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Supply Chain Optimization

“In a general layman’s sense, it tends to mean ‘make it a lot better,’or ‘as good as we can achieve under the present circumstances’ As in, ‘We’re going to optimize our safety stock levels,’ or ‘We optimized the layout in our distribution center’

 

—Dan Gilmore”

INTRODUCTION

Supply chain managers efforts are towards maximizing the profits in the operation of their firm's supply chain. This includes measures like maximizing gross margin return on investment in inventory. This means balancing of the cost of inventory at all points in the supply chain with availability to the customer, minimizing total operating expenses (transportation, inventory and manufacturing), or maximizing gross profit of products distributed through the supply chain. Thus, supply chain needs to be optimized to address the supply chain problem of delivering products to customers at the lowest total cost and highest profit. This includes trading off the costs of inventory, transportation, distributing and manufacturing.

Supply chain optimization has applications in all industries manufacturing and/or distributing goods, retail chains, industrial products, and fast moving consumer goods (FMCG). Supply chains have to satisfy the requirements of the customers with respect to the customized products as well as the corresponding services. The first step towards designing an effective supply chain is to assess the nature of the demand of the goods and services. For example, the shorter life cycle for innovative products exhibits dynamic demand patterns and companies have to periodically modify their supply chains to effectively utilize all the opportunities in the markets to achieve profit.

For gaining a competitive advantage a firms needs a highly effective logistics distribution network. Thus, logistics becomes an integral part of the product distribution that is being delivered to the customer. In addition, the critical element in the quality of the customer service is the lead time. Technological advances can be utilized to reduce the lead times. This can be by using EDI to improve information/document flow (for better knowledge of the customers’ needs at each stage of the supply chain) to support the on time decision-making process.

Thus, in supply chain there are two polemic goals: to achieve customer satisfaction (which is cost driven) and reduce operational cost. Optimization means to achieve the trade-off between the above two goals by re-organizing the supply chain linkages.

OPTIMIZATION

The use of optimization in supply chain planning is extremely beneficial wherein supply chain process is complex in nature. The examples are supply chains in petroleum, retail and automobile industries. The use of optimization solutions are justified by such supply chain benefits as the following:

• Inventory reduction
• Improved customer service
• Increased asset utilization
• Improved corporate profitability

Optimization is beneficial in complex manufacturing environments, wherein there are many interrelated activities to take decisions. These include environments with many resource constraints and large numbers of products, plants, suppliers, and distribution centres. Planners in these complex environments need technology support to make optimized decisions. In strategic and tactical planning, the requirements of optimized solutions are more important than it is for low-level tactical and operational planning. In the former, the set for decisions is much larger, meaning there are more opportunities to make poor decisions. Also, these decisions have serious revenue and cost implications. In industries that experience material shortages, optimizing the use of these materials in the manufacturing process is very crucial. In make-to-order environments, especially in job order or customized manufacturing, optimized production schedules are crucial. For distribution intensive supply chains, planning must focus on optimizing manufacturing and distribution operations simultaneously. In general, optimization is more useful in mature, relatively stable manufacturing industries, where product demand and manufacturing processes are predictable. In such cases, realistic models can be constructed to support all levels of planning. However, in volatile product demand industries, optimization will be less useful for strategic and tactical planning. In these cases planning process focuses on supply chain responsiveness rather than on operational efficiency. Optimization will be more useful when the level of uncertainty is substantially less. For example, in the paper industry, optimization leads to substan tial gains by reducing waste paper from cutting operations. Optimization is used in the fruit beverage and oil industries, where raw materials are limited and prices are volatile. Materials must be efficiently blended to create products that meet specifications.

The goal of supply chain management is to replace physical stock with intelligent information and planning, with the ability to analyse what is possible in different parts of the chain and what is the best global/national plan.

The challenges of supply chain management vary by industry and customer segment. In simple terms, supply chains can be divided into three main classes depending on where the major constraints are: material-intensive, asset-intensive and distribution-intensive industries. In material-intensive-industries, such as high-tech and machinery manufacturing, largest costs and constraints are related to the management of procured and manufactured materials. In asset-intensive industries, such as paper and metal, planners need to concentrate on optimizing machine capacity utilization and the product mix. In distribution-intensive industries, such as consumer packaged goods industry, the major challenge is to manage the distribution network and finished goods inventory from the factory to the end-customer.

AREAS OF OPTIMIZATION

Planning and Forecasting

Planning and forecasting allows businesses to create, modify and track their financial, manufacturing and promotional plans and communicate changes across their entire supply chain. The solution removes or averages out peaks in demand caused by promotions and declines generated by adverse business conditions. Firms can forecast confidently and adjust the plans quickly, meaning that inventory consumes less working capital while firms can meet customer demand.

Accurately predicting the impact of changing demand on key performance indicators such as margin, inventory turn, payment receipts and inventory flow increases sales, reduces working capital requirements and keeps customers happy. However, accurately targeting assortments to customer preferences and predicting the right inventory levels across all channels requires real-time access to critical information for key players across the supply chain.

Planning and forecasting provides the crucial front end to supply chain that takes business to a higher level. Planning includes everything a firm needs to predict and respond to changes in elements such as:

• Demand forecasting
• Channel planning
• Financial planning
• Assortment planning
• SKU planning
• Promotion planning
• Store cluster planning

Inventory

The small variances in inventory can have big impact in the supply chain. Too little inventory will have rush charges, express delivery fees and unhappy customers. On the other hand, too much inventory increases costs and risk write-offs for obsolete or expired goods. A view of the inventory across all channels ensures that the goods are where they are needed.

Inventory optimization enables firm to see inventory across entire network no matter how many channels, products or outlets firm may have. If the inventory data can be shared with suppliers so they can better manage production and shipments. The more extensive firm's supplier network and more intricate the supply chain be an, the more the firm will need inventory optimization. If inventory issues keep firm from doing the best for customers and firm's bottom line, inventory optimization can help to get it right, every time during:

• Replenishment across SC
• Vendor-managed inventory
• Collaborative efforts with SC partners

Order Fulfilment

Even for companies with only one channel or limited products, managing of orders can prove remarkably difficult. Surprise delays lead to stock-outs. Sudden drops in demand generate excess inventory. When a firm's supply chain is complex, managing incoming orders to ensure goods reach customers on time and as specified (without pushing inventory costs high) can seem nearly impossible.

Stock-outs make customers unhappy and cost businesses in terms of lost sales every year. With optimization in order fulfilment, firms can see orders across channels as they come in, manage procurement from suppliers as needed, predict and respond to impending shortages, and track deliveries to ensure that the firm's customers have the goods they want, where and when they want them. The enhanced visibility provides information a firm needs to satisfy customers without carrying excess inventory.

Transportation

Because the customers count on firm to deliver the right products to them when and where they are needed, firm cannot afford to be blindsided by shipping problems at any location in the supply chain. Managing deliveries is only one part of the job, though; firm also needs to manage costs. Firms need to strike a right balance between their own fleet and commercial carriers and negotiate the best rates in every mode. Transportation optimization provides help to reduce costs, re-route around trouble spots, coordinate deliveries precisely and deliver more, faster, for less money. In this, firms require holistic view of transportation across all modes.

Distribution

Firm's distribution network extends from supplier's factory to firm's customer's front door. When a firm is dealing with scores of suppliers on distant continents, third-party logistics companies, multiple distribution centres and customers around in the world, getting visibility into the full distribution process can be extremely challenging.

Distribution optimization solutions provide collaboration and communication with an extensive network of suppliers and partners to allow right products at the right time and at lowest cost.

OPTIMIZATION METHODS

For optimization, different methods or algorithms are used to find solutions. These methods are categorized into four groups as follows.

Mathematical Methods

Under these methods models are built using mathematical equations describing the limitations and objectives. Using a set of mathematical equations, an optimum solution can be arrived at following a certain algorithm. The common amongst mathematical programming techniques used is linear programming (LP). This method works only if all the constraints and a single objective can be expressed as linear equations. The optimum solution is tradeoff of maximum or minimum single objective which can be arrived at. The assumption in LP is that the decision variables can be expressed as regular and continuous numbers. If some decisions can only be expressed as an integer or whole number, LP does not work.

To handle integer or whole number the mixed integer programming (MIP) was developed. This method works only if all the equations are linear. In contrast to LP, however, while an optimum solution can be generated, it may take too long. Other mathematical programming methods include dynamic programming and nonlinear programming, which are not quite often used in supply chain planning optimization.

Heuristics

Under heuristic methods, improvements to a known feasible solution are attempted using the prescribed steps. Heuristics do not guarantee an optimum solution. As an illustration, a simple heuristic for maximizing an objective might follow a three-step approach:

• Freeze decision variables at zero value.
• Increase decision variables one at a time as long as the objective continues to increase.
• Stop when increasing all decision variables no longer increases the objective.

While this heuristic method might not lead to optimum results, but solutions will usually get better or stay the same. Heuristics methods are based on the logic which a reasonable person might follow in looking for an optimum solution.

Some optimization solutions tor scheduling use heuristic logic based on the theory of constraints (TOC) of Eli Goldratt. These methods focus on ‘bottlenecks’ to develop a schedule. The TOC approach revolves around a drum, buffer, and rope concept. First, TOC uses the critically constrained resources to develop a master plan or drum that the plant or system ‘beats to’ or to which the pace is set. Buffers, such as work-in-process inventories and surplus time in the schedule, are put in place to ensure maximum utilization of the critically constrained resources which ensures that they do not sit idle. Lastly, all non-critically constrained resources are ‘tied’ together according to the drum, creating the so-called ropes that pull work through the system.

In addition to TOC, there are many types of heuristic methods that are proprietary knowledge of the vendors. Some of these are based on known, published approaches such as simulated annealing and repair-based scheduling methods.

Genetic Algorithms

These are based on a biological selective breeding concept of survival of the fittest. In this, an optimized solution is derived from a large set of possible solutions by comparing them and selecting the best ones of the group. The ones that survive this test are then mutated or crossbred to establish another set of solutions. This search method continues testing from generation-to-generation for some duration of time, thereby developing an optimized solution. These methods work well when a baseline schedule or plan exists. For example, sequencing a number of orders through a single assembly-line operation to maximize on-time delivery or to minimize changeover is an optimization task where genetic algorithms could be used.

Exhaustive Enumeration

In the exhaustive enumeration method, all possible combinations of decisions are evaluated to find the best combination. This method is used when there are relatively few decision-variable combinations to consider. For example, a job shop with 2 machines and 15 orders to sequence would generate multiple potential combinations for evaluation. This can be done manually. However, this can be done with ease on computer.

PROBLEMS IN OPTIMIZATION

Optimization solutions are used where there are resource constraints and decisions need to be made in a limited resource environment. Most supply chain optimization problems require matching demand and supply when one or both are limited. In supply chain, the most important limited resource is time. It is required for procuring raw material and components, manufacture finished products and deliver the same to the customer. This needs to be done under constraints. As the rate of procurement, production, distribution, and transportation resources is limited, demand cannot be immediately satisfied. It takes some lead time to fulfil the demand. In addition other resources, such as warehouse storage space or a truck's capacity, may pose as constraint in meeting demands. An optimization solution may have the following dimensions:

• Schedules of material procurement to match the production capacity and schedules for order fulfilment.
• Schedules of the finished product to ship to a customer or distribution centre with limitations on the supply plan.
• Supplier's capacity to produce for a specified number of hours per day and a worker that must only work so much overtime.
• A distribution centre's capacity to handle and process receipts.

The constraints in an optimization process may be categorized into two types. The first ones are those which are hard to change. These include fixed working hours in a shift or the maximum loading capacity of a truck. These must be accepted and adhered to. The second types are the ones, which can be subjected to change. These cover finished products delivery due dates or warehouse space limitations. Customer due dates can be changed or a product may be squeezed into a warehouse temporarily, making constraints less stringent. The cost penalties are imposed if these constraints are not met. For example, missing a customer delivery date is a more important concern than inventory updates in a warehouse. Hence, the objectives of optimization are:

• Maximizing profits
• Minimizing supply chain costs
• Minimizing cycle times
• Maximizing customer service
• Minimizing dates
• Maximizing production throughput
• Satisfying customer demands

Once a problem for seeking optimization is formulated, the firm needs to determine the best course of action using a set of logical steps or algorithms/computer programmes to search for a solution that achieves the objective. Three types of solutions towards optimization can be developed as shown in Exhibit 19.1.

 

Exhibit 19.1 Types of Solutions

Feasible Solution	Optimum Solution	Optimized Solution
This satisfies all the constraints of the problem	This is the best feasible solution that achieves the objective of the optimization problem	This is a solution that partially achieves the objective of the optimization problem. It is not the optimum or best solution, but it is a satisfying or reasonable one.
		This is usually one of the best feasible solutions

A large amount of money is wasted due to time and cost inefficiencies at various points in the supply chain. This is due to lack of integration of processes in the supply chain system. In many places manual techniques are used to information analysis and exchange. The time and cost wasted by such manual processes results into loss of orders, late deliveries, high inventory costs and low customer satisfaction.

BENEFITS OF OPTIMIZATION

The supply chain optimization (Exhibit 19.2) improves demand visibility and allows manufacturers and distributors to have forecasting, manufacturing and stocking decisions with high degree of accuracy based on the timely information. The result is reduction in inventory carrying costs. On the marketing side, the decisions on pricing and availability can be taken on real-time information. The errors in orders and product dispatches are less resulting into fewer product returns.Process automation in the flow of supply and demand information up and down the supply chain helps in reducing the operating costs associated with manual information flow. The speed and accuracy level communication gets enhanced many times.

 

Exhibit 19.2 Earlier vs. Optimized Supply Chain Network

Earlier Network	Optimized Network
Local or ad-hoc decision-making	Coordinated decision-making
Sub-optimal production locations	Optimal production locations
Many interplant transfers	Minimized ‘emergency’ transfers
High transportation costs	Optimized transportation
Inconsistent delivery performance	Predictable delivery performance

The Internet is driving a global business transformation as people increasingly conduct business online. An e-business brings about a wealth of opportunities for companies of all sizes. Being online they can extend their reach into new market segments and achieve speedy communications with employees leveraging the Internet and integrating all business processes across the entire supply chain. IT enables to have advanced planning in supply chain based on complete view of customers across the entire supply chain to analyse, optimize and execute on a common set of information platform. This uniform execution enables organizations to fulfil customer demands in the shortest time, at the lowest cost and with maximum profits.

VALUE ENHANCEMENT

It is important to have an understanding of the three dimensions of supply chain. These are time, transparency and trust. Each one is these are interrelated and dependent on the others. The time dimension of the supply chain helps firms to have transparency of activities across the entire. This in turn builds confidence amongst the all supply chain partners and creates trust between them.

All the dimensions are interrelated. If anyone of these is missing the integration in supply chain is broken resulting into loss of transparency, trust and an understanding of time. Of all, ‘time’ is a starting point and it creates transparency and trust in process and partners, respectively, resulting in gaining the competitive advantage.

Time dimension decides the velocity in the process. In general, in many organizations there is a velocity without direction. This means that the partners and employees are doing things which are not aligned with the goals of the organization.

The major objective of supply chain is to maximize the customer perceived value of the product/service. The velocity will further add value by way of customer satisfaction at the right time and place. To have velocity in supply chain time compression is required in all processes such as procurement, manufacturing and distribution. Time is a common measure across all supply chain partners, whereas cost and price data is open to a variety of interpretations. The time is the only focus to get rapid bottom line results.

The time dimension is applicable to non-value added activities (Figure 19.1) in supply chain process. These can be categorized into queuing time, rework time and time wasted due to decisions or indecisions. Sometimes the high safety stocks to enhance customer service level may prove excessive and can be reduced by understanding the time dimension of the non-value added activities.

 

 

In supply chain, the transparency of cost is of critical importance. Hence, it is critical for the supply chain manager to understand that the total cost is not the sum total of cost of sourcing, converting and delivering. There are some hidden costs which can only be revealed through ABC (activity-based costing) technique.

The third dimension of supply chain is the trust, which is required for seamless integration and collaboration of all supply chain processes and partners to achieve the common objective of maximizing customer value and reducing costs. The role of HRM (human resource management) is very critical in building the dimension of trust between organizations. Trust helps in gaining competitive advantage. Trust is required for co-operation, co-ordination and finally collaboration amongst supply chain partners to make the supply chain competitive. All the above three dimensions if dealt with properly helps supply chain process to be:

• Responsive
• Efficient
• Cost-effective

Thus, dilution in time dimension may result into an excessive inventory. It may further lose transparency in supply chain processes and inventories and consequently may result in loss of trust amongst supply chain partners and the employees.

Supply chain complexity has a major impact on supply chain performance, that is, inventory cost, inventory turns, flexibility, responsiveness, etc. In today's environment, businesses are facing many challenges that are increasing the supply chain complexity such as increasing numbers of mergers, acquisitions, and joint ventures to achieve geographic coverage and market penetration, broadening supply base spanning different geographic areas, rising rate of new product launches to combat com-moditization and meeting increasing customer needs and their demand for higher service levels in terms of speed in delivery, reliability and flexibility.

In a nutshell, there are three main drivers of supply chain complexity. These are operational configuration and structure (the physical attributes of a supply chain), operations management processes, and systems and products/services managed by the operational processes. Hence, for reducing complexity and to achieve performance the supply chain needs to be optimized.

The supply chain optimization is nothing but a strategic supply chain design which involves three steps: defining supply chain strategy, design and optimize a simplified supply chain, and manage change with a roadmap.

With the network-wide supply chain optimization, considerable process efficiency can be gained to balance distribution cost vs. capital expenditure, global sourcing and assembly vs. local sourcing and assembly, design for growth vs. design for flexibility, and service levels vs. inventory holding costs.

OPTIMIZATION STRATEGY

A complete supply chain strategy is essential to drive a company forward. The ability to achieve improved marketplace performance begins with a focus on the business needs and supply chain possibilities of an enterprise. As a point of entry into supply chain optimization, companies must first decide whether to go with the latest Internet technology. They must then conduct a strategic assessment of the enterprise to establish a best-fit solution combining business and supply chain strategies, process and technology.

Leverage the Internet

Optimizing and integrating physical processes to enhance growth is not possible without technology. In order to maximize IT investment, companies must align the supply chain strategy with the business strategy to maximize process capabilities, deploy the technology to support the process and connect more potential trading partners more quickly, effectively and inexpensively than ever before.

Build Value Networks

The precise mix of capabilities needed to build a high-performance supply chain must be brought together. This is done by adding value to the operations of each supply chain partner, developing joint efficiencies and removing non-performing assets and generating more trust and confidence in both the ongoing and new supply chain relationships.

Develop Service Collaborations

By developing service collaboration through franchise route, companies can make a stronger service commitment and thereby gain competitive advantage by recognizing and meeting the needs of each individual customer.

Promote Customer Leadership

Company's sales, marketing and supply chain personnel must work together to understand a complete view of the enterprise, including consumer behaviour, customer profitability, product financial performance, promotion effectiveness and segmentation of marketplaces to operate and sell more effectively. The supply chain must be demand-driven rather than forecast-driven.

Deliver Value to Customers

Today's Internet-based supply chain model is designed to increase companies’ bottom line by enhancing collaboration between businesses and their customers, suppliers and trading partners, increasing speed and flexibility of delivery. Customers today demand reliable and accurate delivery of competitively priced products and services that meet their unique requirements. They also want real-time product availability, pricing and delivery before they place an order. They want to design products to suit their unique needs and 24×7 access to track order status, payment and delivery information. A company's ability to respond to customer needs and fulfil customer orders, faster than its competitor is important for an organization to survive in the fast dynamic business environment.

OPTIMIZATION AND SIMULATION

In general, mathematical optimal solutions are not used in practice. Heuristics are used as a pre-process to break the problem down to make it easier for the optimizer to find a solution. Optimization with suitable solution for implementation is used for supply chain network planning, transportation planning, inventory optimization, factory scheduling, etc. In optimization, mathematical techniques like linear programming give the best result.

When using optimization processing over a very large data set, such as a complex global supply chain network or huge transportation plan, heuristics are often used to reduce the size of the problem that the optimizer is working against. This enables it to complete faster, or to ensure it does not produce theoretically optimal, but practically impossible solutions.

Optimization is generally based on some fixed estimates of demand over a given time frame. You can alter that demand estimate and run a different scenario to compare the impact on the recommended solution, but optimization, in general, is not good at handling highly variable demand or system inputs.

In optimization, it is hard for the user to really understand the interplay of various factors in supply chain system. That is where simulation comes into play. In simulation, a model of the system is built and scenarios are tested to get the desired results.

Running the simulation allows the analyst to see the behaviour of the supply chain system over time, as these inputs change. It may allow bottlenecks to be identified that would be missed in an optimization programme. The benefits of simulation are better ability to understand the impact of dynamic events, better total system understanding and risk mitigation. But these benefits come at some cost. However, optimization and simulation can be used together in supply chain network design.

REVIEW QUESTIONS

1. Explain the different methods/techniques used in supply chain optimization.
2. Which are the different areas in supply chain wherein optimization is applied?
3. Describe the scope of optimization and enumerate the major benefits of optimization.
4. Compare and contrast optimization and simulation.

INTERNET EXERCISES

1. Manhattan Associates helping companies streamline their supply chains to achieve lower costs, higher profits and happier customers. Visit their website http://www.manh.com/ to understand the scope and dimensions of supply chain optimization solution. Click the diagrams on website for an interactive approach to understanding SC optimization solution.
2. Applied optimization develops customized, enterprise solutions to improve performance at each link in the supply chain. Their solutions are built around rigorous mathematical models of the customer's process(es), using state-of-the art programming platforms. Visit http://applied-optimization.com/CaseStudy1.aspx to study more.

VIDEO LINKS

1. Supply chain optimization http://www.supplychainbrain.com/content/videos/2011-videos/scl-summit/total-supply-chain-optimization/
2. Tackling challenges of SC optimization http://www.supplychainbrain.com/content/videos/2010-video/operation-stimulus/tackling-the-challenge-of-supply-chain-optimization/

PROJECT ASSIGNMENT

1. Take up a company in FMCG sector where product availability is the key metrics for customer satisfaction and firm's growth. In general, due to the nature of product purchases by the customers the company in FMCG sector locates one distribution centre in each of the major markets in the region. Study the current inventory levels and find out if there is any scope for optimizing the number of distribution centres and inventory level without compromising the service levels.