Explaining The Basic Concepts Of Supply Chain Management

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Supply chains encompass the companies and the business activities needed to design, make, deliver, and use a product or service. Businesses depend on their supply chains to provide them with what they need to survive and thrive. Every business fits into one or more supply chains and has a role to play in each of them.

The pace of change and the uncertainty about how markets will evolve has made it increasingly important for companies to be aware of the supply chains they participate in and to understand the roles that they play. Those companies that learn how to build and participate in strong supply chains will have a substantial competitive advantage in their markets.

Supply chain management - The definition

The term "supply chain management" arose in the late 1980s and came into widespread use in the 1990s. Prior to that time, businesses used terms such as "logistics" and "operations management" instead. Some definitions of a supply chain are offered below:

A supply chain is the alignment of firms that bring products or services to market.

A supply chain consists of all stages involved, directly or indirectly, in fulfilling a customer request. The supply chain not only includes the manufacturer and suppliers, but also transporters, warehouses, retailers, and customers themselves.

A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers.

If this is what a supply chain is then we can define supply chain management as the things we do to influence the behavior of the supply chain and get the results we want. Some definitions of supply chain management are:

The systemic, strategic coordination of the traditional business functions and the tactics across these business functions within a particular company and across businesses within the supply chain, for the purposes of improving the long-term performance of the individual companies and the supply chain as a whole.

Supply chain management is the coordination of production, inventory, location, and transportation among the participants in a supply chain to achieve the best mix of responsiveness and efficiency for the market being served.

There is a basic pattern to the practice of supply chain management. Each supply chain has its own unique set of market demands and operating challenges and yet the issues remain essentially the same in every case. Companies in any supply chain must make decisions individually and collectively regarding their actions in five areas:

1. Production-What products does the market want? How much of which products should be produced and by when? This activity includes the creation of master production schedules that take into account plant capacities, workload balancing, quality control, and equipment maintenance.

2. Inventory-What inventory should be stocked at each stage in a supply chain? How much inventory should be held as raw materials, semi-finished, or finished goods? The primary purpose of inventory is to act as a buffer against uncertainty in the supply chain. However, holding inventory can be expensive, so what are the optimal inventory levels and reorder points?

3. Location-Where should facilities for production and inventory storage be located? Where are the most cost efficient locations for production and for storage of inventory? Should existing facilities be used or new ones built? Once these decisions are made they determine the possible paths available for product to flow through for delivery to the final consumer.

4. Transportation-How should inventory be moved from one supply chain location to another? Air freight and truck delivery are generally fast and reliable but they are expensive. Shipping by sea or rail is much less expensive but usually involves longer transit times and more uncertainty. This uncertainty must be compensated for by stocking higher levels of inventory. When is it better to use which mode of transportation?

5. Information-How much data should be collected and how much information should be shared? Timely and accurate information holds the promise of better coordination and better decision making. With good information, people can make effective decisions about what to produce and how much, about where to locate inventory and how best to transport it.

The sum of these decisions will define the capabilities and effectiveness of a company's supply chain. The things a company can do and the ways that it can compete in its markets are all very much dependent on the effectiveness of its supply chain.

II - How the supply chain work

The goal or mission of supply chain management can be defined using Mr. Goldratt's words as "Increase throughput while simultaneously reducing both inventory and operating expense." In this definition throughput refers to the rate at which sales to the end customer occur. Depending on the market being served, sales or throughput occurs for different reasons. In some markets customers value and will pay for high levels of service. In other markets customers seek simply the lowest price for an item.

As we saw in the previous section, there are five areas where companies can make decisions that will define their supply chain capabilities: Production; Inventory; Location; Transportation; and Information. Chopra and Meindl define these areas as performance drivers that can be managed to produce the capabilities needed for a given supply chain.

Effective supply chain management calls first for an understanding of each driver and how it operates. Each driver has the ability to directly affect the supply chain and enable certain capabilities. The next step is to develop an appreciation for the results that can be obtained by mixing different combinations of these drivers. Let's start by looking at the drivers individually.

Production

Production refers to the capacity of a supply chain to make and store products. The facilities of production are factories and warehouses. The fundamental decision that managers face when making production decisions is how to resolve the trade-off between responsiveness and efficiency. If factories and warehouses are built with a lot of excess capacity, they can be very flexible and respond quickly to wide swings in product demand. Facilities where all or almost all capacity is being used are not capable of responding easily to fluctuations in demand. On the other hand, capacity costs money and excess capacity is idle capacity not in use and not generating revenue. So the more excess capacity that exists, the less efficient the operation becomes.

Factories can be built to accommodate one of two approaches to manufacturing:

1. Product focus-A factory that takes a product focus performs the range of different operations required to make a given product line from fabrication of different product parts to assembly of these parts.

2. Functional focus-A functional approach concentrates on performing just a few operations such as only making a select group of parts or only doing assembly. These functions can be applied to making many different kinds of products.

A product approach tends to result in developing expertise about a given set of products at the expense of expertise about any particular function. A functional approach results in expertise about particular functions instead of expertise in a given product. Companies need to decide which approach or what mix of these two approaches will give them the capability and expertise they need to best respond to customer demands.

As with factories, warehouses too can be built to accommodate different approaches. There are three main approaches to use in warehousing:

1. Stock keeping unit (SKU) storage-In this traditional approach, all of a given type of product is stored together. This is an efficient and easy to understand way to store products.

2. Job lot storage-In this approach, all the different products related to the needs of a certain type of customer or related to the needs of a particular job are stored together. This allows for an efficient picking and packing operation but usually requires more storage space than the traditional SKU storage approach.

3. Crossdocking-An approach that was pioneered by Wal-Mart in its drive to increase efficiencies in its supply chain. In this approach, product is not actually warehoused in the facility. Instead the facility is used to house a process where trucks from suppliers arrive and unload large quantities of different products. These large lots are then broken down into smaller lots. Smaller lots of different products are recombined according to the needs of the day and quickly loaded onto outbound trucks that deliver the products to their final destination.

Inventory

Inventory is spread throughout the supply chain and includes everything from raw material to work in process to finished goods that are held by the manufacturers, distributors, and retailers in a supply chain. Again, managers must decide where they want to position themselves in the trade-off between responsiveness and efficiency. Holding large amounts of inventory allows a company or an entire supply chain to be very responsive to fluctuations in customer demand. However, the creation and storage of inventory is a cost and to achieve high levels of efficiency, the cost of inventory should be kept as low as possible.

There are three basic decisions to make regarding the creation and holding of inventory:

1. Cycle Inventory-This is the amount of inventory needed to satisfy demand for the product in the period between purchases of the product. Companies tend to produce and to purchase in large lots in order to gain the advantages that economies of scale can bring. However, with large lots also comes an increased carrying cost. Carrying costs come from the cost to store, handle, and insure the inventory. Managers face the trade-off between the reduced cost of ordering and better prices offered by purchasing product in large lots and the increased carrying cost of the cycle inventory that comes with purchasing in large lots.

2. Safety Inventory-Inventory that is held as a buffer against uncertainty. If demand forecasting could be done with perfect accuracy, then the only inventory that would be needed would be cycle inventory. But since every forecast has some degree of uncertainty in it, we cover that uncertainty to a greater or lesser degree by holding additional inventory in case demand is suddenly greater than anticipated. The trade-off here is to weigh the costs of carrying extra inventory against the costs of losing sales due to insufficient inventory.

3. Seasonal Inventory-This is inventory that is built up in anticipation of predictable increases in demand that occur at certain times of the year. For example, it is predictable that demand for anti-freeze will increase in the winter. If a company that makes anti-freeze has a fixed production rate that is expensive to change, then it will try to manufacture product at a steady rate all year long and build up inventory during periods of low demand to cover for periods of high demand that will exceed its production rate. The alternative to building up seasonal inventory is to invest in flexible manufacturing facilities that can quickly change their rate of production of different products to respond to increases in demand. In this case, the trade-off is between the cost of carrying seasonal inventory and the cost of having more flexible production capabilities.

Location

Location refers to the geographical sitting of supply chain facilities. It also includes the decisions related to which activities should be performed in each facility. The responsiveness versus efficiency trade-off here is the decision whether to centralize activities in fewer locations to gain economies of scale and efficiency, or to decentralize activities in many locations close to customers and suppliers in order for operations to be more responsive.

When making location decisions, managers need to consider a range of factors that relate to a given location including the cost of facilities, the cost of labor, skills available in the workforce, infrastructure conditions, taxes and tariffs, and proximity to suppliers and customers. Location decisions tend to be very strategic decisions because they commit large amounts of money to long-term plans.

Location decisions have strong impacts on the cost and performance characteristics of a supply chain. Once the size, number, and location of facilities is determined, that also defines the number of possible paths through which products can flow on the way to the final customer. Location decisions reflect a company's basic strategy for building and delivering its products to market.

Transportation

This refers to the movement of everything from raw material to finished goods between different facilities in a supply chain. In transportation the trade-off between responsiveness and efficiency is manifested in the choice of transport mode. Fast modes of transport such as airplanes are very responsive but also more costly. Slower modes such as ship and rail are very cost efficient but not as responsive. Since transportation costs can be as much as a third of the operating cost of a supply chain, decisions made here are very important.

There are six basic modes of transport that a company can choose from:

1. Ship which is very cost efficient but also the slowest mode of transport. It is limited to use between locations that are situated next to navigable waterways and facilities such as harbors and canals.

2. Rail which is also very cost efficient but can be slow. This mode is also restricted to use between locations that are served by rail lines.

3. Pipelines can be very efficient but are restricted to commodities that are liquids or gases such as water, oil, and natural gas.

4. Trucks are a relatively quick and very flexible mode of transport. Trucks can go almost anywhere. The cost of this mode is prone to fluctuations though, as the cost of fuel fluctuates and the condition of roads varies.

5. Airplanes are a very fast mode of transport and are very responsive. This is also the most expensive mode and it is somewhat limited by the availability of appropriate airport facilities.

6. Electronic Transport is the fastest mode of transport and it is very flexible and cost efficient. However, it can only be used for movement of certain types of products such as electric energy, data, and products composed of data such as music, pictures, and text. Someday technology that allows us to convert matter to energy and back to matter again may completely rewrite the theory and practice of supply chain management ("beam me up, Scotty. . .").

Given these different modes of transportation and the location of the facilities in a supply chain, managers need to design routes and networks for moving products.

Information

Information is the basis upon which to make decisions regarding the other four supply chain drivers. It is the connection between all of the activities and operations in a supply chain. To the extent that this connection is a strong one, (i.e., the data is accurate, timely, and complete), the companies in a supply chain will each be able to make good decisions for their own operations. This will also tend to maximize the profitability of the supply chain as a whole. That is the ways that stock markets or other free markets work and supply chains have many of the same dynamics as markets.

Information is used for two purposes in any supply chain:

1. Coordinating daily activities related to the functioning of the other four supply chain drivers: production; inventory; location; and transportation. The companies in a supply chain use available data on product supply and demand to decide on weekly production schedules, inventory levels, transportation routes, and stocking locations.

2. Forecasting and planning to anticipate and meet future demands. Available information is used to make tactical forecasts to guide the setting of monthly and quarterly production schedules and timetables. Information is also used for strategic forecasts to guide decisions about whether to build new facilities, enter a new market, or exit an existing market.

Within the supply chain as a whole, the responsiveness versus efficiency trade-off that companies make is one of deciding how much information to share with the other companies and how much information to keep private. The more information about product supply, customer demand, market forecasts, and production schedules that companies share with each other, the more responsive everyone can be. Balancing this openness however, are the concerns that each company has about revealing information that could be used against it by a competitor. The potential costs associated with increased competition can hurt the profitability of a company.

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