions for future editions of

this text.

Sunil Chopra

Kellogg School of Management

Northwestern University

Peter Meindl

Stanford University

P A R T I

~

BUILDING A

STRATEGIC FRA~E'W"ORK

TO ANALYZE SUPPLY CHAINS

CHAPTER 1

UNDERSTANDING THE SUPPLY CHAIN

~

CHAPTER 2

SUPPLY CHAIN PERFORMANCE: ACHIEVING

STRATEGIC FIT AND SCOPE

~

CHAPTER 3

SUPPLY CHAIN DRIVERS AND METRICS

The goal of the three chapters in Part I is to provide a strategic framework to analyze

the design, planning, and operational decisions within supply chains. Such a frame￾work helps clarify supply chain goals and identify managerial actions that improve sup￾ply chain performance in terms of the desired goals.

Chapter 1 defines a supply chain and establishes the impact that supply chain deci￾sions have on a firm's performance. A variety of examples are used to illustrate supply

chain decisions, their influence on performance, and their role in a firm's competitive

strategy. Chapter 2 describes the relationship between supply chain strategy and the

competitive strategy of a firm and emphasizes the importance of ensuring that strate￾gic fit exists between the two strategies. The chapter also discusses how expanding the

scope of strategic fit across all functions and stages within the supply chain improves

performance. Chapter 3 describes the major drivers of supply chain performance: facil￾ities, inventory, transportation, information, sourcing, and pricing. Key decisions and

metrics related to each driver are identified and linked to a company's ability to sup￾port its competitive strategy.