A study of the effects of supply chain performance through inventory policy improvements and information sharing

Transcription

1 A study of the effects of supply chain performance through inventory policy improvements and information sharing Master thesis in Logistics and Supply Chain Management Aarhus School of Business and Social Sciences, Aarhus University Author: Maren Aareskjold Supervisor: Hartanto Wijaya Wong August 2012

2 Abstract Background: In extended periods at the end of 2011 Lærdal experienced increasing stock-out situations at the inventory facility in the Netherlands, for subsequent periods they struggled to maintain the inventory at a desirable level. The unexpected increase in demand was due to health workers in Switzerland changed the training procedures to apply the CPR doll Little Junior in favour of the previous used CPR doll. The focus of this thesis is to investigate whether a change in Lærdal s inventory policies and improved information sharing will have a positive effect on decreasing these stock-outs periods in the future, while the costs are kept at a minimum level in order to try to improve Lærdal performance. The results: Quantitative results are obtained based on five Excel models where each is created to show Lærdal with different settings and strategies. An attempt was made to change Lærdal s current inventory policies in such a way as to improve control of the inventory, in addition to investigating the information shared between Lærdal and customers/suppliers. Both of these areas have been in focus to be able to reduce potential uncertainty in the supply chain and future stock-outs for Lærdal. It was shown that Lærdal could save a total of 7.8 % in total cost and improve the fill rate by 5% if they altered the inventory policies used today. On the other hand it showed that information sharing between Lærdal and the customer would not improve the service level, however holding cost and variability decreased. Main conclusions and recommendations: Based on the results of the created models, the main conclusion in this thesis is to recommend Lærdal to change the inventory policies currently used to potentially reduce the costs and improve the customer service level and create better relationships in the supply chain where information is shared, in order to reduce the existing variability.

3 Table of Contents Chapter 1 Introduction Introduction and problem statement Motivation behind the thesis Assumptions and Delimitations The structure of the thesis... 7 Chapter 2 Description of Lærdal About the company The initial story Product development Acquisitions Product range Current situation Material flow Lærdal Information Flow Lærdal s Inventory Policy Little Junior The problem Chapter 3 - Literature Review Supply Chain Management Potential problems in a supply chain Inventory management Bullwhip effect Possible solutions to supply chain problems Information sharing Collaborative strategies Vendor-managed inventory (VMI) Collaborative Planning, Forecasting and Replenishment (CPFR) system Periodic flexibility (PF) Concerns about information sharing and collaboration in a supply chain 31 Chapter 4 Methodology Step 2: Identify major issues and problems Step 3: Generation and evaluation of alternative solutions Chapter 5 - Model descriptions and Results Assumptions in the models Distribution fitting

4 5.3 Performance measurements Model 1 - Lærdal s current situation with normal demand Brief model summary Inventory strategy used Expressions Model description Results Model 2 - Lærdal s current situation with periods of increased demand Expressions Model description Results Model 3 Changes to Lærdal s inventory policies Brief model summary Inventory strategy used Expressions Model description Results Model 4 Decentralized supply chain Brief model summary Inventory strategy used Expressions Model description Lærdal s side Customer s side Results Model 5 Coordinated Control where demand information is shared Brief model summary Inventory strategy used Expressions Model description Lærdal s description Customer s description Results Chapter 6 Conclusion Conclusion Criticism of this thesis References Appendix

5 Chapter 1 Introduction 1.1 Introduction and problem statement During the last couple of decades there has been a rapid increase of globalization in business environments due to constant development of technology within manufacturing and information, increased cost pressure, and more aggressive demand from customers. To be able to compete in the market with others offering similar products companies are increasingly working on integrating the supply chain with suppliers and retailers, the aims being to offer products with improved quality and lower price while improving the customer service. This can be achieved by developing long-term contracts that assure cooperation and information sharing among the supply chain participants, which optimally will create a win-win situation for all participants. Benjamin and Wigand (1995) said that understanding the supply chain cooperation helps position the entire chain as a source of competitive advantage. However, it can be problematic for companies to be optimal and excel within every aspect of the supply chain, because the efforts and expenses that need to be made could be unjustifiable. The focus could then rather be on identifying and optimizing the inventory strategies where the objectives are to maximize the efficiency, growth and profitability by reducing the inventory level, which can lead to many of the same improvements as mentioned in an integrated supply chain. According to Mulani s (2002) research a company can then improve the cash flow with 30%, the customer service with 10%, and in addition the company could experience an improved and more efficient supplier relationship. Investigating these areas in a company s setting is the object of this thesis. The company studied is the Norwegian based company Lærdal Medical ASA (in the following called Lærdal), one of the largest and most important medical equipment companies in the world, with a market share of around 45%. Because of Lærdal s high and important market position and loyal customers, Lærdal s representatives have explained that even though there are short periods of stock-outs and delivery delays they don t believe this affects the customer and supplier relationship much, especially not on the cheaper and less important products where they have experienced that most customers are willing to wait until the order is available. 3

6 However, at the end of 2011 the stock-outs periods became longer and more frequent, and Lærdal struggled to a larger degree to stabilize the inventory at a desirable level. Even though they did not experience any subsequent financial problems, there was a natural increase in costs since they increasingly used transhipments and rush orders to be able to fulfil the demand. If the same problems were to happen to more critical products it is not safe to say that the customers would be as understanding and willing to wait for the order as they are for the cheaper products. Lærdal s customers range from large and important actors supplying a whole country or government directives to single individuals purchasing for private use. Because of the large customer variations it can lead to high fluctuation in customer demands, which increases the risk of the bullwhip effect; in addition it can be difficult to find the optimal trade-off between inventory size and cost. Many production companies have solved this by introducing a just-in-time strategy where the lead-time is minimized and the goal is to reduce inventory waste, but this strategy would currently be impossible for Lærdal to implement because the cost of reducing the lead-time to what is optimal for a just-in-time strategy would exceed the income from the product. A study of Lærdal s current implemented inventory and supply chain strategies have only been possible to conduct because of the full disclosure of information and data Lærdal has provided, from this it has been possible to locate the problematic areas and come up with the problem questions below that seem reasonable when locating the causes and potentially solve them. è How can Lærdal reduce the possibility of long stock-out periods in the future? è How to ensure this, while keeping the inventory related costs at a minimum level? è Examine whether Lærdal is at the risk of experiencing bullwhip effect, and how to initiate the correct actions to potentially reduce the impact? Little Junior is used in the thesis as an example of a product that experienced the problems covered by the problem questions presented above. 4

7 1.2 Motivation behind the thesis The education in logistics and supply chain management has been a major influence when finding inspiration for this thesis and deciding on the research area. During the time at Aarhus School of Business and Social Science a lot of different and interesting topics in the area of logistics and supply chain management have been presented and this thesis has been conducted with this knowledge. It is inspiring to get the feeling of familiarity when a company s context is analysed such as to connect it to the theory learned from these courses, which shows that this knowledge can be used in real contexts in the business environment. Another important factor that have been motivational are the possibilities this process has given to be more or less selfdetermined, both when it comes to deciding on the research area studied as well as shaping the thesis to focus on the most interesting aspects of it. Lærdal was chosen as the company to conduct the research on because of its reputation to have a well-controlled and optimized logistics, where it could be possible to learn how things are done in practice and benefit from their knowledge while doing this thesis. It was interesting to see that even though the overall company performance measurements were well above the targeted level they were still struggling in some areas, which often can be neglected because of the company s general good performance, time and resources to investigate this further are then often not prioritized. It was motivational to look into one of these issues since they are real problems in a real company - if executed properly this thesis could come up with solutions that Lærdal might not have considered and the results could then be important and really make a difference for the company. When deciding on the problem area I wanted to focus the thesis on inventory and supply chain management, due to its relation to my studies and increase in focus towards this topic in the business sector. 5

8 1.3 Assumptions and Delimitations The thesis has been designed based on a number of assumptions and delimitations; some of these concerning the construction of the models and are presented in Chapter 5 Model description and results, while the more general assumptions and delimitations and the reasons behind these are explained in this section. In this thesis Lærdal is investigated and analysed based on data and information collected and received from the company s representatives and the introduced changes and final conclusions are based on these and must be interpreted in context where the information and data used are correct and reliable. Many of the delimitations in the problem formulation phase were established to reduce the size of the thesis as well as to meet Lærdal s requests of focusing on the stock-out issues they experienced in 2011 with Chinese products on the European market. Additional delimitation made was to focus on one product only, Little Junior, which was chosen as an example, as it would be possible to implement the suggested changes to other products experiencing similar issues. The focus in this thesis is on supply chain improvements, any potential advances in regard to Lærdal s forecasting techniques have not be fully investigated, but rather a suggestion of an area that could be focused on with regards to improving the company s inventory control. The area investigated is supply chain management, which means that even though Lærdal is the company investigated, other participants would also have to be included to be able to fully explore Lærdal s benefits when there exist a profound cooperation in the supply chain. Since information from customers was impossible to acquire, assumptions are made about how the customers act and their settings, as described in more detail in Chapter 5. In the modelling phase the goal is to show how information, in general, can improve Lærdal s performance. Optimally different collaboration techniques should have been simulated, but in such strategies there are a lot of basic decisions about type of cooperation and contract details that need to be evaluated by all participants in order to find what best suits them in such a way that all participants can optimize the performance. 6

9 1.4 The structure of the thesis The thesis is made up of 6 chapters, where the first chapter, presented above, is an introduction to the problem questions and the areas described later in the thesis. In addition, general delimitations and assumptions are defined. In Chapter 2 an overview is given of the company, the material and information flow, and Little Junior is presented, in addition to the problem Lærdal experienced, which is the background of this thesis. Chapter 3 presents the relevant literature that is related to the subject of this thesis. In Chapter 4 Taylor s 5-step process is used to present the methodology of how Lærdal s problems were identified, and the work done to try to solve them. Chapter 5 gives detailed descriptions of the five models created, in addition the empirical findings are presented and analysed In Chapter 6 the problem questions are answered and a summary of what has been conducted in the thesis is presented. 7

10 Chapter 2 Description of Lærdal 2.1 About the company The average response time for an ambulance is approximately ten minutes and for each minute a human being is without breath the survival rate drops by 7-10%, which illustrates how life saving a basic knowledge of CPR can be The initial story Åsmund S. Lærdal founded Lærdal in the 1940s; in the first couple of decades the company focused on toy production and under the name Tomte Lærdal they became world known for their rubber toys. When the production stopped in 1978 over 100 million toy cars were sold in more than 110 different countries 1. It was Lærdal s reputation as a producer of good quality rubber that made an American medical supply producer request rubber samples, which marked the start of Lærdal s exploration with first aid and emergency medicine products. Lærdal has continuously developed more practical and easy-to-use products, both for hospital treatment and medical training, and is today a world leading company in medical equipment and medical training articles Product development The change of the business focus is symbolized by a girl who drowned in the river Seine in the late 1890s. Åsmund Lærdal was so moved by this story that he wanted everyone to know basic CPR, which resulted in Lærdal developing a life-like resuscitation-training manikin based on the death mask of her face. This Resusci Anne doll is still one of Lærdal s most popular products and is sold around the world. More complicated human-like training dolls with integrated software have been developed in recent years to train users in a more virtual setting that increases the understanding of reality; these are often used in medical training and education. However, simpler and less expensive versions of CPR training articles, such as Little Junior, have also been developed to make it easier and more available for everyone to learn basic CPR

11 Lærdal closely follows medical advances and constantly work on creating and improving products in line with this development. This can be recognized when Lærdal in the 1960s started developing easy to carry and handle equipment for ventilation and airway control, which was done on the basis of new research that showed how vital pre-hospital emergency treatment was for saving lives. Lærdal also started developing heart start-semi-automatic defibrillator in the 1980s when new medical research showed that early defibrillation increased the survival rate of prehospital cardiac arrest Acquisitions During the early years of 2000 Lærdal expanded in multiple areas within medicine equipment that strengthened their position as a world leading company in the area of medical training. Lærdal started off by buying the innovative Texas-based company Medical Plastics Laboratories Inc, now called Lærdal Texas, which in addition to Lærdal s organization in New York, expanded Lærdal into new channels for sale and distribution, and strengthened their position on the US market. Another strategic acquisition made two years later was the Danish-based Sophus Medicals, now called Lærdal Sophus - a leading company within inter-active medical training products, which are software used in the education of pre-hospital, in-hospital and military segments. This introduced Lærdal to new areas of technology, software simulations, and in 2004 they bought SimQuest, which produces virtual reality software. These acquisitions made Lærdal a leader and a pioneer in the micro simulation program market. The final step Lærdal made in this period was to open a new factory in China to manufacture a simple range of low-cost products where software is not implemented. A factory in China would, according to Lærdal, enable the company to be better prepared for the future by providing a quality factory in the Far East, but also access the rapid growth in the Chinese market 2. 2 Lærdal.com: 9

12 2.1.4 Product range Because of the acquisitions and partnerships, and a policy to improve the market, Lærdal is able to offer customers a great range of products. This range can be divided into seven main categories, which can be seen below, and includes everything from simulation software that gives a more realistic training, to simple mouth-to-mouth protection. è First aid Training/ Airway Management è Medical education è Course and Scenario Packages è Simulation è Simple airway management è Immobilization è Heart starter Their goal of these products is to help educate people in all areas of first aid and medical training. 2.2 Current situation In this section Lærdal s current situation is in focus, firstly describing Lærdal s general material and information flow, then Lærdal s inventory policy is specified and at the end there is a short description of the product Little Junior Material flow Lærdal The outline of Lærdal s general supply chain shows how raw materials, parts and finished products are transported between suppliers and production facilities, production facilities and distribution centres (DC), and between DC and customers, which is outlined in figure 2.1. Since the material flow is the same regardless of whether the customer is an end-user or a retailer, they are all classified as customer. Lærdal s products are produced and assembled at a range of different factories around the world, but only three of these (LM-Norway, LM-Texas and LM-China) are owned and controlled by Lærdal. When the production process is completed the products are sent and stored in one of Lærdal s eight distribution centres (DC) around the world. 10

13 However, this thesis focuses on DC in the Netherlands and for this reason figure 2.1 below is mainly outlined based on the material flow affecting this facility. The Norwegian factory, LM-Norway, produces many of Lærdal s most technological and innovative products in the area of medical training, where complicated software programmes are often included. Other products produced at this location are in the airway management category such as suction pumps and ventilations, additionally LM-Norway produces parts used in articles produced at Lærdal s factory in China. The main products manufactured at Lærdal s factory in Texas, LM-Texas, are simulated CPR dolls, but these are less innovative than what is produced at LM- Norway. LM-Texas also produces most of Lærdal s patient care, vein/artery, and anatomical model-products, which are also categorised as medical training products, but in a very simple degree, only studying a limited area of medical practice concentrated on a small part of the human body. Articles produced at the Chinese factory, LM- China, are classified in the simpler category of Lærdal s portfolio where no software is incorporated and the production processes are less complicated compared to what is done in LM-Norway and LM- Texas. The products are assembled with parts supplied from a variety of different suppliers, mainly in China, but some more important strategic parts are produced at other Lærdal factories and shipped to China. The flow of materials is more or less the same for all three of Lærdal s factories (LM- Norway, LM-Texas and LM-China)- they receive components or raw materials from a range of different suppliers around the world, many of these are strategically located close to the factories but, as mentioned above, there are also examples where parts are sent halfway around the world to be used in the production process. The lead-time from suppliers to the factories varies from anywhere between 10 to 58 days, depending on the location of supplier and factory. From the production process starts it takes approximately days until the products are completed and ready to be shipped to Lærdal s DCs where the products are stored until requested by a customer. The exception is shipments from factories outside Europe - these are sent to the DC in the Netherlands, which also serves as a cross-docking centre, where the shipments are consolidated with other shipments and sent to DC in UK and Norway. 11

14 Phillips factory in Seattle is the fourth factory in the figure below, and supplies Lærdal with heart starters (AED - automated external defibrillator). This partnership is about more than just production of AEDs, Phillips and Lærdal cooperate on developing and improving the technology of the AEDs and in this they are keeping up with the market development. Incorporated in the agreement, Lærdal is distributing Phillips AEDs, while Phillips is selling Lærdal s training products together with their own products. But as illustrated in figure 2.1 below, Phillips controls the material flow of the AED until the product is finished and stored at one of Phillip s own facilities, which means that Lærdal is not involved in Phillip s material flow until they can buy the finished product from them. In addition to the strategic partnership with Phillips, Lærdal has outsourced production to approximately twenty various factories of finished goods, for convenience these are merged into one facility in the figure below. Products produced at these factories are immobilising products i.e. head stabilizer, and the product Chester Chest. Although these factories are located around the world, the finished products are transported from the different factories to the Norwegian DC and from this location transhipped to the remaining Lærdal s DCs. There currently exists no formal contract between Lærdal and their customers which guarantees that the order be received within a certain time frame, but Lærdal internally measures their service degree on fulfilled orders and have a goal that customers shall receive the order within 4-6 days, depending on the distance from the inventory location. 12

15 Figure 2.1: Lærdal s Material flow (source: Lærdal Medical) 13

16 2.2.2 Information Flow Information and data goes back and forth between Lærdal s customers, company departments, DCs and factories, and supports Lærdal in controlling the material flow. As can be seen from the figure 2.2, customers can either use Lærdal s web page to make an order or they can place the order at one of Lærdal s sales offices, but no matter which procedure is used, the information is eventually added to Lærdal s ERP system MFG/pro and can be used as a source of information for all internal logistics. Three times a day EDI messages are sent from MFG/pro to the respective DC regarding shipping instructions of customer orders and when a shipment has been completed and shipped to the customer, the DC creates a verification message also sent as an EDI message to Lærdal, and these are automatically uploaded to the MFG/pro once a day. This means that Lærdal always has updated and available information concerning product status and can issue an invoice when they know the order is on its way to the customer. From MFG/pro Lærdal s procurement department has access to all information needed about i.e. inventory, planning data, purchase order and receiving, sales order/withdrawal and billing orders, and this information is used to control the production at the factories and the inventory level at the DCs. The procurement department checks the inventory level regularly and if it is close to or below the reorder point an order is created and sent to the factory by an EDI message, which inform the factory how much to produce of a specific product. The factory then notifies the DC, also with an EDI message, when the order should be completed and ready to be dispatched. In the same way as above, these messages are uploaded and stored in the MFG/pro once a day. Should delivery problems occur, customers are notified automatically if they have a web account, but if the customer does not have an account, Lærdal s customer service inform them either by or phone. Customers can always contact the customer service department with any questions, as this department is the connection between Lærdal and the customers. Today there is limited contact and information shared between Lærdal and customers, and Lærdal and suppliers. Customer contact is very basic and the information shared 14

17 only concerns product tracking information. The same applies for the suppliers where only a few of them share any information with Lærdal, those who do, irregularly shares their quarterly or annual forecasted sales reports. Figure 2.2: Lærdal s Information Flow (source: Lærdal Medical) Lærdal s Inventory Policy Each of Lærdal s eight DC facilities has a strategically centralized location, which makes it easier to reach and support a large market. The DC in the Netherlands, located in Tilburg, supplies most of the European continent with all Lærdal s products, and is the largest of the eight distribution centres sending out approximately shipments a year. Since the Netherlands is a part of the European Union the transportation is quick and smooth and custom declarations are avoided. If any problems occur with satisfying customers demand, the demand will be backlogged and fulfilled as soon as there are available units. In such stock-out 15

18 situations Lærdal has two alternatives of how they can fulfil the unsatisfied demand besides making normal orders to the manufacturer: è Transhipments è Rush orders The first alternative, transhipment, means that the procurement department checks whether the DC in either Norway or the UK have a positive inventory level for the specific product, the backlogged orders can then be fulfilled from these. Because there is no need to do any physical changes to the product when transferred between markets, transhipment is a cheap alternative; the only additional cost incurred is the transportation. In situations where transhipment is not an alternative, Lærdal can make rush orders to the factory, which only takes 22 days but is nine times more expensive than making a regular order. Not all products are worth the costs associated with rush orders or transhipments when a stock-out occurs. To improve product control and inventory level Lærdal uses an ABC analysis that classifies all products in 5 different categories ranging from A to E, which is based on the number of transactions and the unit value. This classification can be found in table 2.1 where the A and B products are the most important and therefore the most important to control. The classification of products is additionally important when Lærdal calculates the products reorder point where the different categories are calculated with different formulas. Classification A B C D E Criteria Non B items with value of more than 1500 NOK All items with more than 50 transactions Non B items with a value of less than 1500 NOK All items with manual follow up All items with 0 transactions Table 2.1: Lærdal s ABC classification (Source: Lærdal Medical) 16

19 2.2.4 Little Junior Little Junior, which is the product focused on in this thesis, is a medical training doll where the goal is to provide users with a better understanding of how it is to do CPR on a child. The training doll is produced at Lærdal s factory in China (LM- China), and as can be seen from figure 2.3, is a simplified model of a child s upper body where the focus is on teaching people how to do correct back bending of head, and chin and jaw lift to open and Figure 2.3: Little Junior (source: Lærdal Medical) ease the airway. Little Junior is a simple product without implemented software or other sophisticated features, it weighs 3.4 kg and most components are made of plastic. Little Junior receives parts from suppliers in China in addition to Lærdal s Norwegian factory; the reason why this product is supplied with parts from Norway is because of previous experienced cases of leaks at the Chinese factory. The parts received from Chinese suppliers are transported by truck to the factory and have a total lead-time of approximately 10 days, while the parts from Norway are shipped by sea and have a lead-time of 58 days. The manufacturing process is a make-to-order, which means that the production does not start until an order is made from the procurement department in Norway. The processing time is 2 days, from this point it takes 10 days to complete Little Junior and make it ready to be dispatch and 46 days until the order is stored at Lærdal s DC in the Netherlands. 17

20 Figure 2.4: Material flow Little Junior in the European market (source: Lærdal Medical) The procurement department in Norway periodically reviews the DC in the Netherlands once a week to see how the inventory level of Little Junior is compared to the reorder point. The calculation of the reorder point is based on historical demand and is recalculated and adjusted every other month. Little Junior is classified as a B product, which means that the reorder point is calculated by: Reorder point = Average demand * lead- time + 1,96* STD + 15%* average demand The average demand is calculated based on the last 52 weeks where the 10 most recent weeks are emphasized by 20%, while the remaining 42 weeks are emphasized with 80% is the set safety factor, referred as z in the literature, multiplied with the standard deviation of the forecasted weekly demand, which make up the buffer for variation in demand. The last part of the formula above (15%*average demand) is a buffer level that Lærdal uses because of the variations in the product s lead-time. With this formula it is possible for Lærdal to use different percentages and buffers according to how reliable the supplier is. For example, it can be enough to use 10%*average demand for a dependable supplier, while for another Lærdal needs to use 20%*average demand to assure satisfying performance. Lærdal uses an additional buffer for products with lead-time longer than 5 weeks, which is the case of Little 18

21 Junior, this was introduced because Lærdal experienced that the formula for calculating the reorder point was often to low for products with long lead-time. Additional buffer = Average demand * 2 Lærdal uses an ordering rule where a minimum of 42 units are ordered each time; the reason this is applied is because Little Junior is packed in cases of 6 units and 7 cases can be placed on one pallet. In situations where orders are greater than the minimum level, it can be adjusted in multiples of 6. The ordered quantity is based on how many units have been sold since the procurement department previously made an order, but the data received from Lærdal shows that most orders made are 42, units even though the demand since the last order made was higher than this. 2.3 The problem In this part a short description of the problem Lærdal experiences will be presented, which is the focus investigated in this thesis. In the last couple of months in 2011 the distribution centre in the Netherlands (DC- NL) experienced delivery problems of Little Junior, in several periods the inventory level was negative and DC-NL was not able to fulfil customers demand. Transhipments from the DC in UK and Norway in addition to rush orders to the factory in China were done in order to try to cover the gap between demand and product availability in the European market. However, even with these actions it is possible to see from figure 2.5 that Lærdal struggled to keep the inventory at DC-NL at a satisfactory level, and from the start of October 2011 there was a large decline in Lærdal s inventory level that ended up negative in November and December. 19

22 Figure 2.5: Weekly Inventory Level of Little Junior (source of information: Lærdal Medical) Even though there is no information from the other DCs it is reasonable to assume that the low inventory level at DC-NL also affected the inventory level at the DC in UK and Norway, especially when transhipments were done, which in worst case can cause similar stock-out problems at these facilities as experienced at DC-NL. To better understand some of the more obvious reasons behind this negative trend that seems to exist at the end of 2011, figure 2.6 outlines the total unit demand from all of Lærdal s customers delivered by DC-NL in 2010 and As can be seen from the red line, there has been a large increase in customers orders in the last quarter of 2011, and in the middle of December the demand was higher than 150 units, which differs much from the situation in 2010, where at the same time the demand was only 15 units. Figure 2.6: Lærdal s Weekly Demand of Little Junior (source of information: Lærdal Medical) 20

23 Due to the high demand from customers at the end of 2011, the procurement department was in this period making larger and more frequent orders than before the increase in demand occurred, as illustrated in figure 2.7. Because of the long leadtime that exist, orders for Little Junior made in November and December 2011 were not in stock until February and March 2012, and at that time there is a chance that the demand reverted to how it was before the increase occurred. If Lærdal is not observant of such change and continues to order at the same pattern as if the demand was still high, they are in great danger of the bullwhip effect. Figure 2.7: Lærdal s Order pattern of Little Junior (source of information: Lærdal Medical) Figure 2.8 shows the total ordered quantity of Little Junior in 2010 and 2011 sorted by each customer, based on this illustration the reason behind the increase in customer demand at the end of 2011 seems to be due to a sudden change in the demand pattern to a customer in Switzerland. If the data of the ordered quantity of the two years are compared it is possible to see that there has been an extreme increase in how many units the customer DEMA-CH ordered from 2010 to 2011, which is indicated by the dark red bar in figure 2.8. In 2010 DEMA-CH ordered approximately 15 units, while in 2011 the ordered quantity was above 450, which is an extreme increase. 21

24 Figure 2.8: Quantity of Customer Orders Little Junior (source of information: Lærdal Medical) Figure 2.9 shows the order frequency in 2010 and 2011 for the same customers as in figure 2.8, which illustrates how the development of DEMA-CH s demand pattern has been in this period. As can be seen the total numbers of orders have actually decreased, this means that each time they made an order the order quantity was high, which was impossible for DC-NL to prepare for especially since the orders were unexpected. Figure 2.9: Customers order frequency for Little Junior (source of information: Lærdal Medical) 22

25 When a customer changes the demand pattern like DEMA-CH did, a stock-out leads to delivery delays for the rest of the customers supplied from DC-NL s as well, and could potentially affect the rest of Lærdal s customers in Europe. This could theoretically become a big problem for Lærdal, since their customers expect to receive the product at least within a week from order date. Should the delivery periods became longer and they need to wait more often for Lærdal to fix stock-out situations, there is always a chance that they will opt out Lærdal in favour of a competitor, even if the representatives from Lærdal claim they are very loyal. In the situation experienced in 2011 Lærdal had to spend unforeseen money on damage control like transhipments and if that does not solve the problem, rush orders to the factory in China, which negatively affects Lærdal s financial results. To stop this negative trend, Lærdal has discussed increasing the reorder point drastically, but this will not necessarily solve the fundamental problem and it can be difficult to see how this action can prevent such incident from happening in the future. If there had been any kind of advanced communication and sharing of information between Lærdal and its customers, Lærdal could been informed beforehand that the medical training personnel in Switzerland were changing the training routines from using a grown up training doll to a child training doll. With such information Lærdal could then have been proactive and to some degree reduced the extent of the problem or entirely avoided it. The customers benefit with such information sharing agreement would first of all be a promise to receive the delivery within the expected time, but there are also other potential benefits to be achieved, like lower unit price and more flexibility. 23

26 Chapter 3 - Literature Review The purpose of this chapter is to explain, based on literature, the problems Lærdal experienced and how these theoretically can be solved. When theoretical justifications are used as potential explanation, it can be easier to understand how and why the output of the created models act the way they do, and draw conclusions as to whether the procedures used are valid or should be rejected. Literature that seem to describe Lærdal s potential problems and solutions best, and therefore are theoretically described in this chapter, are first of all problems associated with inventory management and the bullwhip effect as both of these need to be properly observed in Lærdal s setting because of the of the great impact the outcome could have. Information sharing is a possible solution to avoid the bullwhip effect and other supply chain problems that Lærdal may experience, and at last some collaborative strategies are reviewed as an alternative for Lærdal to enter into a more cooperated environment with suppliers/customers. 3.1 Supply Chain Management Because of high global competition in dynamic markets and increased customer expectations, it has become more important to manage the material and information flow in the supply chain. Simchi-Levi et al. (2009) defines supply chain management (SCM) as a set of approaches utilized to efficiently integrate suppliers, manufacturers, warehouses, and stores, so that merchandise is produced and distributed at the right quantities, to the right locations, and at the right time, in order to minimize system wide costs while satisfying service level requirements. The simplest supply chains consist of only a few participants, such as manufacturer and retailer, but in today s global economy most supply chains involve multiple participants such as raw material suppliers, manufacturers, distributers, and retailers, and due to global development it is not longer critical for these contributors to be situated close to each other, any market has become reachable. However, supply chain management is about more than just moving physical items between different segments in the supply chain, it is also about sharing information and knowledge between the same segments in order to improve the performance. In 24

27 Hao (2005) research, he comments that effective partnerships and coordination between the supply chain members, where everyone seeks to maximize the performance, is the most important factors in order to achieve success in the supply chain. 3.2 Potential problems in a supply chain In situations where companies experience uncertainties within forecasting and production areas, there are possibilities that the environment changes before proper precautions can be implemented and this increases the chances of losing control of individual company, which can have great effect in many ways Inventory management Inventory management is an important part of supply chain management; if it is not controlled properly it could be a huge budget drainer and put an end to the company s flexibility. In Jaksic and Rusjan (2009) research the average cost of holding and managing the inventory in the United States is between 30-35% of its value, inventory represents 1/3 of the current assets and up to 90% of the working capital. These numbers illustrates that inventory is one of the most significant investments in a company, and if not organized and controlled properly the company could end up carrying unnecessary stock, which could increase the cost and reduce the responsiveness. On the other hand if the inventory level is reduced to avoid the high carrying costs a stock-out situation, like Lærdal faced, could occur, which might lower the company s targeted service level. But there are also other reasons why companies are carrying inventory: è It can be cheaper to buy and produce larger quantity of products than immediately needed, and achieve economic of scale è In many circumstances the production process and/or transportation may lead to long lead-time, in Lærdal s case this is several months, and in periods with high demand it can cause stock-outs between deliveries. è When the units are transported over large distances, it would be cost-effective to take advantage of the economics of scale and reduce the unit transportation cost. 25

28 This emphasizes that the most important factor in inventory management is to find the optimal trade-off between the inventory costs and the service level Bullwhip effect The term bullwhip effect was first introduced by Forrester in 1960 and refers to how demand variability increases when moving up in the supply chain from customers to manufacturer, which could be a current phenomenon in Lærdal s environment because of increasing customer demand that occurred at the end in When a retailer forecasts based on customer s demand it could be very different from what actually proves to be sold, which is the same problem the rest of the members in the supply chain encounter when predicting the demand. When it finally reaches the end of the supply chain, i.e. manufacturer, the variability from end customers actual demand to what actually is produced could be huge, resulting in both high inventory level and costs, and reduced service level (Zhang, 2008). Metters (1997) estimated that the economic consequences of the bullwhip effect could be as much as 30% of a company s profit. Multiple reasons for why the bullwhip effect occurs in a supply chain can be found in several research reports and textbooks. If large and infrequent orders are made from one segment in the chain, as Lærdal experienced, it could cause distortion in the ordering pattern in the supply chain. Price fluctuation, longer lead-time that influences the variability, and inflated orders placed during shortage periods, are other factors found to trigger the bullwhip effect. Padmanabhan et al. (1997) are one example of researchers who studied this phenomenon; they focused on whether and why the flow of demand information in a supply chain systematically distorts demand information throughout the supply chain. The conclusion from this study showed that sharing of real demand information between the supply chain members reduced some of the uncertainty that existed and as a result the chance of the bullwhip effect decreased. This theory will be tested in Lærdal s setting to see if the existing variability can be reduced. Simchi-Levi et al. (2009) discovered other theoretical ways to reduce the bullwhip effect: 1) stabilizing customers demand pattern by reducing the variability by i.e. 26

29 keeping a constant price strategy, 2) reduce the lead-time by using i.e. EDI systems, 3) engage in strategic partnership, which also makes it easier to share information. All the suggested solutions to avoid the bullwhip effect mentioned above have one thing in common: the more information shared, the better performance achieved in terms of reducing this phenomenon. 3.3 Possible solutions to supply chain problems Considerable inefficiency in the supply chain may arise from information and data shortage, and may be a reason for the problems mentioned above occurs. However sharing of information among the supply chain is increasingly used to overcome these problems Information sharing Monczaka et al. (1998) define information sharing as the extent to which one party in the chain communicates critical and proprietary information to another party in the chain, and when all members have access to the same information the supply chain can become smoother and more responsive (Huang and Gangopadhyay, 2004). According to Yu et al. (2001) there are three levels of information sharing, the first level is called decentralized control and it refers to a situation where no information is shared in the supply chain and each segment makes all strategic decisions independently to reach individual optimization. The impacts the decisions will have on suppliers and customers are not considered, in the worst case this can lead to situations where the company becomes more exposed to the danger of the bullwhip effect. The second level is called coordinated control and refers to when two inventories are coordinated based on sharing of customers order information. In such a situation the manufacturer receives information about customers demand along with retailer s ordering information and based on these data the manufacturer makes decisions about the proper inventory level. The third and last level is called centralized control, where one single organization or a small group of executives are the decision-makers for the entire supply chain, and 27

30 processes all relevant information to execute decisions that, optimally, should assure better system efficiency and system wide optimization. To utilize information, information technology systems such as ERP (Enterprise Research Planning) and EDI (Electronic Data Interchange) should be implemented in every participating company in order to easily share and store information and data so that anyone in the supply chain can access it at any time. The chances of the bullwhip effect and forecasting mistakes can then potentially be reduced, which could lead to a reduction in system wide costs and increase the chances of total supply chain optimization (Yu et al., 2001). Benefits from information sharing have been analysed by other researches as well, Gerard and Marshall (2000) found that when information sharing is introduced, the cost of holding inventory and backorders can be reduced with 13.8%, while Lee et al. (2000) research found that if information is shared the overall cost has potential to decrease with 12-23% Collaborative strategies Even though there are a lot of advantages of operating in a centralized supply chain, it can sometimes be problematic to obtain because the cooperation is not specifically tailored to all its members, different companies could have underlying objectives and goals that do not fit the supply chain as a whole and makes the cooperation difficult (Walker et al., 2008). Stroh et al. (2002) commented that decision-makers in a centralized supply chain do not have the necessary information to make a perfect decision system wide, which can be understood as another reason why an integrated supply chain partnership might not work. To overcome some of these problems and other difficulties associated with formal contracting, independent supply chain companies can agree to use a collaborative strategy contract where it is possible to achieve some of the same benefits as can be obtained in an integrated supply chain. A large number of such collaborative strategies can be found in todays business environment, only a few are described below, but what they have in common is to identify a strategy where supply chain participants can still act in a decentralized manner while becoming more efficient, which can be associated with centralized control (Zhu et al., 2010). Udin et al. (2006) research concluded that benefits with collaborative strategies are service level 28