Designing Global Supply Chain Networks

1
Designing Global Supply Chain Networks

• Fall, 2014
• Supply Chain ManagementStrategy, Planning, and
  Operation
• Chapter 6
• Byung-Hyun Ha

2
Contents

• The impact of globalization on supply chain
  networks
• The offshoring decision total cost
• Risk management in global supply chains
• The basic aspects of evaluating global supply
  chain design
• Evaluating network design decisions using
  decision trees
• AM Tires Evaluation of global supply chain
  decisions under uncertainty
• Making supply chain decisions under uncertainty
  in practice

3
Impact of Globalization on Networks

• Globalization
• Long-term decisions under uncertainty
• Opportunities and risks, at the same time
• e.g., Nokia and Zara
• Opportunities from globalized network
• Revenue growth
• e.g., Nokia and PG
• Cost reduction
• For easy to ship, standardized goods
• Economy of scale by consolidating production
• e.g., consumer electronics (small, lightweight,
  high-value)
• e.g., apparel (high labor contents)

4
Impact of Globalization on Networks

• Risks from globalized network
• Accenture survey on sources of risk (Table 6-1)
• Performance of supply chain partners
• Volatility of fuel prices
• Natural disasters
• Logistics capacity/complexity
• Forecasting/planning accuracy
• Currency fluctuation
• Supplier planning/communication issues
• ...
• The only constant in global supply chain
  management seems to be uncertainty.
• e.g., Honda Toyota vs. Nissan

5
Offshoring Decision Total Cost

• Offshoring to low-cost countries is likely to be
  most attractive for products with
• High labor content
• Large production volumes
• Relatively low variety
• Low transportation costs
• Total cost perspective
• Offshoring increases the length and duration of
  of
• information, product, and cash flows
• e.g., low-cost countries but increases in
  transportation cost
• Reasons of failing from offshoring
• 1. Focusing exclusively on unit cost rather than
  total cost
• 2. Ignoring critical risk factors

6
Offshoring Decision Total Cost

• Dimensions to consider when evaluating total
  landed cost from offshoring (Table 6-2)
• Order communication, supply chain visibility
• Raw material cost, unit cost, freight costs
• Taxes and tariffs
• Supply lead time, on-time delivery, lead time
  uncertainty
• Minimum order quantity
• Inventories, working capital
• Stock-outs, product returns, hidden costs
• Some efforts for successful global sourcing
• Reduction of transportation content
• e.g., IKEA and Nissan
• Flexible shipping policies
• Appropriate process assignment across global
  network

7
Risk Management in Global Supply Chains

• Risks in global supply chain
• e.g., financial crisis, supplier disruption,
  strengthening of euro, port congestion
• Supply chain risks to be considered (Table 6-3)
• Disruptions
• Delays
• Systems risk
• Forecast risk
• Intellectual property risk
• Procurement risk
• Receivables risk
• Inventory risk
• Capacity risk

8
Risk Management in Global Supply Chains

• Risk mitigation examples
• Multiple suppliers of Nokia (cf. Ericsson)
• Flexible capacity of Hino Trucks
• Tailored risk mitigation strategies
• Increase capacity
• Get redundant suppliers
• Increase responsiveness
• Increase inventory
• Increase flexibility
• Pool or aggregate demand
• Increase source capability
• Price of mitigation strategies
• Increase cost and other risks
• e.g., inventory ? ? responsiveness ? but
  obsolescence risk ?

9
Risk Management in Global Supply Chains

• Flexibility for mitigating risks and
  uncertainties
• New product flexibility
• e.g., common architecture and product platform
• Mix flexibility
• e.g., modular design and common components
• Volume flexibility
• Chaining and containment
• As flexibility increases, the marginal benefit
  derived form the increased flexibility
  decreases.
• Risk mitigation by chaining with lower cost
• Dealing with supply disruption by containment

chainednetworkwithone longchain
chainednetworkwithtwo shortchains
fullyflexiblenetwork
dedicated network
10
Basic Aspects of Evaluating Global Design

• Long-term aspects of global network design
• Cash flows over the duration of time
• Accounting for risks and uncertainties
• Discounted cash flow analysis
• Evaluating the present value of any stream of
  future cash flows
• Comparison in terms of their financial value
• Based on the time value of money
• A dollar today is worth more than a dollar
  tomorrow.

11
Basic Aspects of Evaluating Global Design

• Net present value (NPV)
• Compare NPV of different supply chain design
  options
• Highest NPV ? greatest financial return, in
  general

12
Basic Aspects of Evaluating Global Design

• Net present value (contd)
• Example Trip Logistics
• Data
• Requirement 1,000 sq. ft. for 1,000 units of
  demand
• Demand D 100,000 units per year
• Lease price 1.00 per sq. ft. per year
• Spot market price P 1.20 per sq. ft. per year
• Revenue 1.22 per unit of demand
• Discount factor k 0.1
• Decision
• Spot market for 3 years?
• Each years profit 100,000 ? 1.22 100,000 ?
  1.20 2,000
• NPV 2,000 2,000/1.1 2,000/1.12 5,471
• Lease for 3 years?
• Each years profit 100,000 ? 1.22 100,000 ?
  1.00 22,000
• NPV 22,000 22,000/1.1 22,000/1.12 60,182

13
Basic Aspects of Evaluating Global Design

• Representations of uncertainty
• Binomial representation scenario
• Multiple consecutive periods
• Considering a value P
• e.g., price
• Two possible outcomes at each period
• Move up by factor u gt 1 with probability p
• Move down by factor d lt 1 with probability (1
  p)
• Multiplicative binomial
• Possible outcomes
• Period 1 Pu, Pd
• Period 2 Pu2, Pud, Pd2
• Period 3 Pu3, Pu2d, Pud2, Pd3
• Period 4 Pu4, Pu3d, Pu2d2, Pud3, Pd4
• ...

14
Basic Aspects of Evaluating Global Design

• Representations of uncertainty (contd)
• Additive binomial
• Possible outcomes
• Period 1 P u, P d
• Period 2 P 2u, P u d, P 2d
• Period 3 P 3u, P 2u d, P u 2d, P 3d
• Period 4 P 4u, P 3u d, P 2u 2d, P u
  3d, P 4d
• ...
• ? Probability of binomial outcomes
• f(x, t) Pr(x up-moves at period t) Pr(n x
  down-moves at period t)

15
Basic Aspects of Evaluating Global Design

• Representations of uncertainty (contd)

Pu4 p4
price probability
Pu3 p3
Pu2 p2
Pu3d 4p(1 p)3
Pu p
Pu2d 3p2(1 p)
P 1
Pud 2p(1 p)
Pu2d2 6p2(1 p)2
Pud2 3p(1 p)2
Pd (1 p)
Pud3 4p(1 p)3
Pd2 (1 p)2
Pd3 (1 p)3
Pd4 (1 p)4
16
Basic Aspects of Evaluating Global Design

• Representations of uncertainty (contd)
• Other representations of uncertainty
• Markov process
• Log-normal diffusion process
• Mean reverting process
• ...

17
Evaluating Decisions Using Decision Trees

• Examples of SC network design decisions
• Long-term contract or spot market as needed for
  warehousing?
• Mix of long-term or spot market of transportation
  capacity?
• Fraction of flexible capacity?
• Without uncertainty consideration
• Always long-term contract
• e.g., portfolio of dedicated and flexible
  capacity in pharmaceutical industry
• Decision tree
• A graphic device that can be used to evaluate
  decisions under uncertainty

18
Evaluating Decisions Using Decision Trees

• Procedure of decision tree analysis
• 1. Identify the duration of each period (month,
  quarter, etc.) and the number of periods T over
  the which the decision is to be evaluated.
• 2. Identify factors such as demand, price, and
  exchange rate, whose fluctuation will be
  considered over the next T periods.
• 3. Identify representations of uncertainty for
  each factor that is, determine what distribution
  to use to model the uncertainty.
• 4. Identify the periodic discount rate k for each
  period.
• 5. Represent the decision tree with defined
  states in each period, as well as the transition
  probabilities between states in successive
  periods.
• 6. Starting at period T, work back to period 0,
  identifying the optimal decision and the expected
  cash flows at each step.
• Expected cash flows at each state in a given
  period should be discounted back when included in
  the previous period.

19
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• Decision
• Whether to lease warehouse space for the coming
  three years
• Quantity to lease
• Current condition
• Long-term lease is currently cheaper than the
  spot market rate.
• Uncertainty
• Demand and spot prices over the next three years
• Risks
• Long-term lease is cheaper but could go unused if
  demand is lower than forecast.
• Spot market rates are currently high, and the
  spot market would cost a lot if future demand is
  higher than expected.

20
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• Decision alternatives
• 1. Get all warehousing space from the spot market
  as needed
• 2. Sign a three-year lease for a fixed amount of
  warehouse space and get additional requirements
  from the spot market
• 3. Sign a flexible lease with a minimum change
  that allows variable usage of warehouse space up
  to a limit with additional requirement from the
  spot market
• Data
• Requirement 1,000 sq. ft. for 1,000 units of
  demand
• Current demand D 100,000 units per year
• Up-move by 20 with p 0.5 or down-move by 20
  with 1 p
• Lease price 1.00 per sq. ft. per year
• Spot market price P 1.20 per sq. ft. per year
• Up-move by 10 with p 0.5 or down-move by 10
  with 1 p
• Revenue 1.22 per unit of demand
• Discount factor k 0.1

21
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• Decision tree

22
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• 1. Obtaining all warehouse space from the spot
  market
• Period 2 calculation
• C(D144, P 1.45, 2) 144,000 ? 1.45 208,800
• P(D144, P 1.45, 2) 144,000 ? 1.22 208,800
  33,120
• ...
• Period 1 calculation
• EP(D120, P 1.32, 1) 0.25 ? P(D144, P 1.45,
  2) 0.25 ? P(D144, P 1.19, 2) 0.25 ?
  P(D96, P 1.45, 2) 0.25 ? P(D96, P
  1.19, 2)
• PVEP(D120, P 1.32, 1) EP(D120, P 1.32, 1) /
  (1 k)
• P(D120, P 1.32, 1) 120,000 ? 1.22 120, 000
  ? 1.32 PVEP(D120, P 1.32, 1)
• ...
• Period 0 calculation
• P(D100, P 1.20, 0) 5,471 NPV

C(Dx, Py, t) cost when D x and P y at
period t P(Dx, Py, t) profit EP(Dx, Py, t)
expected profit of next period PVEP(Dx, Py, t)
present value of EP(Dx, Py, t)
23
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• 2. Fixed lease option
• Period 2
• C(D144, P 1.45, 2) 100,000 ? 1.00 44,000 ?
  1.45
• P(D144, P 1.45, 2) 144,000 ? 1.22 C(D144,
  P 1.45, 2)
• ...
• C(D96, P 1.45, 2) 100,000 ? 1.00
• ...
• Period 1
• ...
• Period 0
• P(D100, P 1.20, 0) 38,364 NPV
• ? No uncertainty case (D100 and P 1.20 for all
  periods)
• NPV P(D100, P 1.20, 2) ? (1 1/1.1 1/1.12)
  60,182
• ? Rigid contract is less attractive in the
  presence of uncertainty.

24
Evaluating Decisions Using Decision Trees

• Example Trips Logistics (contd)
• 3. Flexible lease option
• Data
• Upfront payment of 10,000 for lease for 60,000
  100,000 sq. ft.
• Addition price for 1 sq. ft. per year 1.00
• Period 2
• C(D144, P 1.45, 2) 100,000 ? 1.00 44,000 ?
  1.45
• ...
• C(D96, P 1.45, 2) 96,000 ? 1.00
• ...
• Period 0
• P(D100, P 1.20, 0) 100,000 ? 1.22 100,000 ?
  1.00 PVEP(D100, P 1.20, 0) 56,545
• NPV 56,545 10,000 (upfront payment)
  46,545

25
AM Tires Evaluation Under Uncertainty

• Data
• (Uncertain) demand in U.S. Mexico, and exchange
  rate
• Dedicated or flexible capacity in U.S. and Mexico
• Different fixed and variable cost shipping cost
• Capacity (decision) alternatives
• Both dedicated
• Both flexible
• U.S. flexible, Mexico dedicated
• U.S. dedicated, Mexico flexible
• ? For each node, demand should be allocated
  optimally!

U.S.
U.S.
Plants
Markets
Mexico
Mexico
26
Making Under Uncertainty in Practice

• More complicated decision tree analysis
  methodology and simulation
• Combine strategic planning and financial planning
  during global network design
• Use multiple metrics to evaluate global supply
  chain networks
• Use financial analysis as an input to decision
  making, not as the decision-making process
• Use estimates along with sensitivity analysis