Supply Chain Planning Supply Planning

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Supply Chain Planning:

is insufficient production capacity to meet the requirements, they evaluate other options, including alternate sourcing and product allocation The result: a match between demand and supply Supply planning helps address tough business problems, like these:

● Improving customer fill rates

● Reducing inventory levels and costs

● Minimizing transportation costs

● Lowering capital investments and expenditures

How Is Supply Planning Integrated with Supply Chain Planning?

Supply planning is one of the four supply chain planning processes: supply, demand, production,

and fulfillment Note in the figure how these processes overlap the three supply chain functions: procurement, manufacturing, and fulfillment (Click the boxed-in arrows for more details.)

In a well-run supply chain, the planning processes are interdependent Plans from one process

depend on and feed the other plans The goal is to synchronize the plans—and the planners—by

integrating the processes This helps you answer key questions:

● How do the planning processes relate to each other?

● What should I do with the information from my or another planning process?

Let's look at each of these questions before we get into the details of supply planning

Course Objectives

After completing this module, you should be able to do the following:

● Identify the purpose, objectives, and benefits of supply planning

● Describe the different components of supply planning, the business problems they solve, and the key capabilities they require

● Identify key inputs, outputs, and concepts for each of the components of supply planning

● Describe the metrics used to measure the effectiveness of supply planning

Introduction to Supply Planning

Overview

A supply chain is a network of the entities—within and across companies—involved in producing, shipping, and distributing products Each entity is a link in the movement of a product from its raw materials stage to its consumption by the customer A typical supply chain has the following entities:

● Inventory Plan – Determine and plan for how much inventory to hold (finished goods) and where to place the inventory (in which distribution centers)

● Distribution Plan – Determine how, when, and where to replenish this inventory

● Sourcing Plan – Plan when and where to manufacture a product

● Materials Plan – Determine what materials are needed and when

Supply Planning Constraints

Every company is restricted in some ways in its ability to produce and deliver goods This concept called "constraints" is central to the supply planning process For something to qualify as a

constraint, it must be definable in terms of a resource—for example, transportation, manufacturing, labor—and a given time period With money and resources, a constraint is addressed and is no longer an issue

Capacity Constraints

Refers to the number of products that can be produced over a period of time For instance, a

manufacturing line can produce only a certain number of motorcycles in a week

Materials Constraints

Occurs when the number of red motorcycles produced in a week, for example, is limited by the

number of red fenders available from a supplier (This is not just a materials constraint for the

manufacturer, but also a capacity constraint for the fender supplier.)

Reflects the time it takes for material to progress from one stage to another For example,

"manufacturing lead time" refers to the time it takes for product to be manufactured "Transportation

lead time" is the time it takes for product to move from one location to another.

Components of Supply Planning

Supply planning has three components—Inventory Planning, Distribution Planning, and Master Production Scheduling (MPS) How much…where…and when (see the figure)

Master Production Scheduling

Plan when to manufacture the product to meet actual customer demand Plan material requirements

to meet production schedule

Supply Planning Process Flow

Supply planning is an iterative process Click on the boxed-in arrows to see where and why the process repeats

Inventory Planning – This process results in a plan that specifies target safety stock levels at each

location (based on replenishment policies) This is input into the distribution planning process

Distribution Planning – After taking into account both current inventory and high-level

manufacturing constraints, this process creates a plan to fulfill customer orders; generates the net finished goods requirements for manufacturing; and specifies which factories should replenish the inventories at each distribution center (the sourcing plan) Most discrepancies in the plans are

resolved by going back and forth between distribution planning and master production scheduling

Master Production Scheduling – This process results in a feasible production plan/schedule It is

"feasible" because it takes into account more detailed capacity as well as materials constraints

Production Planning then uses the master production schedule to generate more detailed production schedules and materials requirements

Here, we differentiate explicitly between the components of supply planning In reality, there may be

a lot of overlap among them

Although the general principles of inventory planning, distribution planning, and master production scheduling are much the same, planning challenges can vary by industry Next, we will look at the planning challenges in two industries: semiconductor and consumer product goods.

Supply Planning in Different Industries: Semiconductor

The semiconductor industry is capacity constrained Few manufacturers produce this type of product without first having a customer order This business model is known as Make-To-Order (MTO) Because these manufacturers have limited capacity to satisfy customer orders, demand often

exceeds supply As a result, master production scheduling—which considers detailed capacity and materials constraints—is critical in this industry Let's look at some of their challenges:

Chronic Capacity Shortages

Occurs when demand exceeds supply Planners need to be able to allocate capacity among

different customers so as to maximize business objectives

Inaccurate Due-Date Promises

Since there is no inventory on hand in an MTO environment, manufacturers must be able to quote accurate order-promise dates to customers Unfortunately, they rely on predetermined lead times, so the promises may not reflect reality With supply planning, manufacturers know precisely when and where product will be manufactured, so they can quote more accurate order-promise dates to

customers

Visibility into Contract Manufacturers' Plans

Many semiconductor companies outsource manufacturing to other manufacturers (known as

contract manufacturers) The semiconductor companies need visibility into the contract

manufacturers’ plans to ensure accurate order promise dates to customers and to manage any delays

Ability to Quickly Adjust Plans

Actual demand never follows the exact pattern of forecasted demand As companies receive

updated demand and customer order information, they must be able to react quickly

Supply Planning in Different Industries: Consumer Products

The consumer product goods (CPG) industry is low-margin and distribution intensive That

combination makes both inventory and distribution planning key to managing costs Challenges in the CPG industry include the following:

Numerous Production Facilities and DCs

With lots of final points-of-sale, CPG depends on distribution planning to minimize cost These planners need visibility into the entire network to ensure that they can fulfill customer orders from other DCs if planners project that a key DC will be stocked out They carefully plan safety stock levels to avoid having too much or too little inventory in the supply chain

Exploit Alternative Manufacturing Sources

When primary manufacturing facilities are unable to meet projected demand, CPG manufacturers must have a plan that allows them to obtain product from alternative sources

Topic Summary

Supply planning has three components: inventory planning, distribution planning, and master

production scheduling Through this process, you can balance supply and demand using

inventory, distribution, sourcing, and materials plans

Constraints restrict the ability to produce and deliver goods Supply planning constraints include

limits on capacity, material, transportation, and lead time

Supply planning also differs by industry A capacity constrained industry, such as the

semiconductor industry, conducts supply planning differently from the consumer product goods industry, which is distribution intensive

Inventory Planning

Overview

The demand plan forecasts what customers will want, how much, and when It is only a forecast, though…actual demand could be higher or lower If actual demand is higher, you may not be able to meet it unless you have inventory on hand or can expedite production If demand is lower, you are stuck with excess inventory

You want to avoid excess costs, either from carrying too much inventory or from too much

expediting That brings us to the goals of inventory planning:

"To determine how much inventory to maintain at each location…to meet actual

customer demand…within a pre-established, acceptable service level."

Introduction to Inventory Planning

Inventories are stocks of goods and materials used for many purposes: for resale to others, to use in further manufacturing and assembling processes, or for the operation or maintenance of existing

equipment Inventories serve as cushions while items are replenished (arrive) in one pattern and demanded (depart) in another pattern.

To meet demand on time, companies carry inventory to protect against rising and falling demand (demand fluctuation) As inventory dwindles in each location, replenishment policies govern when

to place an order for more items, and what quantities to order In developing these policies,

companies strive to optimize: not too much inventory in the network, and not too little

Inventory Planning Capabilities

To achieve inventory-planning objectives, companies must develop these capabilities:

● Set inventory targets – Determine the amount of buffer required (safety stock) to meet the service level target (order fill rate)

● Define replenishment policies – Decide on order quantity (how much finished goods to order each time inventory needs to be replenished) and when to place the order

● Monitor and track inventory – Set acceptable inventory ranges and ensure that inventory is maintained within those ranges

Usually conducted monthly or quarterly, inventory planning requires advanced modeling techniques and specialized software Course Note

Although inventory is carried for many purposes and in many forms, we limit our discussion to finished goods inventory and to subassemblies and components that are defined as critical to the manufacturing process In reality, inventory planning may be done for all subassemblies and

components and for raw materials as well In addition, we discuss only those inventory planning activities performed internally (not across entities in the supply chain)

Inventory Planning: Stakeholders and Business Objectives

The functions most affected by inventory planning are Fulfillment and Finance:

● Fulfillment ensures that product is available to meet customer demand and target customer service levels

● Finance is concerned with the amount of money spent on meeting service levels Finance monitors inventory levels closely to ensure they are within set limits, and not too high or too low

Effective inventory planning addresses the following business issues:

Improve Customer Service Levels

Increase the total number of orders that are filled completely and on time

Manage Inventory Costs

Minimize the total cost of inventory across the supply chain, focusing on these costs:

● Inventory Carrying Costs – what it costs to carry inventory at each location, based on the cost

of capital

● Ordering Costs – what it costs to place an order, including paperwork, time, and processing costs

● Stock-out Costs – the lost revenue opportunity when a product is out of stock when a

customer wants it

Smooth the Effect of Demand Fluctuation

Operate manufacturing facilities as if demand were constant (which it never is): ensure that they run

at a constant rate—facilities and resources are not underused or overused Without inventory

planning, demand could fluctuate wildly

Inventory Planning: Inputs, Outputs, and Concepts

Now let's focus on how inventory planning works: its inputs and outputs (see the figure), and two key concepts (predictable demand and demand variability) First, let's look at the key outputs

Key Outputs – Safety Stock Levels

The demand forecast is a best guess; actual demand can be higher or lower Because demand is

variable, some excess inventory is kept on hand as a buffer Referred to as "safety stock," this is a key output of the inventory planning process

At the same time, companies strive for a high level of customer service For example, you may

decide that 95 percent of all demand will be met on time—a 95 percent service level In general, the

higher the service level goal, the more safety stock required But you cannot simply carry large

inventories to ensure that all customer demands are met Carrying inventory is expensive It is not only the cost of carrying the inventory, but also the cost of the capital tied up in the inventory

investment What you want is a balance, between service level and total cost

Key Outputs – Safety Stock Levels (continued)

In the chart, the curve illustrates a trade-off: the better the service, the more safety stock required And, the higher the cost of carrying that stock

Note also how the curve rises as service levels increase Between 80 to 90 percent, the safety stock needed to meet the service level increases only gradually As the service level rises from 90 to 95

percent, the safety stock needed rises more sharply And note the big jump in safety stock when the service level increases from 95 to 99 percent.

You must balance this trade-off between high customer service levels and the costs to meet those service levels

Key Outputs – Replenishment Policies

As inventory dwindles at each location, the question is, when and how much to reorder? If you reorder in small quantities, you have to reorder more often If you reorder in large quantities, you have to carry some excess inventory

The answer is to determine optimal order quantities that minimize total costs This is sometimes called the economic order quantity, or EOQ And, the best time to place an order must also be determined:

● Periodically: for example, every week or every month

● When inventory has fallen below a certain point, called the reorder point

Replenishment policies set out your EOQ's and reorder points (In this course, we focus only on

these two replenishment policies; there are many others) Click below for an example

EOQ Example

Suppose that demand is 100 units per day You can choose to reorder 100 units to arrive every day That might incur high transportation costs if that small quantity only partially fills a truck Or, you can order a full truckload at a time, which lowers the transportation costs, but increases the inventory carrying cost You want to use an economic order quantity for the lowest total cost

Key Concepts – Predictable Demand

When demand can be predicted, the result is lower overall costs: better on-time delivery, fewer outs, and higher levels of customer service with less inventory This takes a strong planning focus Sophisticated modeling techniques compute safety stock levels and replenishment policies, and tie them directly to customer service targets If the model is accurate—if demand is accurately predicted and actual demand equals forecast—a company can meet its customer demand without dipping into their safety stock

stock-The figure shows a predictable demand scenario A company places orders weekly, using an order quantity, and maintains a safety stock to account for demand variability The actual demand over time does not require any safety stock

Predictable demand works best with your "bread and butter" products Meaning—your big sellers, with high volumes, where the planning is straightforward Predictable

SAFETY STOCK

is the amount of inventory kept on hand to buffer for unplanned events Safety stock can be driven

by service level requirements, forecast error, demand and lead-time variability

Key Concepts – Demand Variability

Actual demand seldom equals forecast That variability is why we have safety stock The following figures show how safety stock can be used to lessen the effects of demand variability

If actual demand exceeds forecast, you have to use some safety stock This helps meet customer

demand even though the forecasted demand was lower than actual

If actual demand is less than forecast, you do not need to use any safety stock to meet demand

However, some inventory carrying costs are incurred

Key Inputs

Most companies use modeling techniques to determine the right level of safety stock to carry for each item (as well as their economic order quantities and reorder points) Safety stock calculations require several inputs:

Forecast

The forecast of customer demand If demand for a product is an average of 10 items per week, the safety stock required will be less than if demand were 1,000 items per week

Forecast Error

The expected difference between actual and forecasted demand, based on history and experience

So, if the forecasted demand is 100 items per day, but actual demand varies between 80 and 120 items per day (the forecast error), safety stock can cover for this fluctuation In general, the higher the forecast error, the higher the safety stock required to cover it

Lead Time

The time that elapses between placing an order and actually receiving it Assume that demand is

100 units per week, and the lead time for an order is one week That means an order must be placed

at the end of Week 1 to receive it at the beginning of Week 3 Knowing this, you can place an order

at the end of every week to ensure there is enough supply on hand for the following week Typically, the longer the lead time, the earlier you must place orders

Lead-Time Variability

The amount by which lead time varies For example, if the lead time for an order is seven days, and the lead-time variability is two days, then actual lead time varies between five days (–2) and nine (+2) Despite variability, an order might still be placed every week, but some extra inventory would also have to be carried in case the order took the full nine days to arrive So, the higher the lead-time

variability, the more safety stock required.

Supply Variability

The difference between the actual supply quantity and the quantity ordered Supply variability could

be due to defective items or incomplete orders being shipped In general, the higher the supply variability, the more safety stock required

Order Quantities

As inventory is depleted, you must decide how much to order for the next replenishment You can use several different methods to compute the reorder quantity, but the simplest and most commonly used is EOQ, the economic order quantity The simplest form of EOQ minimizes total cost computed

as the sum of inventory carrying costs and order processing costs More advanced formulae are available to include stock-out costs, backorder costs, and price discounts (Winston 2003)

Winston, Wayne L [1991] 2003 Operations Research: Applications and Algorithms 4th ed Boston: PWS-Kent

Publishing Co.

Inventory Planning Considerations

We have seen that inventory planning is based on goals that may seem to conflict: minimize total

costs and increase customer service levels Companies pursue these goals based on their

business objectives:

Improve Customer Service Levels:

Targeted Service A company may segment its service level targets by customer or by product:

● Segment service levels by customer – provide a higher level of service to your best

customers For example, the airline industry provides a higher level of service to those who fly a lot A food-processor distributor could choose to provide a higher level of service to large, high-volume housewares stores, and a lower service level to smaller independent stores This requires setting safety stock levels by item and by customer, which is more complex than the standard process (by item only)

● Segment service levels by product – set a higher service level for fast-moving and

high-margin products Using an ABC classification scheme, you set higher service levels for the class A products

Smooth the Effect of Demand Fluctuation:

Plan for Your Suppliers A company may set inventory and safety stock levels for their suppliers Based on demand pattern, you create customer service level agreements with targets not only for your customers, but also for your suppliers Companies may do this instead of embarking on big supply chain improvement projects, which can be too expensive and too daunting for some To help your key suppliers—and of course, to keep your own operations running smoothly—you could take this approach

Inventory Planning: Example

One output of the inventory planning process is the level of safety stock required for each item at each location Safety stock is calculated to ensure a targeted level of customer service Two

measures of customer service include:

● On-Time Delivery – the percentage of all customer demand that is met on time

● Number of Stock-Outs – the expected number of times a shortage will occur per year

Often, a safety stock level is computed for each measure In some cases, one safety stock level can meet both objectives Or, the choice may be to meet only one objective.

Let's do some inventory planning

Inventory Planning: Example (continued)

We have seen that inventory planning is based on goals that may seem to conflict: minimize total

costs and increase customer service levels Companies pursue these goals based on their

business objectives:

A computer store in a remote township in Ireland sells an average of 1,000 CD boxes per year Annual demand for the CD boxes is normally distributed with a standard deviation of 69.28 boxes (see Course Note below) The store orders the boxes from a regional distributor and each order is fulfilled within one month The cost of placing an order is 50, and the cost of carrying a box of

inventory for one year is 10

The store has the following customer service objectives:

● On-Time Delivery – The store would like to determine the most economic order quantity (EOQ), the reorder point, and the safety stock they should carry to meet 80 percent of all demand on time (Y equals 80 percent)

● Number of Stock-Outs – The store would also like to determine the reorder point and the safety stock they should carry to yield an average of two stock-outs per year (Z equals 2)

Course Note

"Standard deviation" is determined using statistical computations We do not show the computations here, but they can be found in any operations research or inventory theory textbook

Inventory Planning: Example (continued)

To compute the right economic order quantity, safety stock, and reorder points, the store takes the following steps

Determine the EOQ

● EOQ is calculated based on average annual demand, ordering costs, and holding costs This

is the formula:

The square root of ((2 x Ordering cost x Average annual demand)

÷ Holding cost)

● To calculate our EOQ:

The square root of ((2 x 50 x 1,000) ÷ 10) = 100

Determine the reorder point so that Y=80% (where Y is customer service level)

● The reorder point so that Y equals 80 percent is 65.33

● This is determined using inventory theory and statistical computations

● Inputs to the reorder point calculation include EOQ (100), annual demand (1,000 CD boxes), and the standard deviation for demand (69.28)

● We do not show the computations here but they can be found in any operations research or inventory theory textbook

Compute the safety stock so that Y=80% (where Y is customer service level)

● Inputs to the safety stock calculation are reorder point (computed in the previous step) and average demand during lead time (lead time is one month):

Reorder point – Average demand during lead time

● So, here is the amount of safety stock needed to achieve an 80 percent customer service level:

65.33 – (1,000 ÷ 12), or, 65.33 – 83.33 = –18

● The negative number (–18) means they do not need to carry any safety stock to meet the 80 percent target They can meet it (and probably beat it) if they simply use the EOQ (100 boxes) every time safety stock falls below the reorder point (65.33 boxes)

Determine the reorder point that yields a set number of stock-outs (Z) so that Z=2

● The reorder point so that Z equals 2 is 100.13

● This is determined using inventory theory and statistical computations

● Inputs to the reorder point calculation include EOQ (100), annual demand (1,000 CD boxes), and the standard deviation for demand (69.28)

● We do not show the computations here but they can be found in any operations research or inventory theory textbook

Determine the safety stock that yields a set number of stock-outs (Z) so that Z=2

● We use the same safety stock calculation, only this time, we use the stock-out reorder point:

Reorder point (for Z=2) – Average demand during lead time

● To calculate the amount of safety stock needed to yield only two stock-outs per year:

100.13 – 83.33 = 16.8

● So, with 16.8 boxes in safety stock, there will be only two stock-outs per year

Inventory Planning: Example (continued)

This table shows what happens to reorder points and safety stock levels as service levels increase

● Determine how much inventory to maintain at the

different locations to meet actual customer demand

● Improve customer service levels

● Manage inventory costs, including:

● Set inventory targets

● Define replenishment policies

● Monitor and track inventory costs

Distribution Planning

Overview

At this point, you have demand forecasts and inventory targets for each supply chain location

(including distribution centers) Now, you want to maintain those targets by replenishing product from your production facilities That brings us to the goals of distribution planning:

"To determine the net finished good requirements, taking into account demand, inventory levels, and inventory targets…to inform the manufacturing side what product is needed, by item and location…and to inform the distribution centers when

to replenish inventory and the locations from which to source this inventory."

Distribution Network

A typical supply chain is an extended network of suppliers, factories, distribution centers, and

customers Finished goods can flow along many different paths in a network

Introduction to Distribution Planning

Distribution planning replenishes finished goods so that inventory is balanced across the supply chain network The balance is achieved by determining how much, when, and where finished goods are needed Specifically, distribution planning produces the following:

● Net Finished Goods Requirements – what is needed for each item at each location and

when Planners determine the net requirements starting with demand, and then netting out inventory on hand as well as any expected receipts

● Sourcing Plan – which factories, suppliers, or distribution centers should replenish

inventories at each distribution center

● Distribution Plan – which distribution centers should satisfy which customer orders

Distribution Planning Capabilities

To achieve distribution-planning objectives, companies must develop these capabilities:

● Match supply and demand – Develop a plan with no discrepancy between demand and

expected supply

● Apply business constraints – Ensure that supply constraints are considered during the

planning process These include manufacturing capacity constraints, transportation constraints, and lead-time constraints

● Manage exceptions – Manage plans by resolving any variances to those plans

For example, after the sourcing plan is first generated, capacity decreases at one of the facilities because of a machine failure This causes a discrepancy between available supply and demand This is flagged as an exception Planners then resolve this by sourcing the demand from a facility (or supplier) that can handle the added capacity

Distribution Planning: Stakeholders and Business Objectives

The functions most affected by distribution planning include the following:

● Manufacturing and Purchasing need the outputs from distribution planning to determine the

net amount of product that must be manufactured or purchased from suppliers

● Fulfillment needs the distribution plan to determine which distribution centers will ship

products to which customers

● Finance needs the output from distribution planning to monitor total costs and compare them

with budgeted costs

These stakeholders strive to meet the following business objectives:

Maintain Target Inventory Levels

Optimal inventory levels are established (based on minimizing costs) during inventory planning Distribution planners strive to maintain these levels to keep the process within guidelines

Maximize Customer Service

In inventory planning, planners maximize customer service by setting target safety stock levels Now, in distribution planning, planners strive to minimize inventory while keeping service levels high

Minimize Transportation Costs

Minimize the cost of transporting goods across the entire supply chain network Some companies determine their sourcing plan based on minimizing transportation costs and on transportation

capacity constraints

Minimize Order Expediting

By planning ahead, there is enough inventory on hand to meet customer demand without expediting Expediting orders increases costs: for example, rush delivery, overtime, or premium charges for

Distribution Planning: Inputs and Outputs

Now let's focus on how inventory planning works: its inputs and outputs (see the figure), and two key concepts (predictable demand and demand variability) First, let's look at the key outputs

Key Outputs – Distribution Plan

When you have multiple distribution centers and multiple customers, more than one distribution center may fill orders for any given customer The plan that specifies which distribution center fulfills

which customer orders is the distribution plan

Consider a company with two distribution centers (Kuala Lumpur and Manila) and two customers (Calcutta and Hong Kong) For simplicity, assume that the lead time to fulfill a customer demand

from a distribution center is zero, referred to as instantaneous replenishment A simple solution

follows:

Course Note

Note that in this example, we assumed that demand at one location (for example, Calcutta) could be met by supply at one distribution center (Kuala Lumpur) In the real world, this is a process: the planner/software has to consider the existing inventory position at each distribution center to match demand to supply

Key Outputs – Net Finished Goods Requirements

As the distribution centers fulfill customer orders, inventory is depleted and must be replenished The DCs determine the quantity of product they need and place their orders with the manufacturing

facilities or other suppliers of finished goods To determine "net" finished goods requirements,

inventory on hand and expected receipts are netted out (subtracted) from demand

Assume that the lead time to replenish inventory at the distribution centers is zero Also assume that the inventory at the beginning of Week 1 is 25 for Kuala Lumpur and 20 for Manila

Course Note

To simplify our example, we do not discuss other variables involved in determining net finished goods requirements These include lead time (the time between placing an order and receiving the goods), expected receipts (finished goods that have been ordered and are expected to arrive), safety stock level, and order quantities