ACHIEVING SUPPLY CHAIN COLLABORATION USING THEORY OF CONSTRAINTS

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To maximise the profits earned from the entire supply chain, it is necessary that all the participating members of the supply chain work together. The benefits received from such collaboration are far more than what would be received if each member worked to maximise its own profit. This synergistic behaviour though is not generally seen in today's world due to the dilemma of individual profits versus global profits. This research paper attempted to apply the Theory of Constraints philosophy to overcome this dilemma and recommended the use of Constraint-based Approach, Collaborative Replenishment Policy and Collaborative Performance Metrics.

TABLE OF CONTENTS

Page

TITLE PAGE

i

ACKNOWLEDGEMENTS

ii

ABSTRACT

iii

TABLE OF CONTENTS

iv

LIST OF FIGURES

v

CHAPTER I: INTRODUCTION

1

CHAPTER II: REVIEW OF LITERATURE

2

CHAPTER III: METHODOLOGY

6

CHAPTER IV: ANALYSIS

9

CHAPTER V: CONCLUSION

15

REFERENCES

16

LIST OF FIGURES

Figure 1

The Supply Chain

Page 2

Figure 2

Supply Chain Management

Page 3

Figure 3

Supply Chain Collaboration Dilemma

Page 6

Figure 4

Collaborative Replenishment Policy at different points in Supply Chain

Page 12

Figure 5

Collaborative Performance Metrics

Page 13

INTRODUCTION

Supply chain collaboration can be defined as two or more independent firms jointly working to align their supply chain processes so as to create value to end customers and stakeholders with greater success than acting alone. In today's world, such supply chain collaboration is often seen and one of the reasons or this is the dilemma that exists in the minds of the participating members. Collaboration is necessary to achieve the goals of the supply chain.

This study was conducted to find out the reasons for the non-collaboration between the participating members. The significance of this study can be seen from the fact that most of the today's top performing companies have reached that level through excellent supply chain management. Companies such as Wal-Mart, UPS, etc. owe their success to efficient supply chain management.

In this paper, secondary data has been used to find out the reasons behind the non-collaboration. The Theory of Constraints philosophy and the thinking process along with the Constraint-based approach is then used to suggest ways to overcome the dilemma. Two techniques namely the Collaborative Replenishment Policy and Collaborative Performance Metrics based on the Theory of Constraints have been suggested to improve collaboration and achieve the goal of the supply chain.

REVIEW OF LITERATURE

Supply Chain:

A supply chain is a network of storage facilities and distribution centres that performs the functions of procuring or purchasing raw materials, transforming these materials into parts, components and finished goods, and distributing these parts, components or finished goods to other businesses or customers. Supply chains exist in both manufacturing and service organisations. The complexity of the supply chain generally varies to a great extent depending upon the type of industry or firm.

Figure1: The Supply Chain

Supply Chain Management:

Supply Chain Management (SCM) is the management of a network of inter-connected or inter-related businesses that are involved in providing products and services required by end customers. SCM covers all storage and movement of raw materials, work-in-process (WIP) inventory, and finished goods from point of origin to point of consumption. SCM can also be defined as the designing, planning, executing, controlling, and monitoring of all the activities in a supply chain.

Supply Chain Management emphasizes the integration of information flows and activities that enables the firm to increase value for the customer. SCM is typically viewed to fall between completely vertically-integrated firms, where the complete flow of material is owned by a single firm and those where each and every member of the channel is an independent entity that operates in isolation. Hence coordination between the various players or firms in the chain is the key to its effective management.

Supply chain management is a cross-functional approach that includes managing the supply of raw materials or parts from suppliers to the organisation, some aspects of the material-handling and the movement of end products from the organization to other businesses or customers. The focus of organisations is to become more flexible and concentrate on their core competencies. This is achieved by reducing their ownership of network and distribution channels. These functions are now being increasingly outsourced to other firms or entities that can perform the activities more cost effectively or better than the firm itself. This results in reducing management control of day-to-day logistics operations but at the same time increasing the number of entities involved in satisfying customer demand. More supply chain partners and less control has led to the creation of new supply chain management concepts. The objective of supply chain management is to improve coordination and mutual understanding among supply chain entities thereby improving the speed of inventory movement between various stages and allowing for inventory tracking.

Supply Chain Management software  commonly includes Supplier Management/Sourcing, Inventory Management, Purchase Order Processing, Customer requirement processing, Goods Receipt and Warehouse Management.

Figure 2: Supply Chain Management

Theory of Constraints:

The Theory of Constraints (TOC) was coined by Eliyahu M. Goldratt in the 1980s. The theory focuses on initiating and implementing breakthrough improvement by focusing on a constraint that prevents a system from achieving higher level of performance. The TOC is a management philosophy which essentially states that every organisation must have at least one constraint. A constraint is any element or factor inside or outside the system that limits the system from doing more of what it was designed to accomplish (i.e. achieving its goal). The goal of any system needs to be established by those owning and running the system. The goal of any business entity is to make money in present and in the future. The TOC thus encourages managers to identify what is preventing the system from moving towards its goals as well as necessary conditions for the same and find solutions to overcome this limitation.

The TOC comprises a set of three separate but interrelated areas - logistics, performance measurement, and logical thinking. The TOC applications to logistics include the drum-buffer-rope scheduling method and buffer management Performance measurements are necessary to determine whether the system is accomplishing its goal of making money or not. Performance measurement includes operating measures and local performance measures. Logical thinking comprises the five-step-focusing process and the thinking process.

This five step thinking process of TOC is as follows-

IDENTIFY the system's constraint(s)

Decide how to EXPLOIT the system's constraint(s)

SUBORDINATE everything else to the above decision

ELEVATE the system's constraint(s)

If in a previous step a constraint has been broken, go back to step 1, but do not allow INERTIA to cause a system's constraint

The Theory of Constraints was initially considered only as means to solve problems in production systems and its use in other areas was not known. Methods such as the constraint focused performance measurement, buffer management and the drum-buffer-rope scheduling were used to eliminate constraints in production systems. TOC was developed further and applied to other areas of business such as project management, marketing and sales and supply chain management. A large number of articles, books, research papers have been published on the Theory of Constraints in the last two decades. Problems in manufacturing, healthcare as well as service organisations have been addressed as well as those in core public services.

Many firms nowadays adopt the TOC approach to guide the improvement initiatives to leverage their supply chain performance. Firms are now going beyond their internal business processes to gain a competitive advantage. Existing literature on TOC supply chain solutions deals mainly with managing the supply chain from a single enterprise perspective. The TOC approach can be used to guide a single firm to concentrate on exploiting resources based on different logistics cost along the supply chain.

Little attention has been given to dealing with managing supply chain collaboration composed of independent firms. Exceptionally, few researchers have appeared to conceptualise the TOC approach to the supply chain with independent members. The TOC thinking process can be used to identify problems in the supply chain of an organisation and managers from different firms participating in the supply chain have to be brought together to cooperate in improving the overall supply chain profit. Stein in 1997 proposed a conceptual model of locating the time buffer at different positions of participating members to protect actual sales from demand and supply uncertainty. Performance measures have been conceptualised by Goldratt to maintain trust amongst the participating members.

This research paper follows up the previous two decades of research by explaining how the supply chain participating members can benefit from applying the TOC philosophy to supply chain collaboration and using this philosophy to devise strategies to improve the supply chain performance as a whole thus gaining a competitive advantage.

METHODOLGY

Dilemma of supply chain collaboration:

Based on secondary data sources, it was observed that, a dilemma exists between supply chain members when they get into collaboration. There is a conflict between taking decisions that benefit an individual firm and decisions that benefit the entire supply chain i.e. all the members in the supply chain. This dilemma of supply chain collaboration is as shown in the figure 3 below.

Figure 3: Supply Chain Collaboration Dilemma

As can be seen from the figure, if the members have to maximise the benefits of collaboration, then they must maximise the revenue of the entire supply chain from sales to end customers and also protect the profitability of individual members. In order to maximise the revenue of the entire supply chain from sales to end customers, the members must take decisions based on supply chain-wide performance measures. It is assumed that if the chain members put in maximum efforts, only then the revenue can be maximised. In order to protect the individual profitability of the chain members, they must take decisions tied to link-centric-performance measures. It is assumes that chain members are in direct control of their individual parts of the supply chain and there is lack of linkage between link-centric performance measures and supply chain-wide performance measures.

Hence, we can see from the figure 3 that there is direct conflict between taking decisions in the interest of the supply chain as a whole and taking decisions in the interests of the individual participating members.

Frequently, individual members have a tendency to make decisions that are in their own interests and not in the interests on the supply chain as a whole. These chain members often think that supply chain collaboration means a decrease in bargaining power to minimise costs. Due to this, they think that if they minimise the cost of the supply chain linkage, the cost of the entire supply chain will come down. Hence, it will improve its performance. Due to this, these individual members focus on maximising revenues from immediate buyers and minimising costs from immediate sellers. What they actually should do is maximise the revenues and minimise costs of the entire supply chain. An inventory transaction that takes place among the partners is assumed to be sale even before the product is "bought" by the final consumer. This leads to every member taking decisions that maximise only its own performance. As a result, the individual members tend to think in terms of organisational boundaries, rather than considering the supply chain as a whole. Each firm maximises individual revenue but ignores the effect of its actions on other linkages of the supply chain. Hence, in many cases the maximisation of an individual performance occurs at the expense of the performance of the entire supply chain and hence true maximisation is often not achieved. This can be basically termed as focus on local maximisation in place of global maximisation.

The traditional approach to addressing the dilemma of collaboration remains focusing on cost minimisation at each link of the supply chain. In this approach, every member saves costs to the maximum extent possible which is usually at the expense of other chain members. It was found that buyers with higher bargaining power often require their suppliers to carry out improvement initiatives such as time compression, inventory reduction, and bar coding. As a result, decisions apparently bring gains to individual members but have a devastating impact by lowering the overall supply chain profit.

The way to resolve the dilemma is to dissolve the conflict in figure 3. This means that focus should be ion global benefit instead of on local benefits. What needs to be done for this is a new replenishment policy has to be made that benefits all members. Secondly, the performance measurement system has to be changed so that global performance metrics would be used to make local decisions. The strength of a chain is determined by the weakest link in the chain. Hence, strengthening some links of the chain individually will not strengthen the chain if the weakest link is ignored. The need is to strengthen the weakest link (constraint) using the TOC way.

ANALYSIS

The Constraint-based Approach:

The constraint-based approach is an approach which removes the impact of local profit maximisation on the overall profitability of the supply chain. In this approach, the constraint(s) of the system have to be identified as per the five-step TOC thinking process. This approach can directly be useful in maximising profitability of the entire supply chain. This approach can help organisations by providing good and accurate performance metrics to measure to help measure the performance of supply chain. It will also help in focusing on areas and improvement of those areas that directly impact the supply chain performance.

The constraint-based approach for improving supply chain collaboration necessitates the view of the supply chain as a system in itself. The goal of this system as of any other is to make money. So, to measure this system's performance, the three measurement parameters that Goldratt defined, namely, throughput, inventory and investment are to be used.

Goldratt defined Throughput (T) as the rate at which the system (here, supply chain) generates money through sales. This will include the revenue generated by the supply chain from sale to end-consumer. The truly variable cost for generating the sale will have to be subtracted from the revenue to get the throughput. For many supply chains, truly variable costs include the material costs, sales commissions, markdowns, consumable supplies, and so on.

Goldratt defined Investment (I) as all the money the system (here, supply chain) invests in things it intends to sell. The larger portion of this investment for a supply chain is raw materials or purchased parts. This definition excludes the added value of labour and overheads. In a supply chain, investment comes in three forms: raw materials, finished products not as yet sold, and things somewhere in between (work-in-process).

Goldratt defined Operating Expense (OE) as all the money the system (here, supply chain) spends in turning its investment into throughput. This includes direct labour and overheads and other fixed expenses that would be incurred even if it never produced a single product.

The supply chain participants should prioritise increasing throughput and then focus on reducing inventory and the operating expenses. The performance measurements of the constraint based approach focus on global metrics than on local metrics.

The constraint for a profit making supply chain is whatever stops or prevents the supply chain from generating more profits. Constraints obviously exist otherwise supply chains would be making infinite profits. Hence, the focus of the supply chain participating members should be on these constraints. Only this will help to overcome the aforementioned dilemma.

One important thing is that all the participants should have a consensus about the identified constraint that is preventing the chain from making more profits. Improvement can be done only after this consensus is achieved. Constraints can either be physical or policy constraints and can be within or outside the supply chain. Physical constraints include demand, resources etc whereas policy constraints means inefficient management policies, decision making guidelines etc. Constraints within the chain are insufficient resources etc. whereas those outside the chain are market conditions. The various constraints are often interdependent and are created when the system is established, when its goals are set and when it is operational.

The policies and the performance parameters need to be changed with time though that's seldom the case. Such outdated policies and practices hamper the profitability of the supply chain. Use of such outdated policies and practices is often the result of people's resistance to change. It is the result of the human thinking that such outdated policies continue to be used and these policy constraints usually give rise to physical constraints.

Using the five-step thinking process, a firm has to decide the goal of the entire supply chain and identify the constraint. This constraint maybe within or outside the supply chain and may be physical or policy constraint. Once the constraint is identified, the constraint has to be exploited. This means not wasting the constraint and it generally needs proper scheduling. The entire supply chain should work together and subordinate all resources to the above constraint. Only then can the constraint be eliminated. Once the constraint is eliminated, it results in increased profitability. This however would give rise to yet another constraint and the procedure is followed again. As can be seen, it is a continuous process focused on maximising profitability. The improvement initiatives of the supply chain members would improve the cash flow, net profit and return on investment.

Collaborative Replenishment Policy:

Information technology can be used to aid the increase in profitability. This can be done by matching the demand and supply at different points in the supply chain. In cases where the supply chain makes made-to-stock products, the constraint is the end customers that purchase the products from the retailers. To exploit this constraint, it is necessary that retailer provided information to its suppliers. The retailer thus needs to be authorised to make decisions that improve the profitability of the entire supply chain. This requires the collaboration of the retailer and supplier wherein the retailer takes decisions on how much to stock and the supplier guarantees on time delivery of required quantity. This would help to increase the responsiveness of the supply chain and hence increase its profitability.

The retailer has a major role to play in this collaboration. Analysis of the demand in the market is necessary. This involves study of consumer behaviour, market segmentation, payment terms etc. The supply has to be matched with demand. Accurate forecasting techniques are necessary for this and the information flows up the supply chain from retailer to distributor to manufacturer to his supplier and so on.

The idea behind this collaborative replenishment policy is that the supplier's products should replenish the products sold by the retailers. So replenishment takes place after stock from retailers has been cleared and there is no dumping of stocks on the retailer. Some buffer stock would be there at the retailer's end to protect against market uncertainties.

The Collaborative Replenishment Policy at different points in the supply chain is as shown in figure 4. It shows the flow of the product and information through the supply chain and the location of stocks and buffers in the supply chain. This can be compared to the analogy of water supply in a city. In the water supply network in the city, water is stored at various points in the supply network. This water flows to the next storage area when the consumer consumes water from a tap in his or her house. The delivery of water in this case is on-time, demand fluctuations can be handled and costs are minimum.

Figure 4: Collaborative Replenishment Policy at different points in Supply Chain

The amount of buffer goes up the supply chain as least buffer stock is kept at the retailer and most is kept at the producer. The later the storage of buffer in the supply chain, the more the costs involved. This is also, to a certain extent, an outcome of the Bullwhip effect. Buffer management has to be used to keep correct quantities of buffer and at proper locations in the supply chain. The size of the buffer depends on the consumption pattern in the market and the market uncertainties. Techniques such as the two-bin system may be used to signal replenishment of stocks up the supply chain. Use of tags is also suggested to signal inventory levels and the quantity required to be replenished and the time when it needs to be replenished. Lead times have to be taken into account when such replenishment policies are made. Just-in-time, however good it sounds, is not feasible in practice.

When a distributor has to deal with a number of retailers, proper combination of the products should be done to combine deliveries to different retailers and hence drive down transportation costs.

Supply Chain Performance Metrics:

The success of the Supply Chain Collaborative Replenishment Policy depends upon the trust between the different supply chain members. Collaboration will work as long as the different partners in the chain trust each other. Supply chain performance metrics can be used to guide the various members of the collaboration. The metrics will give each member an idea about the performance of every other member in the chain and how their own performance is affecting the overall performance of the chain. Thus, the collaborative performance metrics consist of parameters that evaluate the performance of individual members of the supply chain as compared to the overall performance of the supply chain.

Figure 5: Collaborative Performance Metrics

Figure 5 shows the collaborative performance metrics. These metrics would be used to evaluate the movement of a supply chain towards its goal of making money. The various supply chain members have to monitor the current global metrics like ROI, net profit, cash flows and based on this project the future metrics that the chain wishes to achieve through its operation. This requires formation of common strategic objectives for all members of the supply chain that will ensure that the goal is achieved. The individual performance metrics ensure the performance of the whole chain and this is represented in the figure 5. The individual performance metrics for the members includes the aforementioned throughput, inventory and the local operating expenses as defined in the Theory of Constraints philosophy by Goldratt. These individual performance metrics allow for the evaluation of performance of individual members of the chain in comparison to the global performance. These metrics are also designed to force the individual members to perform better. As we have already seen, apart from the local operating expenses, the rest two parameters depend upon the rest of the chain. So, it is the duty of every member to reduce the operating expenses without reducing the global throughput. This means that a certain amount of throughput has to be created at not more than the specified level of inventory and operating expense.

Various other metrics also support the individual performance metrics. These supporting metrics may not always be tangible and quantifiable. Constraint and buffer metrics are such supporting metrics. Monitoring of customer needs is also an important parameter and so is the satisfaction of customer needs. The profitability of the supply chain depends on whether the end consumer is satisfied or not.

Hence, the Collaborative Performance Metrics allow each member to evaluate the performance of every other member and the whole supply chain and to be evaluated by other members of the supply chain.

CONCLUSION

This paper provides a way to improve collaboration between the different participating members of a supply chain. The inherent dilemma in of the participating members, as seen above, needs to be broken in order to achieve maximum profitability. The participating members must be able to unanimously identify and exploit the constraints in the supply chain to ensure profitability. Constraints, especially the policy constraints need to be dealt with immediately.

The proposed Collaborative Replenishment Policy aims at matching the demand and supply to accomplish fulfilment of consumer needs and hence ensure customer satisfaction at minimum cost and in minimum time. The proposed Collaborative Performance Metrics helps the participating members in assessing and being assessed by other participating members.

The Theory of Constraints philosophy and the Thinking Process thus helps the supply chain in achieving its goals by suggesting ways to improve collaboration between the participating members.

This paper leaves the scope for research into other ways of improving supply chain profitability and integrating forward and reverse logistics to make much more efficient utilisation of the supply chain.

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