Role of supply chain management decisions in effective inventory control.

ABSTRACT

Supply Chain (SC), which involves the configuration, coordination, and improvement of sequentially related set of operations in establishments, integrates technology and human resource capacity for optimal management of operations to reduce inventory requirements and provide support to enterprises in pursuance of a competitive advantage in the marketplace. A coordinated SC integrates procurement, production, and distribution and links together suppliers, manufacturers, distributors, customers and carriers in a network system that allows for effective planning, information exchange, transaction execution, and performance reporting. This paper addresses the structures of supply chain management (SCM) and the activities involved in SCM decisions that help promote profound improvement in efficiency and effectiveness in business operations. In broader context, the paper examines the types of activities involved in SCM decisions; the dynamics of the traditional SCM, the complementarities of technology in achieving effective management of operations through enablers of electronic data interchange (EDI) and quick response (QR) disciplines to implement Just-in-Time (JIT) management techniques; and integrated SC and inventory control as it relates to capacity imbalances and transaction costs.

1. INTRODUCTION

Supply chain management involves the movement of products, services, and information between and within businesses, the creation of value, and support of enterprises in the pursuance of a competitive advantage in the market place (Kilty, 2000). It involves the cooperation and coordination of activities of all parties for the production and distribution of products to the final consumer with mechanism in place to optimize inventories across the entire supply chain (Haan, et al., 2003; Viswanathan and Piplani, 2001). With effective management of products to create added value and competition among firms move from national to regional and to a global level, new strategies are being adopted by a number of manufacturers and retailers, particularly, in the manufacturing industries to gain a competitive advantage in world markets (Kincade, Casill, and Williamson, 1983). Pressures from low-cost and the new global competitive environment require companies to be more productive, react faster to market changes, and maintain smaller inventories. These developments in the operation of businesses entail significant changes in the traditional ways of manufacturing system (Park, 1994).

The upstream and downstream coordination engendered by supply chain management with the goal of minimizing uncertainty and variations along the supply chain shows that businesses can no longer expect that the objective of business can be met just by becoming efficient in itself. As indicated by Hameri and Palsson (2003), process rationalization and measurement system would need to be implemented to improve the operational efficiency inside a company by reducing lead times and by partnering with upstream and downstream players of the supply chain. The situation requires that for value to reach the customers, efficiency must be evident even in the suppliers, the distribution channel, and all associated activities and partners. Competition is no longer between individual businesses, but between groups of companies that are linked together in a chain for delivering customer value (Chandra, 2000).

The organization of this paper is as follows. In Section 2, we examine the structure of supply chain management using a model of supply chain network that illustrates the flow of products from the vendor to until it reaches the final consumers in the markets. Section 3 looks at the supply chain management decision with a discussion on the link in the decision making processes. In Section 4, the paper discusses the dynamics of supply chain with a focus on traditional approach to supply chain and the implication for market disequilibria in demand and supply. Section 5 examines integration supply chain and inventory management with a model showing functional integration among procurement, production and distribution for optimum result. Finally, Section 6 provides summary and concluding remarks.

2. STRUCTURES OF SUPPLY CHAIN MANAGEMENT

Supply chain is often represented as a network similar to the one displayed in Figure 1 below. The nodes in the network represent facilities, which are connected by links that represent direct transportation connections permitted by the company in managing its supply chain (Shapiro, 2001). The network has four levels of facilities. Product flow downstream from vendors to plants, plants to distribution centers, and distribution centers to markets. In general, a supply chain network may have an arbitrary number of levels. In some instances, products may flow upstream when intermediate products are returned to plants for rework or reusable products are returned from markets to distribution centers for recycling.

[FIGURE 1 OMITTED]

The model that is demonstrated in Figure 1 below is assuming a process with physical product being produced and distributed to reach consumers. For a broader contest, models could be used to demonstrate supply chain network for service companies like banks, insurance, airways operation and other services that operate value chains of networks of facilities for which coordinated planning is required (Shapiro, 2001). As pointed out by Fine (1999), the supply chain structure could take different dimensions depending upon the structure of industry under which it operates. If the industry demonstrates vertical structure and the product architecture is integral, competitive market forces push the structure toward a horizontal and modular configuration (Hanna and Newman, 2001). The forces include among others the following:

* The relentless entry of niche competitors hoping to pick up discrete industry segments.

* The challenge of keeping ahead of the competition across the many dimensions of technology and markets required by an integral system.

* The bureaucratic and organizational rigidities that often settle upon large, established companies.

As put by Fine (1999), these forces typically weaken the vertical giant and create pressure toward a more horizontal, modular structure. On the other hand, when an industry supply chain has a horizontal structure, a different set of force pushes the system toward more vertical integration and integral product architecture. The forces include the following:

* Technical advances in one subsystem the can create opportunity in making scarce commodity in the chain, giving market power to its owner.

* Market power in one subsystem that encourages bundling with other subsystems to increase control and more value.

* Market power in one subsystem that encourages engineering integration with other subsystems to develop integral solutions.

The dynamics of supply chain discussed above demonstrates the complexities in its management organization. The structure revolves in a cycle between integral/vertical and horizontal/modular forms. With other uncertainties in the market, the speed with which the structures complete a cycle is influenced by the clock-speed of the industry. Significant to the management of supply chain is the possibility that each product in the system could have a unique set of nodes and flow paths associated with it. For example, a single product may exhibit alternative supply chains, thus creating opportunity for cost reduction through selection of optimal supply chains for each material. Notwithstanding the possibility of channels of alternative, in general, the supply chain network system follows path of product movement from vendors to plants, plants to distribution centers, and distribution centers to markets with transition from each node recognizing the significance product service and delivery time, cost control, and inventory management.

3. SUPPLY CHAIN MANAGEMENT DECISION

Supply chain management has emerged over the past few years as the key to success in the global economy, regardless of industry or company size. Its premise is simple: operational strategies should be designed and managed around customer needs. Imagine three links in the supply chain--distribution, production, and procurement/materials (Cloud, 2000). The link in the decision making process has not been particular. Other studies have used other approaches such as procurement, production, and distribution, or vendors, plants, distributions, and markets (Kilty, 2000; Shapiro, 2001). Notwithstanding the approaches, the focus has been how companies can add value to their products as they pass through supply chain and deliver the products to geographically dispersed markets/customers in the correct quantities, with the correct specifications, at the correct time, and at a competitive cost.

Distribution--It is the closest ring to customer demand, the first link in the supply chain flow path that ensures that product and service must be available when the customer wants and needs them. According to Kilty (2000), distribution has evolved from providing a secondary but necessary role of warehousing and transporting goods to being a critical link in delivering products to the marketplace within the supply chain. It is a key factor to achieving the service-level goals set forth for the various classes of customers of the enterprise. To achieve this goals, process efficiency and accuracy are required, hence producers must be able to source materials, produce goods, and deliver the right products to the right markets on time. This means that distribution networks need to accept shorter lead times, deliver across the globe, and provide flexible product options at lowest cost.

Production--As part of the flow-path for supply chain management, production should be aligned with distribution so that we can have a production system that is capable of moving small or large quantities and standard or custom orders. However, most companies produce goods according to forecasts, not orders. Part of the reason is that traditional costing and decision-making tools can't accommodate the faster, customer-oriented system. To solve this problem, companies need to stop using standard costing for internal decision-making, and develop throughput accounting, a system that focuses on orders filled rather than goods produced (Cloud, 2000). Standard costing productivity measurements classify inventory as an asset and thus encourage production regardless of the number of orders. As a result, standard costing metrics simply do not fit a production process that emphasizes speed, flexibility, and low inventory. Throughput accounting, on the other hand, captures conversion speed, i.e. order-to-delivery cycle time and flexibility, i.e. the number of orders filled on time.

Procurement/Materials--To develop and manage system that support fast, on-time distribution networks and quick, flexible production processes, companies must transcend traditional organizational boundaries and include suppliers in the planning and administration of operations. As the teams develop, key information, viz., forecasts, product plans, and design information should be shared with suppliers.

4. DYNAMICS OF TRADITIONAL SCM

Companies operating within a traditional supply chain are likely to have procurement, production, and distribution all operating generally within a departmental structure basis and responding from individual unit to conflicting performance measures. For example, under sub-optimal operating condition model, where functional units focus on individual performance results, procurement would be interested in lowest cost if it means buying raw material in larger volumes than is necessary. Also, production would be interested in maximizing machine utilization, resulting in buildup of work in process and finished goods inventory. In the same way, distribution would be focus on high service levels and preventing stock-outs.

The consequence of pursuing such traditional approach to supply chain is that activities would not be integrated and inventory would become a disequilibria factor in demand and supply as illustrated in Figure 2 below. For example, in a typical consumer products company, marketing managers determine sales strategies for the next period (future). Their plan is passed on to the manufacturing managers who are asked to develop an appropriate production strategy. The joint marketing and manufacturing strategy is then passed on to logistics managers who are given the responsibility of developing appropriate transportation, warehousing, and inventory strategies to meet it. Thus, although the logistics managers may seek to minimize total logistics costs, larger issues of integrating strategies for logistics manufacturing, and even marketing are not addressed (Shapiro, 2001). Also, comprehensive and rapid information transfer between the sectors of the pipeline from retail point-of sale back upstream is not in place or implemented. As a result, the overall supply chain strategy of the consumer products company may be significantly sub-optimal.

[FIGURE 2 OMITTED]

When the flow path of the supply chain is not integrated as shown in figure 2, the organization will find it difficult to achieve its goals and objectives, particularly in maintaining optimum control in its transaction costs and inventory management. Often the success of an organization depends not only on how well each sector performs but also on how well the sectors in the organization interface with each other. For instance, unless logistics, production, and inventory management are well coordinated and integrated, the marketing segment of procurement may promote goods or service that operations cannot profitably deliver, or operations may turn out goods or services for which there is no demand. The consequence of this is overall slack in the organization resulting into inadequately managed transaction costs and excess inventory. Thus, new strategies need to be adopted to gain competitive advantage in world markets. The operation of businesses with pressures from low-cost, global sources require significant changes in the traditional ways from which businesses are managed. The new direction requires companies to be more productive, react faster to market changes, and maintain smaller inventories with low transaction costs.

Part of the strategy for success in supply chain management decision is the adoption of just-in-time management and lean production. The adoption of this strategy is to help eliminate wasteful and expensive inventory. Integration allows for coordinated planning, real time exchange of information, bidding and negotiation, transaction execution, and performance reporting. Integrated supply chain will help envelop all of the communications tools available from enablers of EDI and quick response (QR) to the internet. The discipline will require participants, both upstream and downstream, to implement new technologies and use the tools to:

* improve service to demanding, inventory-lean stores by providing them with the goods that consumers actually want in a timely manner;

* reduce inventory and lower attendant costs; and

* free up capital for other purposes and projects.

As a result of the conscious effort of businesses to integrate the various units of business operations, there is more opportunity to coordinate activities across the supply chain for competitive advantage.

5. INTEGRATED SUPPLY CHAIN AND INVENTORY MANAGEMENT

Integrated supply chain require that each segment of the supply chain i.e., procurement, production and distribution as shown in Figure 3 be functionally integrated for optimum result. Today's technology is the key that allows the supply chain to become integrated and therefore reduces the inventory requirement. Some examples are the electronic transmission of advance ship notices (ASN) to advise customers of the contents of a shipment and its expected delivery date. The transmission of purchase orders via electronic data interchange (EDI) can provide more timely and accurate data to suppliers, allowing for more efficient information in management and production planning (Kilty, 2000). Also, freight tracking systems now are being used in the management of the movement of goods, which provides flexibility that can be used to react to rapidly changing internal and external needs such as changes in production schedule or changes in customer product delivery requirements.

[FIGURE 3 OMITTED]

It is important that companies develop a supply chain management strategy that is consistent with their overall business strategy. A key tool to achieving this is to develop a supply chain "diagnostic method" that can be used to improve operations and reduce inventories (see Kilty, 2000). The first consideration here is for the company to examine and understand their supply and demand planning. This is the key to optimizing resources as well as the timing of activities associated with procuring raw materials and producing and distributing products. The next step is to begin the process of transitioning from a functional organization to a process organization. And finally, as companies reorganize to be process driven, then the performance measures for the various functional departments should be changed to support the overall supply chain management goals. Some examples of the measurements would include perfect order fulfillment, customer satisfaction, product quality, total supply chain cost, inventory days supply, and cash-to-cash cycle time.

The process described above will not achieve optimum result desired by supply chain if each subsystem works independently. To eliminate wasteful and expensive inventory, supply chain needs to be integrated as illustrated in the integrated model (Figure 3) below. As put by Shapiro (2001), supply chain refers to integrated planning. First, it is concerned with functional integration of purchasing, manufacturing, transportation, and warehousing activities. It also refers to spatial integration of these activities across geographically dispersed vendors, facilities, and markets. And finally, it refers to inter-temporal integration of these activities over strategic, tactical, and operational planning horizon. In the study by Porter (1985), it is pointed out that effective linkage (integration) among activities (or subsystems) in company's can lead to competitive advantage in two ways: (1) optimization, and (2) coordination. This proposes that a firm must optimize linkages in a way to reflect its competitive advantage. It also reinforces that the ability to coordinate linkages is significant to reducing costs or enhances differentiation. Advances in information technology (IT) have helped facilitated the developments in integrated supply chain planning and management.

A major goal of the integrated supply chain is the coordination of the logistics, distribution and production, and production management in a direction that will optimize the value chain of the company and help to minimize transaction costs and inventory sock keeping unit (SKU) level. Conventionally, we know that a company may hold inventories of raw materials, parts, work-in-progress, or finished products either to hedge against the uncertainties of supply and demand or to take advantage of economies of scale associated with manufacturing or acquiring products in large batches. Similarly, inventories are considered essential to build up reserve for seasonal demands or promotional sales (Shapiro, 2001). However, with the new reengineering in management and companies not just adopting just-in-time inventory practices but engaging in more integrated supply chain management, attention has recently been more focused on creating processes that reduce or eliminate inventories, mainly by reducing or eliminating uncertainties that make them necessary. These efforts have been motivated in part by the recognition that metrics describing the performance of a company's inventory management practices can be important signals to shareholders regarding the efficiency of the company's operations and hence its profitability.

The maintenance of lower transaction costs and optimum inventory control management is not without some costs and tradeoff. Past experiences have shown that managing inventory effectively in our economy and the business environment is often difficult. For example, in 1993, Dell Computer's stock plunged after the company predicted a loss. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write-downs. Also, in 1993, Liz Claiborne experiences an unexpected earnings decline as a consequence of higher-than-anticipated excess inventories. And in 1994, IBM struggled with shortages in the ThinkPad line due to ineffective inventory management (Simchi-Levi et al., 2000). In recognition of these difficulties and the urgency to pursue effective integrated supply chain management, Barsky and Ellinger (2001) pointed out that to generate lower levels of inventory and fewer stock-outs for customers, suppliers and manufacturers may have to hold significantly more inventory and expend considerably more staff time to administer the program effectively.

6. CONCLUSION

In this paper, we have examined the structures of supply chain management (SCM) and the activities involved in supply chain decisions that help promote profound improvement in efficiency and effectiveness in business operations. The paper has discussed critical issues regarding how the pressures from low-cost and the new global competitive environment require companies to be more productive, react faster to market changes, and maintain smaller inventories.

The issue of supply chain management is discussed with the implications of the vertical and horizontal structure of industry and its relationship to procurement, production and distribution in the supply chain process. In the discussion of supply chain management decision, the study points out that operational strategy should be designed and managed around customer needs with a focus on how companies can add value to their products as they pass through supply chain and deliver the products to geographically dispersed markets/customers. With inventory management as a major factor in operational efficiency, the implications of supply chain integration and non-integration were discussed. The study shows that through integration, and by partnering with upstream and downstream players of supply chain, companies have demonstrated improved ability to manage and deliver products to customers in the correct quantities, with the correct specifications, at the correct time, and at a competitive cost. Also, a major lesson for entrepreneurs from the implementation of supply chain is that businesses that focus only on cost containment will miss out on revenue-generating opportunities. Similarly, it is observed that efficient operations will not lead to superior profits if companies' products are being manufactured in plants with outdated technologies that are poorly located relative to companies' vendors and their markets.

REFERENCES

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Author Profiles:

Dr. Julius A. Alade received his Ph.D. in Industrial Economics from the University of Utah. He has authored and co-authored several journal articles/abstracts in National and International Journals. In his research, he has combined theoretic economics with financial and operations management, using linear and goal programming models. Dr. Alade is a Professor of production management/quantitative methods and the Acting Chair in the Department of Business, Management and Accounting, University of Maryland Eastern Shore, Princess Anne, Maryland.

Dr. Dinesh K. Sharma received his Ph.D. in Operations Research from the Chaudhary Charan Singh University at Meerut, India. He is currently an Associate Professor of Quantitative methods & Computer Applications in the Department of Business, Management and Accounting at the University of Maryland Eastern Shore. His research interests include multi-objective programming, nonlinear programming, and application of operations research to business & industry.

Dr. Hari P. Sharma received his Ph.D. in Applied Business Economics (Corporate Investments) from the Agra University, Agra (India). Currently, he is an Associate Professor of Finance in the Department of Accounting and Finance at the Virginia State University, Petersburg, Virginia. He has served as Vice President (Market Risk Manager) at Bank of America. His research interests are in the mathematical modeling, portfolio management and risk analysis of mortgage servicing portfolio, designing and developing of data analysis tools and models in Finance. Dr. Sharma has published several journal articles in National and International Journals. He is a member of Financial Management Association and Global Association of Risk Professionals.

Julius A. Alade ([e-mail]), University of Maryland Eastern Shore, Princess Anne

Dinesh K. Sharma ([e-mail]), University of Maryland Eastern Shore, Princess Anne

Had P. Sharma ([e-mail]), Virginia State University, Petersburg, Virginia