Managerial Levers to Achieve Coordination in a Supply Chain

Having identified obstacles to coordination, we now focus on actions a manager can take to help overcome the obstacles and achieve coordination in the supply chain. The following managerial actions increase total supply chain profits and moderate information distortion:

• Aligning goals and incentives
• Improving information visibility and accuracy
• Improving operational performance
• Designing pricing strategies to stabilize orders
• Building strategic partnerships and trust

1. Aligning Goals and Incentives

Managers can improve coordination within the supply chain by aligning goals and incentives so every participant in supply chain activities works to maximize total supply chain profits.

Aligning goals across the supply chain Coordination requires every stage of the sup­ply chain to focus on the supply chain surplus or the total size of the pie rather than just its indi­vidual share. A key to coordination is coming up with mechanisms that allow the creation of a win-win scenario in which the supply chain surplus grows along with the profits for all supply chain stages. An example of such a mechanism occurs when Walmart pays Hewlett-Packard (HP) for each printer sold and gives HP the power to make replenishment decisions while limit­ing the amount of printer inventory that can be held at a store. This setup improves coordination because both parties gain if the supply of printers at a store matches demand.

ALIGNING incentives across functions One key to coordinated decisions within a firm is to ensure that the objective any function uses to evaluate a decision is aligned with the firm’s overall objective. All facility, transportation, and inventory decisions should be evaluated based on their effect on profitability or total costs, not functional costs. This helps prevent situations such as a transportation manager making decisions that lower transportation cost but increase overall supply chain costs (see Chapter 14).

PRICING for coordination In many instances, suitable pricing schemes can help coordi­nate the supply chain. A manufacturer can use lot-size-based quantity discounts to achieve coor­dination for commodity products if the manufacturer has large fixed costs associated with each lot (see Chapter 11 for a detailed discussion). For products for which a firm has market power, a manufacturer can use two-part tariffs and volume discounts to help achieve coordination (see Chapter 11 for a detailed discussion). Given demand uncertainty, manufacturers can use buy­back, revenue-sharing, and quantity flexibility contracts to spur retailers to provide levels of product availability that maximize total supply chain profits (see Chapter 15 for a detailed dis­cussion). Buyback contracts have been used in the publishing industry to increase total supply chain profits. Quantity flexibility contracts have helped Benetton increase supply chain profits.

ALTERING SALES FORCE INCENTIVES FROM SELL-IN TO SELL-THROUGH Any change that reduces the incentive for a salesperson to push product to the retailer reduces the bullwhip effect. Manufacturers should link incentives for the sales staff to sell-through by the retailer rather than sell-in to the retailer. This action eliminates any motivation the sales staff may have to encourage forward buying. Elimination of forward buying helps reduce fluctuations in the order stream. If sales force incentives are based on sales over a rolling horizon, the incentive to push product is further reduced. This helps reduce forward buying and the resulting fluctuation in orders.

2. Improving information Visibility and Accuracy

Managers can achieve coordination by improving the visibility and accuracy of information available to different stages in the supply chain.

SHARING customer demand data Sharing customer demand data across the supply chain can help reduce the bullwhip effect. A primary cause for information distortion is the fact that each stage of the supply chain uses orders to forecast future demand. Given that orders received by different stages vary, forecasts at different stages also vary. In reality, the only demand that the supply chain needs to satisfy is that from the final customer. If retailers share demand data with other supply chain stages, all stages can forecast future demand based on customer demand. Sharing of demand data helps reduce information distortion because all stages now respond to the same change in customer demand. Observe that sharing aggregate demand data is sufficient to dampen information distortion. It is not necessary to share detailed point-of-sale (POS) data. Use of appropriate information systems facilitates the sharing of such data.

Walmart has routinely shared its POS data with its suppliers. Dell shares demand data as well as current inventory positions of components with many of its suppliers via the Internet, thereby helping avoid unnecessary fluctuations in supply and orders placed. P&G has convinced many retailers to share demand data. P&G, in turn, shares the data with its suppliers, improving coordination in the supply chain.

Implementing collaborative forecasting andplanning Once customer demand data are shared, different stages of the supply chain must forecast and plan jointly if complete coordination is to be achieved. Without collaborative planning, sharing of demand data does not guarantee coordination. A retailer may have observed large demand in the month of January because it ran a promotion. If no promotion is planned in the upcoming January, the retailer’s forecast will differ from the manufacturer’s forecast even if both have past POS data. The manu­facturer must be aware of the retailer’s promotion plans to achieve coordination. The key is to ensure that the entire supply chain is operating with a common forecast. To facilitate this type of coordination in the supply chain environment, the Voluntary Interindustry Commerce Standards (VICS) Association set up a Collaborative Planning, Forecasting, and Replenishment (CPFR) Committee that identified best practices and design guidelines for collaborative planning and forecasting. These practices are detailed later in the chapter.

Designing single-stage control of replenishment Designing a supply chain in which a single stage controls replenishment decisions for the entire supply chain can help dimin­ish information distortion. As we mentioned earlier, a key cause of information distortion is that each stage of the supply chain uses orders from the previous stage as its historical demand. As a result, each stage views its role as one of replenishing orders placed by the next stage. In reality, the key replenishment is at the retailer, because that is where the final customer purchases. When a single stage controls replenishment decisions for the entire chain, the problem of multiple fore­casts is eliminated and coordination within the supply chain follows.

Several industry practices, such as continuous replenishment programs (CRPs) and vendor- managed inventories (VMIs) detailed later in the chapter, provide a single-point control over replenishment. Walmart typically assigns one of its suppliers as a leader for each major product category to manage store-level replenishment. This gives suppliers visibility into sales and a single decision maker for replenishment decisions.

3. Improving Operational Performance

Managers can help dampen information distortion by improving operational performance and designing appropriate product rationing schemes in case of shortages.

REDUCING REPLENISHMENT LEAD TIME By reducing the replenishment lead time, managers can decrease the uncertainty of demand during the lead time (see Chapter 12). A reduction in lead time is especially beneficial for seasonal items because it allows for multiple orders to be placed with a significant increase in the accuracy of the forecast (see Chapter 13). If lead times are short enough, replenishment can be scheduled to actual consumption, thus eliminating the need for a forecast.

Managers can take a variety of actions at different stages of the supply chain to help reduce replenishment lead times. Ordering electronically, either online or through electronic data inter­change (EDI), can significantly cut the lead time associated with order placement and informa­tion transfer. If every stage shares its long-term plans with suppliers, potential orders can be scheduled into production well in advance, with the precise quantity being determined closer to actual production. This reduces the scheduling time, which is often the largest component of lead time. At manufacturing plants, increased flexibility and cellular manufacturing can be used to achieve a significant reduction in lead times. A dampening of information distortion further reduces lead times because of stabilized demand and, as a result, improved scheduling. This is particularly true when manufacturing produces a large variety of products. Advance shipping notices (ASNs) can be used to reduce the lead time as well as efforts associated with receiving. Cross-docking can be used to reduce the lead time associated with moving the product between stages in the supply chain. Walmart has used many of these approaches to significantly reduce lead time within its supply chain.

REDUCING LOT SIZES Managers can reduce information distortion by implementing opera­tional improvements that reduce lot sizes. A reduction of lot sizes decreases the amount of fluc­tuation that can accumulate between any pair of stages of a supply chain, thus decreasing distortion. To reduce lot sizes, managers must take actions that help reduce the fixed costs associ­ated with ordering, transporting, and receiving each lot (see Chapter 11). Walmart and Seven- Eleven Japan have been very successful at reducing replenishment lot sizes by aggregating deliveries across many products and suppliers.

Computer-assisted ordering (CAO) refers to the substitution through technology of the functions of a retail order clerk through the use of computers that integrate information about product sales, market factors affecting demand, inventory levels, product receipts, and desired service levels. CAO and EDI help reduce the fixed costs associated with placing each order.

In some cases, managers can simplify ordering by eliminating the use of purchase orders. In the auto industry, some suppliers are paid based on the number of cars produced, eliminating the need for individual purchase orders. This eliminates the order-processing cost associated with each replenishment order. Information systems also facilitate the settlement of financial transactions, eliminating the cost associated with individual purchase orders.

The large gap in the prices of truckload (TL) and less-than-truckload (LTL) shipping encourages shipment in TL quantities. In fact, with the efforts to reduce order-processing costs, transportation costs are now the major barrier to smaller lots in most supply chains. Managers can reduce lot sizes without increasing transportation costs by filling a truck using smaller lots from a variety of products (see Chapter 11). P&G, for example, requires all orders from retailers to be a full TL. The TL, however, may be built from any combination of products. A retailer can thus order small lots of each product as long as a sufficiently large variety of products are included on each truck. Seven-Eleven Japan has used this strategy with combined trucks, in which the separation is by the temperature at which the truck is maintained. All products to be shipped at a particular temperature are on the same truck. This has allowed Seven-Eleven Japan to reduce the number of trucks sent to retail outlets while keeping product variety high. Some firms in the grocery industry use trucks with different compartments, each at a different tempera­ture and carrying a variety of products, to help reduce lot sizes.

Managers can also reduce lot sizes by using milk runs that combine shipments for several retailers on a single truck, as discussed in Chapter 14. In many cases, third-party transporters combine shipments to competing retail outlets on a single truck. This reduces the fixed transpor­tation cost per retailer and allows each retailer to order in smaller lots. In Japan, Toyota uses a single truck from a supplier to supply multiple assembly plants, which enables managers to reduce the lot size received by any one plant. Managers can also reduce lot sizes by combining shipments from multiple suppliers on a single truck. In the United States, Toyota uses this approach to reduce the lot size it receives from any one supplier.

As smaller lots are ordered and delivered, both the pressure on and the cost of receiving can grow significantly. Thus, managers must implement technologies that simplify the receiving process and reduce the cost associated with receiving. For example, ASNs identify shipment content, count, and time of delivery electronically and help reduce unloading time and increase cross-dock efficiency. ASNs can be used to update inventory records electronically, thus reduc­ing the cost of receiving. Bar coding of pallets and the use of radio frequency identification (RFID) can further simplify receiving.

Another simple way to minimize the impact of batching is to break any synchronization of orders. Frequently, customers that order once a week tend to do so on either a Monday or Friday. Customers that order once a month tend to do so either at the beginning or the end of the month. In such situations, it is better to distribute customers ordering once a week evenly across all days of the week, and customers ordering once a month across all days of the month. In fact, regular ordering days may be scheduled in advance for each customer to level out the order stream arriv­ing at the manufacturer.

RATIONING BASED ON PAST SALES AND SHARING INFORMATION TO LIMIT GAMING To diminish information distortion, managers can design rationing schemes that discourage retailers from artificially inflating their orders in case of a shortage. One approach, referred to as turn- and-earn, is to allocate the available supply based on past retailer sales rather than current retailer orders. Tying allocation to past sales removes any incentive a retailer may have to inflate orders. In fact, during low-demand periods, the turn-and-earn approach pushes retailers to try to sell more to increase the allocation they receive during periods of shortage. Several firms, including General Motors, have historically used the turn-and-earn mechanism to ration available product in case of a shortage. Others, such as HP, have historically allocated based on retailer orders but are now switching to using past sales.

Other firms have tried to share information across the supply chain to minimize shortage situations. Firms such as Sport Obermeyer offer incentives to their large customers to preorder at least a part of their annual order. This information allows Sport Obermeyer to improve the accu­racy of its own forecast and allocate production capacity accordingly. Once capacity has been allocated appropriately across different products, it is less likely that shortage situations will arise, thus dampening the inflation of orders. The availability of flexible capacity can also help in this regard, because flexible capacity can easily be shifted from a product whose demand is lower than expected to one whose demand is higher than expected.

4. Designing Pricing Strategies to Stabilize Orders

Managers can reduce information distortion by devising pricing strategies that encourage retail­ers to order in smaller lots and reduce forward buying.

MOVING FROM LOT-SIZE-BASED TO VOLUME-BASED QUANTITY DISCOUNTS As a result of lot-size-based quantity discounts, retailers increase their lot size to take full advantage of the discount. Offering volume-based quantity discounts eliminates the incentive to increase the size of a single lot because volume-based discounts consider the total purchases during a specified period (say, a year) rather than purchases in a single lot (see Chapter 11). Volume-based quantity discounts result in smaller lot sizes, thus reducing order variability in the supply chain. Volume- based discounts with a fixed end date at which discounts will be evaluated may lead to large lots close to the end date. Offering the discounts over a rolling time horizon helps dampen this effect.

STABILIZING PRICING Managers can dampen the bullwhip effect by eliminating promotions and using everyday low pricing (EDLP). The elimination of promotions removes forward buying by retailers and results in orders that match customer demand. P&G, Campbell Soup, and several other manufacturers have implemented EDLP to dampen the bullwhip effect.

Managers can place limits on the quantity that may be purchased during a promotion to decrease forward buying. This limit should be retailer specific and linked to historical sales by the retailer. Another approach is to tie the promotion dollars paid to the retailer to the amount of sell-through rather than the amount purchased by the retailer. As a result, retailers obtain no ben­efit from forward buying and purchase more only if they can sell more. Promotions based on sell-through significantly reduce information distortion.

5. Building Strategic Partnerships and Trust

Managers find it easier to use the levers discussed earlier to achieve coordination if trust and strategic partnerships are built within the supply chain. Sharing of accurate information that is trusted by every stage results in a better matching of supply and demand throughout the supply chain. A better relationship also tends to lower the transaction cost between supply chain stages. For example, a sup­plier can eliminate its forecasting effort if it trusts orders and forecast information received from the retailer. Similarly, the retailer can lessen the receiving effort by decreasing counting and inspections if it trusts the supplier’s quality and delivery. In general, stages in a supply chain can eliminate dupli­cated effort on the basis of improved trust and a better relationship. This lowering of transaction cost, along with accurate shared information, helps improve coordination. Walmart and P&G have tried to build a strategic partnership that will better coordinate their actions and be mutually beneficial.

Research by Kumar (1996) showed that the more retailers trusted their suppliers, the less likely they were to develop alternate sources while significantly increasing sales of their prod­ucts. In general, a high level of trust allows a supply chain to become more responsive at lower cost. Actions such as information sharing, changing of incentives, operational improvements, and stabilization of pricing typically help improve the level of trust. Growing the level of coop­eration and trust within a supply chain requires a clear identification of roles and decision rights for all parties, effective contracts, and good conflict resolution mechanisms.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.