This chapter is excerpted from the book titled, 'Supply Chains: A Manager's Guide', authored by David A. Taylor,...
published by Addison-Wesley Professional in September, 2003, ISBN 0-201-84463-X. Copyright 2007 Pearson Education, Inc. For more information, please visit: www.awprofessional.com
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Demand, Supply and Cash
The essential goal in managing a supply chain is to achieve an orderly flow of goods from extractors to consumers. It should not be surprising, then, that the deepest roots of the discipline can be found in transportation management, which is responsible for moving finished goods to the next link in the chain. Over time, transportation management merged with a related function, materials management, to form the broader discipline of logistics, which handles the flow of materials all the way from suppliers through the three internal inventories and out to customers.
What distinguishes the current discipline of supply chain management (SCM) from its predecessors is that it is equally concerned with two other flows: the flow of demand and the flow of cash up the chain, as shown in Figure 2.4. Without these other flows, the goods would never move: It's demand that provides the impetus for that movement, and it's cash that provides the motivation. The great insight of supply chain management is that the key to managing the flow of goods effectively lies in synchronizing all three flows. This synchronization becomes particularly difficult when, as shown in the "stack" notation in Figure 2.4, there can be any number of organizations at each link of the chain.
The basic operation of a supply chain could hardly be simpler. Demand flows up the chain and triggers the movement of supply back down the chain. As supplies reach their destinations, cash flows up the chain and compensates suppliers for their goods. Naturally, the behavior of real-world supply chains is never quite this simple. But recognizing the fundamental elegance of supply chain dynamics provides the best foundation for understanding the complexities that inevitably arise.
With a few exceptions, such as oil moving through a pipeline, the three flows in a supply chain are discrete rather than continuous. That is, they move in distinct "packets" that convey particular
quantities at particular times. Demand is normally conveyed through orders, supply through shipments, and cash through payments (Figure 2.5). A great deal of supply chain management is concerned with balancing the tradeoffs between the size and the frequency of these packets. For example, economies of scale favor infrequent orders of large quantities of material, whereas reducing inventory carrying costs requires more frequent shipments of smaller quantities. For any given rate of flow, the smaller the packets become, the closer the chain comes to operating as a continuous flow rather than moving discrete lumps of demand, supply, and cash across the chain.
As Figure 2.5 illustrates, each exchange of demand, supply, or cash takes place between a customer and a supplier. In this book, these terms refer to the parties involved in a transaction across any link of the chain, regardless of their location within the chain. In other words, I use the terms in a relative rather than an absolute sense, the way the terms buyer and seller are used in discussing a purchase. This is a common usage for these terms but it's not universal; many writers use the term customer to refer to the ultimate consumer of the goods, and others use the term supplier only for
upstream members of the chain who provide basic materials or assemblies. I avoid confusion in this book by always using the terms in the relative sense, but you should be aware of the inconsistent usage in other discussions. Be particularly alert to the differences in the way various authors use the terms customer and consumer; the muddling of these concepts often leads to pointless diatribes about who the "real" customer is.
Orders trigger the flow of goods, but, depending on the production strategy, they may or may not trigger their immediate production by a supplier (Figure 2.6). In the make-to-stock strategy, a supplier makes products in advance of demand and holds them in finished goods inventory, satisfying demand from that inventory as orders come in. In the make-to-order strategy, the supplier doesn't build a product until it has an order in hand. There is also an intermediate strategy, assemble-to-order, in which a product is partially built in advance of demand, but final assembly is postponed until an order is received. Some companies use a mix of
these three techniques, but choose one as their primary strategy. For example, Sony uses make-to-stock, Boeing uses make-to-order, and Dell uses assemble-to-order.
The choice of production strategy has a major impact on the dynamics of a supply chain. With the classic make-to-stock strategy, inventory is produced in advance of and "pushed" down the chain toward consumers so that it will be on hand when they go to buy it. This strategy relies on demand forecasts to determine how much inventory to build and where to hold it. With make-to-order production, inventory is "pulled" down the chain by immediate orders. Forecasts are less important with make-to-order because there is no danger of making too much or too little inventory, though long-term forecasts are important to setting the correct levels of manufacturing capacity.
These dynamics are often used to characterize supply chains as either push chains or pull chains, but in reality every chain is a mixture of push and pull. As long as consumers have a choice about what products they buy and when they buy them, the last link in the chain is always a pull link. At the other end of the chain, the extraction of raw materials from the earth almost always occurs in advance of demand for finished products. In effect, consumers pull and extractors push. Somewhere in between the two is the pushpull boundary (Figure 2.7), the point at which the flow of goods switches from being pulled by consumers to being pushed by extractors. In the case of the assemble-to-order strategy, for example, the push-pull boundary is located at the final assembly plant.
Actually, the push-pull distinction applies to every link in the chain, so it's possible for any link to operate in pull mode even though it is up in the push region of the chain. Ford's supply chain is a push chain right down to the dealer showroom, but it contains many links that are pure pull. For example, Johnson Controls
builds a seat from raw materials and delivers it to Ford within four hours of receiving an order, allowing the company to supply seats to Ford based on firm orders for specific configurations. In the context of a massive supply chain involving tens of thousands of companies building against anticipated demand, Johnson Controls is able to supply this particular component on a pull basis.
Of the three primary flows in supply chains, cash flow is the one that receives the least attention. This is understandable: Supply chains exist to move products to consumers, and orders are the mechanism for triggering that movement. But cash is the ultimate driver for the entire process; take it out of the equation and the whole business would come to a halt pretty quickly. Yet cash flow performance is the worst of the three, with producers routinely taking months to pay suppliers for goods that were shipped within days of being ordered. This situation is now changing, and accelerating the flow of cash is coming to be recognized as a key element of supply chain excellence.
In addition to the three key flows, there is something else that moves across the chain: information. Actually, information is already implicit in the three flows: Orders represent information about immediate demand, some products can be transmitted as information, and even cash can be exchanged in the form of information. But the more interesting kind of information isn't part of the actual transactions—it is exchanged in order to facilitate those transactions. This information includes demand forecasts, production plans, promotion announcements, and reports of all kinds. Unlike the three basic flows, information can move across the chain at any time, without being part of a particular transaction, and it isn't constrained to move sequentially up or down the chain. Instead, it can be broadcast simultaneously to any subset of the chain, ensuring that they are all operating with the same information at the same time (Figure 2.8).
One of the great insights into the behavior of supply chains is that information can often be substituted for inventory. Instead of requiring every member of the chain to maintain safety stock to buffer against uncertainty in demand, that uncertainty can be reduced by sharing information that helps members anticipate coming changes in the flows of demand, supply, and cash. Information is usually far cheaper than inventory, and it has the advantage that it can be in many places at the same time. The result: Substituting information for inventory is a key technique for improving supply chain performance and will be a continuing theme of this book.
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