Contents CHAPTER 1 Introduction A.G. de Kok and Stephen C. Graves 1 1. Introduction 1 2. Main business trends that created SCM 2 3. Outline of the volume 11 PART I Supply Chain Design CHAPTER 2 Supply Chain Design and Planning – Applications of Optimization Techniques for Strategic and Tactical Models Ana Muriel and David Simchi-Levi 17 1. Introduction 17 Part I: Production/Distribution Systems 2. Introduction 19 3. Piece-wise linear concave costs 22 4. All-unit discount transportation costs 39 Part II: Pricing to improve supply chain performance 5. Introduction 65 6. Coordinating pricing and inventory decisions 66 7. Pricing models with production capacity limits 74 8. Computational results and insights 76 Part III: Supply chain design models 9. Introduction 77 10. The single-source capacitated facility location problem 78 11. A distribution system design problem 82 12. Conclusions 88 References 89 CHAPTER 3 Supply Chain Design: Safety Stock Placement and Supply Chain Configuration Stephen C. Graves and Sean P. Willems 95 v vi Contents 1. Introduction 95 2. Approaches to safety stock placement 97 3. Model formulation 102 4. Heavy industry and consumer packaged goods example 107 5. Supply-chain configuration 120 6. Conclusion 129 References 131 CHAPTER 4 Supply Chain Design: Flexibility Considerations J.W.M. Bertrand 133 1. Introduction 133 2. Conceptual research on manufacturing flexibility 135 3. The flexible machine investment problem; volume and mix flexibility 142 4. Resource flexibility, range, mobility, uniformity and throughput time 152 5. Empirical research on flexibility 161 6. Supply chain flexibility 164 7. Design for supply chain flexibility 172 8. Conclusion 191 References 193 CHAPTER 5 Design for Postponement Jayashankar M. Swaminathan and Hau L. Lee 199 1. Introduction 199 2. Postponement enablers 201 3. Process standardization 202 4. Process resequencing 213 5. Component standardization 218 6. Related strategies and other benefits 221 7. Conclusions 223 References 224 PART II Supply Chain Coordination CHAPTER 6 Supply Chain Coordination with Contracts Ge´rard P. Cachon 229 1. Introduction 229 2. Coordinating the newsvendor 233 Contents vii 3. Coordinating the newsvendor with price-dependent demand 257 4. Coordinating the newsvendor with effort-dependent demand 264 5. Coordination with multiple newsvendors 271 6. Coordinating the newsvendor with demand updating 285 7. Coordination in the single-location base-stock model 292 8. Coordination in the two-location base-stock model 297 9. Coordination with internal markets 312 10. Asymmetric information 316 11. Conclusion 329 References 332 CHAPTER 7 Information Sharing and Supply Chain Coordination Fangruo Chen 341 1. Introduction 341 2. Value of information 343 3. Incentives for sharing information 377 4. Future research 410 References 413 CHAPTER 8 Tactical Planning Models for Supply Chain Management Jayashankar M. Swaminathan and Sridhar R. Tayur 423 1. Introduction 423 2. Notations used 427 3. Stationary and independent demand 428 4. Alternative demand assumptions 436 5. Generalizations 440 6. Applications 446 7. Conclusions and future directions 448 References 449 PART III Supply Chain Operations CHAPTER 9 Planning Hierarchy, Modeling and Advanced Planning Systems Bernhard Fleischmann and Herbert Meyr 457 1. Types of supply chains 458 2. Supply chain planning 468 viii Contents 3. Advanced planning systems: General structure 480 4. Advanced planning systems: Particular systems 508 References 519 CHAPTER 10 Supply Chain Operations: Serial and Distribution Inventory Systems Sven Axsa¨ ter 525 1. Introduction 525 2. Different ordering policies 528 3. Serial systems 536 4. Order-up-to-S policies in distribution systems 541 5. Batch-ordering in distribution systems 551 6. Conclusions 554 References 556 CHAPTER 11 Supply Chain Operations: Assemble-to-Order Systems Jing-Sheng Song and Paul Zipkin 561 1. Introduction 561 2. One-period models 563 3. Multi-period, discrete-time models 567 4. Continuous-time models 575 5. Research on system design 590 6. Summary and future directions 592 References 593 CHAPTER 12 Planning Supply Chain Operations: Definition and Comparison of Planning Concepts Ton G. de Kok and Jan C. Fransoo 597 1. Introduction 597 2. The hierarchical nature of SCP 608 3. Constraints for SCOP 618 4. Mathematical programming models for supply chain planning 626 5. Stochastic demand models for supply chain planning 633 6. Comparison of supply chain planning concepts for general supply chains 655 7. Summary and issues for further research 667 References 671 Contents ix CHAPTER 13 Dynamic Models of Transportation Operations Warren B. Powell 677 1. Operational challenges in transportation 682 2. A general modeling framework 698 3. Algorithmic strategies 707 4. Modeling operational problems 724 5. Implementation issues for operational models 752 6. Summary remarks 753 References 754 Subject Index 757 A.G.de KokandS.C. Graves, Eds., HandbooksinOR &MS, Vol. 11 (cid:1) 2003Elsevier B.V.Allrights reserved. Chapter 1 Introduction A.G. de Kok TechnischeUniversiteit,Eindhoven Stephen C. Graves MassachusettsInstituteofTechnology 1 Introduction Supply Chain Management (SCM) has been a very visible and influential research topic in the field of operations research (OR) over the course of the last decade of the twentieth century. The problems and experiences that have emerged from business practices have stimulated many researchers to contributetoadeeperunderstandingaboutunderlyingphenomenaandcausal relationships. Supply Chain Management has also served as an application area, where existing OR methods and techniques have been applied to new models for new problems, to new models for old problems that regained attentionandtoexistingmodelsforoldproblems.Inthelastcasewefindthat progress has been made to extend existing results, stimulated by the apparent need for such extensions. OnemightnaturallystartahandbookonSCMwithadefinitionoftheterm SupplyChainManagement.Wehavedecidedtoresistthistemptationasthere are already too many competing definitions, and we do not see value in attempting to create a new definition or synthesize one from the current contenders. SCM has developed into a notion that covers strategic, tactical and operational management issues. We have made an attempt to structure theareabymeansofthechaptersinthishandbook.Bynomeansdoweclaim to deal with all management issues commonly understood as being part of Supply Chain Management. Nevertheless, we do believe that this handbook covers abroad range ofSCM issues that lend themselves tobeing formulated and analysed with mathematical models. As appropriate for an OR handbook, this volume focuses primarily on supply chains as a context to apply OR methods and models. As a consequence, we are concerned with the decision-making processes that arise in SCM and are derived from managerial and economic considerations. In particular, we investigate and explore how OR can support decisions in the design,planningandoperationofasupplychain.Bydoingso,weidentifythe 1 2 Introduction richness ofSCM as anORapplication field, which promises another ‘Golden Decade’ of research. In this introduction we provide an overview of SCM as an OR application area. Since many of the chapters in this handbook carefully position a particular aspect ofSCM ina businessandeconomic context, wedeliberately restrict the introduction to a high-level of abstraction. This allows us to discussanumberofrelevanttrendsinthebusinessenvironmentthatprovedto be the main impetus for the prospering of SCM during the last decade of the twentiethcentury.Theaddedvalueofsuchanoverviewshouldbetoposition SCM in its business context and to provide a framework to understand and position the subsequent chapters of this handbook in relation to each other. 2 Main business trends that created SCM In this section we discuss the main business trends during the late eighties and nineties of the twentieth century that provided the fertile soil from which SCM developed. 2.1 Core competencies Prahalad and Hamel (1990) argue that a number of companies have achieved significantly better results than their competitors by focussing on only a few competencies, so-called core competencies, and by outsourcing other non-core activities to companies that have a core competence on those activities. This reasoning has gained a lot of attention from large, highly vertically-integrated companies, such as Philips Electronics, Unilever, P&G, General Motors, etc. and has been adopted at a surprisingly fast pace. Whereas implementation of a company-wide information systems, such as an Enterprise Resource Planning (ERP) system, typically has taken three to seven years within these large companies, the implementation of the core- competency strategy has often been accomplished within one or two years. In our effort to understand the success of the core-competency strategy in terms of its adoption by global companies, we identify a number of circum- stances that seem to characterize the late eighties business environment. 2.1.1 Short-term focus In the Westerneconomic world the eighties were adecade of relatively low economic growth and high unemployment rates. In that climate a short-term focus prevailed. The core-competency strategy allowed firms to increase their return on investments (ROI) and related business performance indicators almost instantaneously: outsourcing non-core competencies eliminated the associated fixed cost in the denominator of ROI, which typically resulted in increasing the ROI. The economic climate permitted big multinational companies to outsource high-cost operations to companies with lower costs; Ch. 1. Introduction 3 forinstance,companieswithunionoperationsandexpensivelabourcontracts would outsource these operations to non-union companies with more cost flexibility.Thus,firmscouldsubstantiallyreducenotonlyfixedcosts,butalso the variable product costs as well. The first companies adopting the core-competency strategy showed immediate improvements in their balance sheets, resulting in rapid increases in their stock market value. Many companies decided to reap similar benefits and started outsourcing, as well. 2.1.2 Technological improvements require high capital investments By the end of the eighties, multinational companies with a tradition of capital-intensive manufacturing, such as electronics, white goods, automotive and consumer packaged goods, had invested for three decades in manufacturing mechanization and automation. This process replaced labour with capital, to the point that their capital–labour ratio approached that of primary industries, such as chemicals and metals. In fact, most of these vertically integratedcompaniesfoundthatmoreandmoreoftheaddedvalue from their manufacturing had shifted upstream in their supply chains, from assembly to fabrication. Consequently, the investments required for further improvementsin labourproductivityandprocesscapabilitieskeptincreasing. A sector that was archetypical for such capital investment requirements was thesemiconductorindustrythatemergedintheearlyseventiesandmaturedin the eighties. Many multinational electronics manufacturers had their own semiconductor division. These capital investment requirements demanded a strategic assessment. Most companies decided to concentrate on their brands, implying that they concentrated on Marketing and Sales, and Research and Development of their product portfolio as well as on Purchasing in order to leverage their buying power. Upstream manufacturing activities were outsourced to subcontractors. Interestingly, but logically, a number of these subcontractors decided to consider manufacturing their core competence and started a processofacquisitionsthatcontinuestodate.Intheelectronicsindustrythese companies are currently called Electronics Manufacturing Services (EMS) companies; in the semiconductor industry these companies are known as foundries. Apparently it is possible for them to carry the burden of large capitalinvestmentsthatcouldnotbecarriedbytheglobalmulti-billionbrand- owners. A possible explanation can be found in the stock market, again. The stock market analysts seem to have lower ROI expectations of these new manufacturing conglomerates than of the brand-owners. Whether the current situation with multinational brand-owners focussing on Marketing and Sales, Research and Development, and Purchasing and multinational ‘service companies’ focussing on manufacturing and logistics is a stable economic equilibrium remains to be seen. In his thought-provoking book Clockspeed, Fine (1998), provides empirical evidence of his theory thatthebusinessenvironmentshowsaconstantprocessofverticalintegration 4 Introduction and disintegration, stimulated by competition based on technological break- throughsandfosteredbyinternalinertiaoflargevertically-integratedcompanies. 2.1.3 SCM as core competence Intheearlyninetiesanumberofcompanies,suchasHewlett-Packard(HP), recognizedthatSCMwasoneoftheircorecompetencies.AlthoughHPwasin thetestandmeasurementindustryandthecomputerindustrysincethe1950’s, by the early nineties the company had evolved from a business-to-business company into a business-to-consumer company delivering PCs and printers via a dealer network to the consumers. In parallel to concentration on Research and Development (in particular software and printing technology), MarketingandSales,andoutsourcingmanufacturing,HPdevelopedtheskills for ‘worldclass’ SCM. HP recognized that one of its key differentiators could betoofferbothspeedofdeliveryandproductdiversitytothemarket,andthat this could be done without owning traditional manufacturing assets. Lee and Billington (1993, 1995) discuss the main ideas behind the HP approach. They introduce the term postponement in the SCM field, implying that product diversity is created as close as possible to the consumer, thereby allowing for efficiencies upstream in the supply chain. The postponement concept is developed and explored in Chapter 5. AnothercompanythathasmadeSCMitscorecompetenceisDell.Priorto Dell, PC manufacturers sold PCs through their dealer network, implying substantial capital investments in inventory by the dealers and exposure to obsolescenceriskforthemanufacturer.Incontrast,Delldecidedtoselldirect to the customer using the Internet as its marketing and sales channel. Dell is then able to assemble to order each client’s PC, thereby eliminating the need for final product inventory. The Dell business model requires that Dell’s suppliersholdstocksofcomponentsinconsignmentatornearDell’sassembly factories. Thus Dell operates its supply chain with minimal inventories on its books. Whereas the above is a somewhat idealized description, Dell does operate its supply chain with considerably less inventory than its competitors, while providing customized products with short delivery lead times. The Dell example should be considered a showcase of ‘worldclass’ SCM. It shows the potentialforoperatinglow-inventory,high-flexibilityandcustomized-product supplychains.Inmanyindustrialsectorsthepotentialmustbehuge,giventhe fact that many sectors have much lower market diversity than the PC sector. 2.1.4 Relevance for Operation Research applied to supply chains Thedisintegration ofthebrand-owningcompanieshasledtoanenormous increaseinthenumberofcontractualrelationshipsbetweenbrand-ownersand theirsubcontractorsandsuppliers,aswellasbetweenbrand-ownersandtheir downstream channel partners. Contracts are the mechanisms by which the brand-owner can leverage its buying power, yielding lower purchase prices, higher product quality and greater delivery reliability and speed. As such, the Ch. 1. Introduction 5 careful design of contracts is paramount to the profitability of the brand- owner. These contracts are also critical to assuring the sustainability of the supplier or subcontractor, recognizing their need to obtain sufficient economies of scale and scope. Furthermore, these contracts are essential mechanismsforfindingeffectivewaystospreadtheriskacrossasupplychain. In Chapters 6 and 7 of this handbook supply chain contracts are extensively discussed. Chapter 6 focuses on the design of contracts in general with an emphasis on risk sharing, while Chapter 7 examines the design of contracts with respect to sharing of demand and supply information. The myriad of relationships between legally independent companies operating a supply chain from commodities to consumers poses structurally complex network design problems to each of these companies. Whereas contractual relationships are one-to-one by definition, the network design problem is a many-to-many problem. Apart from questions concerning locations of factories and warehouses, tactical issues of safety stock positioning, capacity slack positioning and transportation mode selection have to be addressed. Operations research has wide applicability to these issues, and has provided very useful decision support. In this volume, Chapter 2 covers the application of optimization models and methods to supply chain design. Chapter 3 discusses the strategic positioning of safety stocks, while Chapter 4 focuses on investments in resources across the supply chain so that a strategic trade-off between customer service, market diversity and supply chain flexibility investments can be made. 2.2 The Bullwhip effect One particular phenomenon that has attracted great attention in industry and academia is the Bullwhip effect. In the late fifties Forrester (1958) conductedexperimentalresearchthatrevealedthatdemandvariationsamplify from link to link going upstream in the supply chain, i.e., from consumers to raw materials. By means of simulation, he identified the root causes of this variation amplification: information distortion and information delay. Lee,PadmanabhanandWhang(1997)builtuponandextendedtheideasof Forrester to identify common business practices that led to information distortion and information delays. This paper stimulated a large amount of work on understanding the phenomenon and developing counter measures. This work drew upon and applied concepts from the OR literature, including echelon stock concepts, inventory pooling and forecasting processes that inducedthe bestestimates offuturedemand. Thelatterseems obvious,butin many situations incentives are not aligned between business functions, yielding wishful thinking forecasts or target sales forecasts. Echelon stock concepts and inventory pooling stimulated the implementation of Vendor Managed Inventory (VMI) concepts. The implementation and dissemination of these concepts improved the overall knowledge base on Supply Chain Management. In general, one may