CH-7-8 Demand Management – Supply Chain Management: A Logistics Perspective : Book Guide

This Document Contains Chapters 7 to 8 CHAPTER 7 DEMAND MANAGEMENT LEARNING OBJECTIVES After reading this chapter, you should be able to do the following: • Understand the critical importance of outbound-to-customer logistics systems. • Appreciate the growing need for effective demand management as part of an organization’s overall logistics and supply chain expertise. • Know the types of forecasts that might be needed and understand how collaboration among trading partners will help the overall forecasting and demand management processes. • Understand the basic principles underlying the sales and operations planning process. • Identify the key steps in the order fulfillment process and appreciate the various channel structures that might be used in the fulfillment process. CHAPTER OVERVIEW The terms “convergence” and “collaboration” have been popping up recently in discussions about improving logistics and supply chain management processes and the collection and synchronization of the data that can foster those improvements. When discussing collaboration in terms of end-to-end logistics and supply chain processes, it is referred to the basics such as real-time contact with carriers, sharing long-term plans with 3PLs, clearly communicating data through collaborative planning with suppliers, etc. Introduction Outbound-to-customer logistics systems, also referred to as physical distribution, refer to the processes, systems, and capabilities that enhance an organization’s ability to serve its customers. Correspondingly, the topic of inbound-to-operations logistics systems refers to the activities and processes that precede and facilitate value-adding activities such as procurement manufacturing and assembly. Demand Management Demand management might be thought of as “focused efforts to estimate and manage customers’ demand, with the intention of using this information to shape operating decisions.” Traditional supply chains typically begin at the point of manufacture or assembly and end with the sale of product to consumers or business buyers. The essence of demand management is to further the ability of firms throughout the supply chain—particularly manufacturing through the customer—to collaborate on activities related to the flow of product, services, information, and capital. Demand management seeks to satisfy customers and solve customer problems such as: • Gathering and analyzing knowledge about consumers, their problems, and their unmet needs • Identifying partners to perform the functions needed in the demand chain • Moving the functions that need to be done to the channel member that can perform them most effectively and efficiently • Sharing with other supply chain members knowledge about consumers and customers, available technology, and logistics challenges and opportunities • Developing products and services that solve customers’ problems • Developing and executing the best logistics, transportation, and distribution methods to deliver products and services to consumers in the desired format Demand data might be used strategically to enhance an organization’s growth, portfolio, positioning, and investment strategies. As suggested, effective use of demand data can help organizations guide strategic resources in a number of important ways. Balancing Supply and Demand The essence of demand management is to estimate and manage customer demand and use this information to make operating decisions. There are four methods that are commonly used across many industries. Two of those, price and lead time, are referred to as external balancing methods. The other two, inventory and production flexibility, are called internal balancing methods. External balancing methods are used in an attempt to change the manner in which the customer orders in an attempt to balance the supply-demand gap. Internal balancing methods utilize an organization’s internal processes to manage the supply-demand gap. Production flexibility allows an organization to quickly and efficiently change its production lines from one product to another. The tradeoff here is between production changeover costs and safety stock costs. Inventory is probably the most common, and maybe the most expensive, method used to manage the imbalance between supply and demand. Many organizations produce product to a forecast that includes safety stock to smooth the effects of both demand and lead time variability. In today’s business environment, companies struggle to meet today’s growth objectives. Volatility in demand has become the norm, and companies understand that they need the ability to quickly calibrate because sustainable demand continues to be more challenging than expected./ Traditional Forecasting A major component of demand management is forecasting the amount of product that will be purchased, when it will be purchased, and where it will be purchased by customers. Although various statistical techniques exist to forecast demand, the common thread for all forecasts is that they will ultimately be wrong. Factors Affecting Demand Two types of demand exist: independent and dependent. Independent demand is the demand for the primary item. Dependent demand is directly influenced by the demand for the independent item. Normally, the demand for independent demand items is known as base demand, that is, normal demand. However, all demand is subject to certain fluctuations. Normally, the demand for independent demand items is known as base demand, that is, normal demand. However, all demand is subject to certain fluctuations. One type of demand fluctuation is caused by random variation. Random variation cannot be anticipated and is usually the cause to hold safety stocks to avoid stockouts. A second type of demand fluctuation is caused by trend. Trend is the gradual increase or decrease in demand over time for an organization. A third type of demand fluctuation is caused by seasonal patterns. Seasonal patterns will normally repeat themselves during a year for most organizations. Finally, demand fluctuations can be caused by normal business cycles. These are usually driven by the nation’s economy and can be growing, stagnant, or declining. Forecast Errors Almost all forecasts will be wrong. Some forecasts will be higher than demand, and some will be lower. Managing the forecasting process requires minimizing the errors between actual demand and forecasted demand. The key to successful forecasting is to choose the technique that provides the least amount of forecast error. To determine which forecasting technique is best for a set of data, the forecast error must be measured. Four types of forecast error measures can be used. The first is called the cumulative sum of forecast errors (CFE) and can be calculated using the formula below: n CFE = ∑et t−1 CFE calculates the total forecast error for a set of data, taking into consideration both negative and positive errors. This is also referred to as bias and was used in Tables 7-2 through 7-8. This gives an overall measure of forecast error. However, taking into consideration both negative and positive errors, this method can produce an overall low error total although individual period forecasts can either be much higher or much lower than actual demand. The second measure of forecast error is mean squared error (MSE). This measure is introduced in Table 7-9 and can be calculated using Formula 7.7. The second measure of forecast error is mean squared error (MSE). This measure is introduced in Table 7-9 and can be calculated using Formula 7.7. ∑ Et2 MSE = ---------- n This measure squares each period error so the negative and positive errors do not cancel each other out. MSE also provides a good indication of the average error per period over a set of demand data. Closely related to MSE is the third type of forecast error measure: mean absolute deviation (MAD). It can be calculated using Formula 7.8. ∑|Et| MAD = ----------- n This measure is also calculated in Table 7-9. By taking the absolute value of each error, the negative and positive signs are removed and a good indication of average error per period is calculated. This measure is popular because it is easy to understand and provides a good indication of the accuracy of the forecast. The final measure of forecast error is mean absolute percent error (MAPE). MAPE can be calculated using Formula 7.9. (|Et|/Dt)100 MAPE = --------------- n Forecasting demand is a highly scientific art. Rigorous quantitative techniques exist to manipulate historical data to predict the future. However, the assumption made here is that the future will repeat the past. This is normally not the case. As such, it is important to choose the technique that best fits the data in order to minimize the forecast error. Minimizing this error will result in the most accurate forecast. Forecasting Techniques There are many different statistical techniques companies use to generate forecast. All of these techniques require accurate data and rely on the assumption that the future will repeat the past. However, these requirements are usually violated and the forecast will be generating a forecast error. The key to good forecasting is to minimize forecast error by utilizing a forecasting technique that best fits the nature of the data. Simple Moving Average The simple moving average is probably the simplest to develop method in basic time series forecasting. It makes forecasts based on recent demand history and allows for the removal of random effects. The simple moving average method does not accommodate seasonal, trend, or business cycle influences. Formula: At = Sum of last n demands N = Dt + Dt−1 + Dt−2 + … Dt−n+ Where : Dt = Actual demand in period t n = Total number of periods in the average At = Average for period t Adding together the error terms for the forecasts results in what can be called bias. Bias measures how accurate the forecast is compared to actual demand. A positive bias means that the demand was higher than forecast during the forecast period, resulting in stockouts; a negative bias means the demand was lower than the forecast, resulting in excess inventories. The closer the bias term is to zero, the better the forecast. Weighted Moving Average In the simple moving average method, each previous demand period was given an equal weight. The weighted moving average method assigns a weight to each previous period with higher weights usually given to more recent demand. The formula is: At = 0.60Dt + 0.25Dt−1 + 0.15Dt−2 Exponential Smoothing Exponential smoothing is one of the most commonly used techniques because of its simplicity and its limited requirements for data. Exponential smoothing needs three types of data: an average of previous demand, the most recent demand, and a smoothing constant. The smoothing constant must be between 0 and 1. Using a higher constant assumes that the most recent demand is a better predictor of future demand. This formula is used to calculate the forecast. At = α (Demand this period) + (1 − α)(Average calculated last period) = α Dt + (1 − α)At − 1 7.3 Sales and Operations Planning Many organizations developed several functional forecasts for the same products during the same time period such as a financial forecast, a manufacturing forecast, a marketing forecast, and a distribution forecast. What compounds the complexity of having multiple forecasts is that most times these functional forecasts did not agree. It is necessary for an organization to arrive at a forecast internally that all functional areas agree upon and can execute. A process that can be used to arrive at this consensus forecast is called the sales and operations planning process (S&OP). The S&OP Benchmarking Consortium in the Center for Supply Chain Research adopted a five step process in arriving at this consensus forecast. The five-step S&OP process can be seen in Figure 7-2. Collaborative Planning, Forecasting, and Replenishment Many industry initiatives have attempted to create efficiency and effectiveness through the integration of supply chain activities and processes which has been identified by such names as quick response (QR), vendor-managed inventory (VMI), continuous replenishment planning (CRP), and efficient consumer response (ECR). One of the most recent initiatives aimed at achieving true supply chain integration is collaborative planning, forecasting, and replenishment (CPFR). CPFR has become recognized as a breakthrough business model for planning, forecasting, and replenishment. Using this approach, retailers, distributors, and manufacturers can utilize available Internet-based technologies to collaborate on operational planning through execution. Transportation providers have now been included with the concept of collaborative transportation management (CTM). Simply put, CPFR allows trading partners to agree to a single forecast for an item where each partner translates this forecast into a single execution plan. This replaces the traditional method of forecasting where each trading partner developed its own forecast for an item and each forecast was different for each partner. The CPFR process begins with the sharing of marketing plans between trading partners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit (SKU), by week, and by quantity. Theoretically, an accurate CPFR forecast could be translated directly into a production and replenishment schedule by the manufacturer since both quantity and timing are included in the CPFR forecast. This would allow the manufacturer to make the products to order (based on the quantity and timing of demand) rather than making them to inventory, thus reducing total inventories for the manufacturer. SUMMARY • Outbound-to-customer logistics systems have received the most attention in many companies; but, even in today’s customer service environment, outbound and inbound logistics systems must be coordinated. • Demand management may be thought of as “focused efforts to estimate and manage customers’ demand, with the intention of using this information to shape operating decisions. • Although many forecasts are made throughout the supply chain, the forecast of primary demand from the end user or consumer will be the most important. It is essential that this demand information be shared with trading partners throughout the supply chain and be the basis for collaborative decision making. • Various approaches to forecasting are available, each serving different purposes. The S&OP process has gained much attention in industry today. It serves the purpose of allowing a firm to operate from a single forecast. • The S&OP process is a continual loop involving participation from sales, operations, and finance to arrive at an internal consensus forecast. • CPFR is a method to allow trading partners in the supply chain to collaboratively develop and agree upon a forecast of sales. This allows for the elimination of inventories held because of uncertainty in the supply chain. ANSWERS TO STUDY QUESTIONS 1. What are the differences and similarities between outbound and inbound logistics systems? Which types of industries would place heavier emphasis on outbound systems? On inbound systems? Explain your choices. In an effort to serve their customers, many firms have placed significant emphasis on what may be termed their outbound to customer logistics systems. Also referred to as physical distribution, this essentially refers to the set of processes, systems, and capabilities that enhance a firm's ability to serve its customers. Correspondingly, the topic of inbound to operations logistics systems refers to the activities and processes that precede and facilitate value adding activities such as manufacturing, assembly, and so on. Other terms that focus on these elements of the supply chain include materials management and physical supply. Although many of the principles of inbound logistics are conceptually similar to those of outbound logistics, there are important differences that must be recognized. As a practical matter, in many firms the outbound to customer logistics system receives far more attention than the inbound to operations system. While this is changing quickly, it is largely due to the historical priority firms have had on improving service to their customers. 2. How do outbound logistics systems relate directly to needs of the customer? The focus on outbound logistics has led to an emphasis on attributes such as product availability, on time and order delivery, timely and accurate logistics information, overall responsiveness, and post sale customer support. Very simply, providing the customer with an acceptable level of service has been of greater concern, historically, than assuring the efficient and effective flow of materials to value adding operations. In today's business environment, successful firms find it necessary to place an equal emphasis on being proficient in both of these areas. 3. How can demand management help to unify channel members, satisfy customers, and solve customer problems? The essence of demand management is to further the ability of firms throughout the supply chain particularly manufacturing through the customer to collaborate on activities related to the flows of product, services, information, and capital. The desired end result should be to create greater value for the end user or consumer, for whom all supply chain activity should be undertaken. The following list suggests a number of ways in which effective demand management will help to unify channel members with the common goal of satisfying customers and solving customer problems. • Gathering and analyzing knowledge about consumers, their problems, and their unmet needs • Identifying partners to perform the functions needed in the demand chain • Moving the functions that need to be done to the channel member that can perform them most effectively and efficiently • Sharing with other supply chain members knowledge about consumers and customers, available technology, and logistics challenges and opportunities • Developing products and services that solve customers' problems • Developing and executing the best logistics, transportation, and distribution methods to deliver products and services to consumers in the desired format As firms identify the need for improved demand management, a number of problems occur. First is that lack of coordination between departments (i.e., the existence of "functional silos") results in little or no coordinated response to demand information. Second is that too much emphasis is placed on forecasts of demand, with less attention on the collaborative efforts and the strategic and operational plans that need to be developed from the forecasts. Third is that demand information is used more for tactical and operational than for strategic purposes. In essence, and since in many cases historical performance is not a very good predictor of the future, demand information should be used to create collective and realistic scenarios of the future. Primary emphasis should be on understanding likely demand scenarios and mapping their relationships to product supply alternatives. The end result will be to better match demand as it occurs with appropriate availability of needed product in the marketplace. 4. What are some of the logistical problems that may arise when supply and demand for a product are not aligned properly? What are some of the methods used to soften the effects of this imbalance? Among logistical problems, the lack of coordination between departments (i.e., the existence of "functional silos") results in little or no coordinated response to demand information. Second is that too much emphasis is placed on forecasts of demand, with less attention on the collaborative efforts and the strategic and operational plans that need to be developed from the forecasts. Third is that demand information is used more for tactical and operational than for strategic purposes. In essence, and since in many cases historical performance is not a very good predictor of the future, demand information should be used to create collective and realistic scenarios of the future. Primary emphasis should be on understanding likely demand scenarios and mapping their relationships to product supply alternatives. The end result will be to better match demand as it occurs with appropriate availability of needed product in the marketplace. 5. What are the basic types of forecasts? What are their strengths and weaknesses? The simple moving average is probably the simplest to develop method in basic time series forecasting. It makes forecasts based on recent demand history and allows for the removal of random effects. The simple moving average method does not accommodate seasonal, trend, or business cycle influences. This method simply averages a predetermined number of periods and uses this average as the demand for the next period. Each time the average is computed, the oldest demand is dropped and the most recent demand is included. A weakness of this method is that it forgets the past quickly. A strength is that it is quick and easy to use. In the simple moving average method, each previous demand period was given an equal weight. The weighted moving average method assigns a weight to each previous period with higher weights usually given to more recent demand. The weights must equal to one. The weighted moving average method allows emphasis to be placed on more recent demand as a predictor of future demand. This is primarily because the weighted moving average method does not assume equal weights for each period in the calculation. However, the results from the weighted moving average method are still not very good forecasts of demand. There are three possible causes for this. First, the weights assigned to the three periods might not accurately reflect the patterns in demand. Second, using three periods to develop the forecast might not be the appropriate number of periods. Finally, the weighted moving average technique does not easily accommodate demand patterns with seasonal influences. Exponential smoothing is one of the most commonly used techniques because of its simplicity and its limited requirements for data. Exponential smoothing needs three types of data: an average of previous demand, the most recent demand, and a smoothing constant. However, exponential smoothing forecasts will lag actual demand. If demand is relatively constant, exponential smoothing will produce a relatively accurate forecast. However, highly seasonal demand patterns or patterns with trends can cause inaccurate forecasts using exponential smoothing. The next method will attempt to introduce the concept of trend into the forecast. 6. What are the basic elements of the S&OP process? How do marketing, logistics, finance, and manufacturing contribute to each element? A process that can be used to arrive at this consensus forecast is called the sales and operations planning process. The S&OP Benchmarking Consortium in the Center for Supply Chain Research adopted a five step process in arriving at this consensus forecast. Step 1 (Run sales forecast reports) requires the development of a statistical forecast of future sales. This would be done using one or more of the forecasting techniques discussed in the previous section. Step 2 (Demand planning phase) requires the sales and/or marketing departments to review the forecast and make adjustments based on promotions of existing products, the introductions of new products, or the elimination of products. This revised forecast is usually stated in terms of both units and dollars since operations are concerned with units and finance is concerned with dollars. Step 3 (Supply planning phase) requires operations (manufacturing, warehousing, and transportation) to analyze the sales forecast to determine if existing capacity is adequate to handle the forecasted volumes. This requires analyzing not only the total volumes but also the timing of those volumes. However, heavy promotions might produce a “spike” in demand that might exceed existing capacity. Two options to solve this capacity constraint are available. First, the promotional activity could be curtailed to bring demand to a more stable level. This could result in lost revenue. Second, additional manufacturing could be secured either by investing in more manufacturing capacity. Step 4 (Pre-S&OP meeting) involves individuals from sales, marketing, operations, and finance. This meeting will review the initial forecast and any capacity issues that might have emerged during Step 3. Initial attempts will be made during this meeting to solve capacity issues by attempting to balance supply and demand. Alternative scenarios are usually developed to present at the executive S&OP meeting (Step 5) for consideration. These alternatives would identify potential lost sales and increased costs associated with balancing supply and demand. The sales forecast is also converted to dollars to see if the demand/supply plan meets the financial plan of the organization. Finally, Step 5 (Executive S&OP meeting) is where final decisions are made regarding sales forecasts and capacity issues. 7. What are the critical elements of collaborative planning? What benefits do they provide for the supply chain? One of the most recent initiatives aimed at achieving true supply chain integration is collaborative planning, forecasting, and replenishment (CPFR). CPFR has become recognized as a breakthrough business model for planning, forecasting, and replenishment. Using this approach, retailers, distributors, and manufacturers can utilize available Internet-based technologies to collaborate on operational planning through execution. Transportation providers have now been included with the concept of collaborative transportation management (CTM). Simply put, CPFR allows trading partners to agree to a single forecast for an item where each partner translates this forecast into a single execution plan. This replaces the traditional method of forecasting where each trading partner developed its own forecast for an item and each forecast was different for each partner. Figure 7-3 shows the CPFR model as a sequence of several business processes that include the consumer, retailer, and manufacturer. The four major processes are strategy and planning, demand and supply management, execution, and analysis. Two aspects of this model are important to note. First, it includes the cooperation and exchange of data among business partners. Second, it is a continuous, closed-loop process that uses feedback (analysis) as input for strategy and planning. CPFR emphasizes a sharing of consumer purchasing data (or point-of sale data) as well as forecasts at retail among and between trading partners for the purpose of helping to manage supply chain activities. From these data, the manufacturer analyzes its ability to meet the forecasted demand. If it cannot meet the demand, a collaborative effort is undertaken between the retailer and manufacturer to arrive at a mutually agreed-upon forecast from which execution plans are developed. The strength of CPFR is that it provides a single forecast from which trading partners can develop manufacturing strategies, replenishment strategies, and merchandising strategies. The CPFR process begins with the sharing of marketing plans between trading partners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit (SKU), by week, and by quantity. The planning period can be for 13, 26, or 52 weeks. A typical forecast is for seasonal or promotional items that represent approximately 15 percent of sales in each category. The regular turn items, or the remainder of the products in the category, are forecast statistically Then the forecast is entered into a system that is accessible through the Internet by either trading partner. Either partner may change the forecast within established parameters. Theoretically, an accurate CPFR forecast could be translated directly into a production and replenishment schedule by the manufacturer since both quantity and timing are included in the CPFR forecast. This would allow the manufacturer to make the products to order (based on the quantity and timing of demand) rather than making them to inventory, thus reducing total inventories for the manufacturer. The retailer would enjoy fewer out-of-stocks at the retail shelf. Although CPFR has not yet fully developed into a make-to-order environment, it has enjoyed the benefits of reduced supply chain inventories and out-of-stocks. The use of collaborative efforts among supply chain partners can have positive results on the service and cost performance of these partners. 8. What are the similarities between the CPFR and S&OP processes? What are the differences? One of the similarities between the CPFR and S&OP processes is both are structured to arrive at a consensus forecast for the same products during the same time period. In addition sharing of data is critical in both processes and both processes are a continuous closed-loop process that uses feedback as input. Another similarity is both processes have a supply and demand phase, however one of the differences between the two processes is S&OP has a separate phase for supply and a separate phase for demand, whereas CPFR has supply and demand in one phase. Another one of the differences is the S&OP process describes how organizations structure their planning process to arrive at a consensus forecast internally, whereas CPFR describes how a consensus forecast is created externally. Case Studies Case 7.1 Tires for You, Inc. 1. Calculate a forecast using a simple three-month moving average. 2. Calculate a forecast using a three-period weighted moving average. Use weights of 0.60, 0.30, and 0.10 for the most recent period, the second most recent period, and the third most recent period, respectively. 3. Calculate a forecast using the exponential smoothing method. Assume the forecast for period 1 is 9,500. Use alpha = 0.40. 4. Once you have calculated the forecasts based on the above data, determine the error terms by comparing them to the actual sales for 2012 given below: 5. Based on the three methods used to calculate a forecast for TFY, which method produced the best forecast? Why? What measures of forecast error did you use? How could you improve upon this forecast? Case Study 7.2 Playtime, Inc. 1. What are the issues associated with Playtime’s current forecasting process? What impacts, negative or positive, does this process have on the marketing, operations, supply chain, and finance functions? There is currently no process in place for Playtime to arrive at a consensus forecast. Since the finance department gives the final approval to the forecast, the operations and sales departments have little or no input on capacity constraints. As such, each functional area develops its own forecast based on its individual needs and capacities. 2. Using the S&OP process discussed in this chapter, design a more effective and efficient forecasting process that will mitigate the negative impacts you identified in question 1. Students will need to use their creativity in answering this question. They can use Figure 7.2 as a framework for their analysis. CHAPTER 8 ORDER MANAGEMENT AND CUSTOMER SERVICE LEARNING OBJECTIVES After reading this chapter, you should be able to do the following: • Understand the relationships between order management and customer service. • Appreciate how organizations influence customers’ ordering patterns as well as how they execute customers’ orders. • Realize that activity-based costing (ABC) plays a critical role in order management and customer service. • Identify the various activities in the SCOR process D1 (deliver stocked product) and how it relates to the order-to-cash cycle. • Know the various elements of customer service and how they impact both buyers and sellers. • Calculate the cost of a stockout. • Understand the major outputs of order management, how they are measured, and how their financial impacts on buyers and sellers are calculated. • Be familiar with the concept of service recovery and how it is being implemented in organizations today. CHAPTER OVERVIEW Introduction This chapter will present two phases of order management. First, the concept of influencing the order will be presented. This is the phase where an organization attempts to change the manner by which its customers place orders. Second, the concept of order execution will be discussed. This phase occurs after the organization receives the order. Customer service includes all activities that impact information flow, product flow, and cash flow between the organization and its customers. Customer service can be described as a philosophy, as performance measures, or as an activity that can be an organization-wide commitment to providing customer satisfaction through superior customer service. Influencing the Order—Customer Relationship Management Customer relationship management is the art and science of strategically positioning customers to improve the profitability of the organization and enhance its relationships with its customer base. The concept of CRM, however, has not been widely used in the business-to business environment as traditionally, manufacturers and distributors are more adept at and actively involved in order execution which involves filling and shipping what their customers order. There are four basic steps in the implementation of the CRM process in a business-to-business environment. Step 1: Segment the Customer Base by Profitability Most firms allocate direct materials, labor, and overhead costs to customers using a single allocation criterion. However, firms today are beginning to use techniques such as activity-based costing. Step 2: Identify the Product/Service Package for Each Customer Segment This step presents one of the most challenging activities in the CRM process. The goal of this step is to determine what each customer segment values in its relationship with the supplier. The challenge here is how to “package” the value-adding products and services for each customer segment. One solution is to offer the same product/service offering to each customer segment, while varying the product quality or service levels. Another solution to this part of the CRM process is to vary the service offerings for each customer segment. Step 3: Develop and Execute the Best Processes In Step 2, customer expectations were determined and set. Step 3 delivers on those expectations. Organizations many times go through elaborate processes to determine customer needs and set target performance levels, only to fail when it comes to executing on those customer promises. Step 4: Measure Performance and Continuously Improve The goal of CRM is to better serve the different customer segments of the supplier organization, while at the same time improving the profitability of the supplier. Once the CRM program has been implemented, it must be evaluated to determine if (1) the different customer segments are satisfied and (2) the supplier’s overall profitability has improved. The concept behind CRM is simple: align the supplier’s resources with its customers in a manner that increases both customer satisfaction and supplier profits. Activity-Based Costing and Customer Profitability Traditional cost accounting is well suited to situations where an output and an allocation process are highly correlated. Traditional cost accounting is not very effective in situations where the output is not correlated with the allocation base. This is the more likely scenario in logistics. ABC can be defined as, “A methodology that measures the cost and performance of activities, resources, and cost objects.” Resources are assigned to activities, then activities are assigned to cost objects based on their use. ABC recognizes the causal relationships of cost drivers to activities. Traditional customer profitability analyses would start with gross sales less returns and allowances (net sales) and subtract the cost of goods sold to arrive at a gross margin figure. Although this number might provide a general guideline for the profitability of a customer, it falls short on capturing the real costs of serving a customer. Those customers who fall into the “Protect” segment are the most profitable as their interactions with the shipper provide the shipper with the most cost efficiencies. Those customers who are in the “Danger Zone” segment are the least profitable and are more than likely incurring a loss for the shipper. For these customers, the shipper has three alternatives: (1) change the manner in which the customer interacts with the shipper so the customer can move to another segment; (2) charge the customer the actual cost of doing business (this would more than likely make the customer stop doing business with the shipper—this is usually not an acceptable strategy employed by most shippers); or (3) switch the customer to an alternative distribution channel. The customers who fall into the “Build” segment have a low cost to serve and a low net sales value. The strategy here is to maintain the cost to serve but build net sales value to help drive the customer into the “Protect” segment. Finally, the customers who are in the “Cost Engineer” segment have a high net sales value and a high cost to serve. Executing the Order—Order Management and Order Fulfillment The order management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction. To the extent that an organization conducts all activities relating to order management in a timely, accurate, and thorough manner, it follows that other areas of company activity can be similarly coordinated. The logistics area needs timely and accurate information relating to individual customer orders; thus, more and more organizations are placing the corporate order management function within the logistics area. Order-to-Cash (OTC) and Replenishment Cycles When referring to outbound-to-customer shipments, the term order to cash (or order cycle) is typically used. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Traditionally, organizations viewed order management as all of those activities that occur from when an order is received by a seller until the product is received by the buyer which is called the order cycle. Thirteen principal activities constitute the OTC cycle. D1.1: Process Inquiry and Quote. This step in the process precedes the actual placement of the order by the customer. D1.2: Receive, Enter, and Validate Order. This step involves the placement and receipt of the order. D1.3: Reserve Inventory and Determine Delivery Date. This step in the process has traditionally been referred to as order processing. In the case where the seller has inventory to fill the order, the delivery date is based on the concept of available to deliver (ATD). If the seller does not have the inventory but knows when it will be produced internally or delivered from a supplier to the seller’s distribution centers, the delivery date is based on the concept of available to promise (ATP). D1.4: Consolidate Orders. This step examines customer orders to determine opportunities for both freight consolidation as well as for batch warehouse picking schedules. Both of these consolidation opportunities offer cost efficiencies for the seller. D1.5: Build Loads. This step takes the freight consolidation opportunities identified in D1.4 and the delivery date given in D1.3 and develops a transportation plan. D1.6: Route Shipments. This step can follow or be concurrent with D1.5. Here, the “load” (usually a transportation vehicle) is assigned to a specific route for delivery to the customer. D1.7: Select Carriers and Rate Shipments. Following or concurrent with D1.5 and D1.6, this step will assign a specific carrier to deliver an order or a consolidation of orders. D1.8: Receive Product From Source or Make. This step gains importance when an ATP has been given to a customer’s order. In this step, product is received at the distribution center and the order management system is checked to see if there are any orders outstanding that need this particular product. D1.9: Pick Product. This step uses the outputs from D1.3, D1.4, and D1.5 to determine the order picking schedules in the distribution center. D1.10: Pack Product. Once the order has been processed, it must be packed. This step readies the order to be loaded onto a transportation vehicle for delivery. D1.11: Load Vehicle and Generate Shipping Documents. Based on the output from D1.5 and D1.6, the transportation vehicle is loaded in. Finally, this step will generate shipment documents to provide to the carrier to execute the shipment. These documents might include bills of lading, freight bills, waybills, and manifests for domestic shipments as well as customs clearance documents for international shipments. D1.12: Ship Products. With the vehicle properly loaded and all shipping documents generated, the vehicle is now dispatched from the loading facility to begin its movement to the customer. Some shippers will generate an electronic data interchange (EDI) message, referred to as an ASN (advance ship notice), and send it to the customer (business to business transaction) to notify them of shipment date and shipment contents. D1.13: Receive and Verify Product by Customer Site. Once the shipment is delivered to the customer location, the receiving location will determine whether or not the delivered product is what was ordered. D1.14: Install Product. If an order involves a product that must be installed at the customer location, it is at this point in the OTC cycle where installation takes place. D1.15: Invoice. This step is the culmination of the OTC cycle for the buyer and seller. Length and Variability of the Order-to-Cash Cycle While interest has traditionally focused more on the overall length of the OTC cycle, recent attention has been centered on the variability or consistency of this process. Industry practices have shown that while the absolute length of time is important, variability is more important. A driving force behind the attention to OTC cycle variability is safety stock. The concept of the order cycle is used here because the focus is on the delivery of Order Management and Customer Service product to the buyer and not on the flow of cash to the supplier. If the seller is concerned only with customer service prior to shipping, as per traditional metrics, the buyer might not be satisfied and the seller might not know it, because of problems occurring during the delivery process. Furthermore, the seller using traditional metrics would have no basis upon which to evaluate the extent and magnitude of the problem. The supply chain approach, focusing on measurement at the delivery level, not only provides the database to make an evaluation, but it also, and perhaps more importantly, provides an early warning of problems as they are developing. E-Commerce and Order Fulfillment Strategies Many organizations are using Internet technology as a means to capture order information and transmit it to their “back end” systems for picking, packing, and shipping. What the Internet is now allowing is the faster collection of cash by the seller organizations. As can be seen in the D1 process shown in Figure 8.6, cash is collected by the seller in the last step of the process. This figure shows the traditional “buy-make-sell” business model used by many organizations that produce product to inventory to wait for an order. Obviously, the longer it takes the selling organization to complete the order management process, the longer it takes to collect its cash. Applying internet technology to the order management process has allowed organizations to take time out of the process and increase the velocity of cash back to the seller. Customer Service Having the right product at the right time in the right quantity without damage to the right customer is an underlying logistics principle. Successful companies have adopted customer service strategies that recognize the importance of speed, flexibility, and customization. The Logistics/Marketing Interface Customer service is often the link between logistics and marketing within an organization. Today, logistics is taking on a more dynamic role in influencing customer service levels as well as impacting the organizations financial position. Defining Customer Service Customer service needs to be put into the context of anything that touches the costumer. From a marketing perspective there are three levels of a product that the firm provides: the core benefit or service, the product or service itself, and the augmented product which encompasses benefits that are secondary to the primary benefit but still yet an integral enhancement. Elements of Customer Service Time: Time refers to order to cash from the sellers perspective. Successful logistics operations maintain a high degree of control of most elements of lead time including processing, picking, and shipping. Dependability: This may be more important for many buyers than the absolute length of time. There are three dimensions of dependability. Cycle time, safe delivery, and correct orders. •Cycle time - The buyer can minimize its inventory levels if lead time is constant. Providing a dependable lead time reduces some of the uncertainty faced by the buyer. A seller who can assure the buyer of a given level of lead time, plus some tolerance, distinctly differentiates its product from that of its competitors. •Safe delivery - The safe delivery of an order is the ultimate goal of any logistics system. If product arrives damaged or is lost in transit, the buyer cannot use the product as intended. A shipment containing damaged product impacts several buyer cost centers—inventory, production, and marketing. •Correct orders - Dependability embraces filling orders correctly. The buyer who has not received what was requested might face potential lost sales, production, or satisfaction. Communications: Three types of communication occur between a buyer and seller: pre-transaction, transaction, and post-transaction. Pre-transaction information includes availability and delivery dates. Transaction information includes specifics about the order. Post-transaction information involves repair, assembly, or returns. Convenience: The logistics service level must be flexible. System capabilities should be matched to customer segment needs. Performance Measures for Customer Service Traditionally measures of performance have been created from the customer’s perspective. These basic outputs of logistics include product availability, order cycle time, logistics operations responsiveness, logistics systems information, and post sale product support. Typically measurement is made after Step D1.10 of the SCOR model. Expected Cost of Stockouts A principal benefit of inventory availability is to reduce the number of stockouts. Once a convenient method is determined to calculate the cost of a stockout, stockout probability information can be used to determine the total expected stockout cost. Alternative customer service levels can be analyzed by directly comparing the expected cost of stockouts with the revenue-producing benefits of improved customer service. Calculating stockout costs for finished goods is generally more challenging than calculating these costs for raw material stockouts. The main reason for this is that finished goods stockouts might result in lost current and/or future customer revenue. A stockout occurs when desired quantities of finished goods are not available when or where a customer needs them. When a seller is unable to satisfy demand with available inventory, one of four possible events might occur: (1) the buyer waits until the product is available; (2) the buyer back-orders the product; (3) the seller loses current revenue; or (4) the seller loses a buyer and future revenue. Back Orders As previously mentioned, a back order occurs when a seller has only a portion of the products ordered by the buyer. The back order is created to secure the portion of the inventory that is currently not available. By placing the back order, the buyer is indicating that it is willing to wait for the additional inventory. However, after experiencing multiple back orders with a seller, a buyer might decide to switch to another seller. Lost Sales Most organizations find that although some customers might prefer a back order, others will turn to alternative supply sources. Much of the decision here is based on the level of substitutability for the product. In such a case, the buyer has decided that if the entire order cannot be delivered at the same time, it will cancel the order and place it with another seller. In the likely event that the seller will sustain lost sales with inventory stockouts, the seller will have to assign a cost to these stockouts as suggested earlier. Then the seller should analyze the number of stockouts it could expect with different inventory levels. Lost Customer The third possible event that can occur because of a stockout is the loss of a customer; that is, the customer permanently switches to another supplier. A supplier who loses a customer loses a future stream of income. Estimating the profit (revenue) loss that stockouts can cause is difficult. Determining the Expected Cost of Stockouts To make an informed decision as to how much inventory to carry, an organization must determine the expected cost it will incur due to a stockout. The first step is to identify a stockout’s potential consequences. These include a back order, a lost sale, and a lost customer. The second step is to calculate each result’s expense or lost profit (revenue) and then to estimate the cost of a single stockout. Order Management Influences on Customer Service A major portion of this chapter has discussed the concepts of order management and customer service as somewhat mutually exclusive. However, the beginning of this chapter explained that these two concepts are, in fact, related to one another. This section of the chapter will introduce and explain the five major outputs of order management that influence customer service: product availability, order cycle time, logistics operations responsiveness, logistics system information, and post sale logistics support. Each of these outputs impacts customer service/satisfaction, and the performance of each is determined by the seller’s order management and logistics systems. Product Availability Although not the most important, product availability is usually the most basic output of an organization’s order management and logistics systems. This is true because product availability can be measured by asking the simple question: Did I get what I wanted, when I wanted it, and in the quantity I wanted? Sellers will normally hold more inventory to increase product availability. Buyers will hold more inventory to reduce stockouts, thus increasing product availability. An important aspect of product availability is defining where in the supply chain it is being measured. Another important aspect of product availability is determining whether or not all products should be made available at the same level. Some organizations strive to have 100 percent product availability across all products. The cost associated with achieving this goal would be prohibitive and unnecessary. Product availability levels for products can be determined by examining the level of substitutability and related stockout costs for a product as well as the demand profile for that product. •Metrics: Many methods exist to measure the efficiency and effectiveness of product availability. However, four metrics are widely used across multiple industries: item fill rate, line fill rate, order fill rate, and perfect order. Item fill rate and line fill rate are considered internal metrics; that is, they are designed to measure the efficiency of how well the seller is setting its inventories to fill items or lines on an order. Order fill rates and perfect order rates are external metrics; that is, they are designed to capture the buyer experience with product availability. Order fill rate is the percent of orders filled complete. Finally, perfect order rate is the percent of orders filled completely, received on time, billed accurately, etc. A strategic profit model calculation would be required to determine the change in ROI as a result of the improvement in order fill rate. The next step would require the seller to determine the break-even point between order fill rates and inventory costs. Order Cycle Time Order cycle time is the time that elapses from when a buyer places an order with a seller until the buyer receives the order. The absolute length and reliability of order cycle time influences both seller and buyer inventories and will have resulting impacts on both revenues and profits for both organizations. Normally, the shorter the order cycle time the more inventory that must be held by the seller and the less inventory that must be held by the buyer, and vice versa. •Metrics: Order cycle time, or lead time, includes all activities and related time from when an order is placed by a buyer until the order is received by the buyer. This definition can be viewed as the buyer’s perception of lead time because this time ends when the buyer receives the ordered goods. A seller might look at lead time from the perspective of order-to-cash cycle time. This definition of lead time for the seller is important because the receipt of payment for the shipment ends this process for the seller. Another, often overlooked, definition of order cycle time is customer wait time (CWT). Used in both the private and public sectors, CWT includes not only order cycle time but also maintenance time. •Order cycle time can also have an impact on a buyer’s or seller’s financial position, depending on who owns the inventories in the supply chain. Inventory costs have an impact on both the balance sheet and income statement. Balance sheet impacts reflect ownership of inventory as an asset and liability; income statement impacts reflect the cost of holding inventory as an expense and therefore a reduction in cash flow. Order cycle time influences two types of inventory: demand, or cycle, stock and safety stock. Logistics Operations Responsiveness The concept of logistics operations responsiveness (LOR) examines how well a seller can respond to a buyer’s needs. This “response” can take two forms. First, LOR can be how well a seller can customize its service offerings to the unique requirements of a buyer. Second, LOR can be how quickly a seller can respond to a sudden change in a buyer’s demand pattern. •Metrics: Usually, LOR metrics will measure performance above and beyond basic on-time delivery or order fill rates. Examples of LOR metrics can be found in Process D1 of the SCOR model under flexibility. These three metrics are: (1) upside deliver flexibility, (2) downside deliver adaptability, and (3) upside deliver adaptability. •Another dimension of LOR metrics is one that addresses a seller’s ability to customize a product or its packaging. In the consumer-packaged goods (CPG) industry, manufacturers routinely offer special packaging of products through the use of co-packers. So, a metric that could be used to address customization might be one that measures the time it takes the seller to offer a new package for sale in the retailers’ stores. Logistics System Information Logistics system information (LSI) is critical to the logistics and order management processes. It underlies an organization’s ability to provide quality product availability, order cycle time, logistics operations responsiveness, and post sale logistics support. Timely and accurate information can reduce inventories in the supply chain and improve cash flow to all supply chain partners. Three types of information that must be captured and shared to execute the order management process: pre transaction, transaction, and post transaction. Pre transaction information includes all information that is needed by the buyer and seller before the order is placed. Transaction information includes all information that is required to execute the order. Post transaction information includes all information that is needed after the order is delivered. •Metrics: Most metrics involved with LSI address how accurate and timely the data are to allow a decision to be made or an activity to be performed. For example, forecast accuracy is the result of accurate data on past consumption as well as on good predictions on future consumption. Another example would be inventory accuracy. The accuracy of the inventory counts in a distribution center is the result of capturing consumption data from that facility in an accurate and timely manner. Data integrity is another metric that can be used to measure the quality of outputs from an LSI. Post Sale Logistics Support Many organizations focus primarily on outbound logistics, i.e., getting the product to the customer. For some organizations, supporting a product after it is delivered is a competitive advantage. Post sale logistics support (PLS) can take two forms. First, PLS can be the management of product returns from the customer to the supplier. The second form of PLS is product support through the delivery and installation of spare parts. •Metrics: For the most part, the PLS that manages product returns is measured by the ease in which a customer can return a product. A metric such as time to return a product to a seller is usually not important to a customer. Remember, a product return usually involves some level of dissatisfaction by a customer for a seller’s product. So, making it easy for a customer to return a product is a critical metric. •Of the two types of PLS, spare parts logistics provides an easier methodology for calculating financial impacts. Service Recovery No matter how well an organization plans to provide excellent service, mistakes will occur. Even in a Six Sigma statistical environment, 100 percent performance will not happen. High performance organizations today realize this and are using the concept of service recovery. Basically, service recovery requires an organization to realize that mistakes will occur and to have plans in place to fix them. SUMMARY • Order management and customer service are not mutually exclusive; there is a direct and critical relationship between these two concepts. • There are two distinct, yet related, aspects of order management: influencing the customer’s order and executing the customer’s order. • Customer relationship management (CRM) is a concept being used today by organizations to help them better understand their customers’ requirements and understand how these requirements integrate back into their internal operations processes. • Activity-based costing (ABC) is being used today to help organizations develop customer profitability profiles that allow for customer segmentation strategies. • Order management, or order execution, is the interface between buyers and sellers in the market and directly influences customer service. • Order management can be measured in various ways. Traditionally, however, buyers will assess the effectiveness of order management using order cycle time and dependability as the metric, while sellers will use the order-to-cash cycle as their metric. • Customer service is considered the interface between logistics and marketing in seller organizations. • Customer service may be defined in three ways: (1) as an activity, (2) as a set of performance metrics, and (3) as a philosophy. • The major elements of customer service are time, dependability, communications, and convenience. • Stockout costs can be calculated as back order costs, the cost of lost sales, and/or the cost of a lost customer. • The five outputs from order management that influence customer service, customer satisfaction, and profitability are (1) product availability, (2) order cycle time, (3) logistics operations responsiveness, (4) logistics system information, and (5) postsale logistics support. • The concept of service recovery is being used by organizations today to help identify service failure areas in their order management process and to develop plans to address them quickly and accurately. ANSWERS TO STUDY QUESTIONS 1. Explain how order management and customer service are related. How an organization receives an order (electronically versus manually), how it fills an order (inventory policy and number and location of warehouses), and how it ships an order (mode choice and its impacts on delivery times) are all dictated by how an organization manages an order. Customer service, on the other hand, is anything that touches the customer. This includes all activities that impact information flow, product flow, and cash flow between the organization and its customers. Customer service can be described as a philosophy, as performance measures, or as an activity. Customer service as a philosophy elevates customer service to an organization-wide commitment to providing customer satisfaction through superior customer service. This view of customer service is entirely consistent with many organizations’ emphasis on value management, elevates it to the strategic level within an organization, and makes it visible to top executives. Most organizations employ all three definitions of customer service in their order management process. Figure 8-1 shows one way in which order management and customer service are related. As this figure shows, customer service is involved in both influencing a customer’s order as well as in executing the customer’s order. The topics in this figure will be discussed in more detail in this chapter. 2. Describe the two approaches to order management. How are they different? How are they related? Order management defines and sets in motion the logistics infrastructure of the organization. In other words, how an organization receives an order (electronically versus manually), how it fills an order (inventory policy and number and location of warehouses), and how it ships an order (mode choice and its impacts on delivery times) are all dictated by how an organization manages an order. There are two phases of order management. First, influencing the order this is the phase where an organization attempts to change the manner by which its customers place orders. Second, the concept of order execution this phase occurs after the organization receives the order. These two phases are related in that both phases of the order management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction. To the extent that an organization conducts all activities relating to order management in a timely, accurate, and thorough manner, it follows that other areas of company activity can be similarly coordinated. In addition, both present and potential customers will take a positive view of consistent and predictable order cycle length and acceptable response times. By starting the process with an understanding of customer needs, organizations can design order management systems that will be viewed as superior to competitor firms. 3. What is the role of activity-based costing in customer relationship management? In customer segmentation? Figure 8-5 shows one method to classify customers by profitability. The vertical axis measures the net sales value of the customer, while the horizontal axis represents the cost to serve. Those customers who fall into the “Protect” segment are the most profitable. Their interactions with the shipper provide the shipper with the most cost efficiencies. Those customers who are in the “Danger Zone” segment are the least profitable and are more than likely incurring a loss for the shipper. For these customers, the shipper has three alternatives: (1) change the manner in which the customer interacts with the shipper so the customer can move to another segment; (2) charge the customer the actual cost of doing business (this would more than likely make the customer stop doing business with the shipper—this is usually not an acceptable strategy employed by most shippers); or (3) switch the customer to an alternative distribution channel (for example, the shipper might encourage the customer to order through a distributor or wholesaler rather than buying direct from the shipper). The customers who fall into the “Build” segment have a low cost to serve and a low net sales value. The strategy here is to maintain the cost to serve but build net sales value to help drive the customer into the “Protect” segment. Finally, the customers who are in the “Cost Engineer” segment have a high net sales value and a high cost to serve. The strategy here is to find more efficient ways for the customer to interact with the shipper. This might include encouraging the customer to order in tier quantities rather than in case quantities. This switch in ordering policy would reduce the operating cost of the shipper and possibly move the customer into the “Protect” segment. Combining ABC, customer profitability, and customer segmentation to build profitable revenue is a strategy being utilized by an increasing number of organizations today. This strategy helps define the true cost of dealing with customers and helps the shipper influence how the customer interacts with the shipper to provide the highest level of cost efficiency for the shipper. Combining these three tools with CRM allows the shipper to differentiate its offerings to its different customer segments, resulting in maximum profit for the shipper and maximum satisfaction for the customer. 4. Compare and contrast the concepts of order-to-cash cycle time and order cycle time. When referring to outbound-to-customer shipments, the term order to cash (or order cycle) is typically used. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Basically, one organization’s order cycle is another’s replenishment cycle. Traditionally, organizations viewed order management as all of those activities that occur from when an order is received by a seller until the product is received by the buyer. This is called the order cycle. The OTC cycle is all of those activities included in the order cycle plus the flow of funds back to the seller based on the invoice. The OTC concept is being adopted by many organizations today and more accurately reflects the effectiveness of the order management process. 5. Explain the impacts of order cycle time length and variability on both buyers and sellers. While interest has traditionally focused more on the overall length of the OTC cycle, recent attention has been centered on the variability or consistency of this process. Industry practices have shown that while the absolute length of time is important, variability is more important. A driving force behind the attention to OTC cycle variability is safety stock. The absolute length of the order cycle will influence demand inventory. The concept of the order cycle is used here because the focus is on the delivery of product to the buyer and not on the flow of cash to the supplier. For example, assume that the order cycle (time from order placement to order receipt) takes 10 days to complete and the buyer needs five units per day for its manufacturing process. Assuming the basic economic order quantity (EOQ) model is being used by the buyer, the buyer will place an order when it has 50 units of demand inventory on hand. Assuming that the supplier has been able to reduce the order cycle to eight days, the buyer will now place an order when it has 40 units of demand inventory on hand. This is a reduction of 10 units of demand inventory on hand during lead time for the buyer. 6. Customer service is often viewed as the primary interface between logistics and marketing. Discuss the nature of this interface and how it might be changing. Customer service is often the key link between logistics and marketing within an organization. If the logistics system, particularly outbound logistics, is not functioning properly and a customer does not receive a delivery as promised, the organization could lose both current and future revenue. Manufacturing can produce a quality product at the right cost and marketing can sell it, but if logistics does not deliver it when and where promised, the customer will not be satisfied. The traditional role of customer service is at the interface between marketing and logistics. This relationship manifests itself in this perspective through the “place” dimension of the marketing mix, which is often used synonymously with channel-of-distribution decisions and the associated customer service levels provided. In this context, logistics plays a static role that is based upon minimizing the total cost of the various logistics activities within a given set of service levels, most likely determined by marketing. However, logistics today is taking on a more dynamic role in influencing customer service levels as well as in impacting an organization’s financial position. Again, appropriate examples here would include both Dell and Walmart that have both used logistics and customer service to reduce product prices, increase product availability, and reduce lead times to customers. These two organizations have gained an appreciation for the impact of dynamic logistics systems on their financial positions. 7. Organizations can have three levels of involvement with respect to customer service. What are these, and what is the importance of each? The beginning of this chapter offered three different perspectives on customer service: (1) as a philosophy, (2) as a set of performance measures, and (3) as an activity. However, customer service needs to be put into perspective as including anything that touches the customer. From a marketing perspective, there are three levels of a product that an organization provides to its customers: (1) the core benefit or service, which constitutes what the buyer is really buying; (2) the tangible product, or the physical product or service itself; and (3) the augmented product, which includes benefits that are secondary, but an integral enhancement to, the tangible product the customer is purchasing. In this context, logistics customer service can be thought of as a feature of the augmented product that adds value for the customer. However, the product and logistics customer service are not the only outputs by which a seller “touches” the customer. Customer service also includes how a seller interfaces with a customer and provides information about the product. This would include providing information about product availability, pricing, delivery dates, product tracking, installation, post sale support, and so on. Customer service is really an all-encompassing strategy for how a seller interacts with its customers. Customer service is an activity, a set of performance measures, a philosophy, a core benefit, a tangible product, and an augmented product. Customer service focuses on how a seller interacts with its customers on information flows, product flows, and cash flows. 8. Explain the relationship between customer service levels and the costs associated with providing those service levels. Customer service is an important reason for incurring logistics costs. Economic advantages generally accrue to the customer through better supplier service. As an example, a supplier can lower customer inventories by utilizing air transportation rather than motor carrier transportation. Lower inventory costs result from air transportation’s lower and more reliable transit time, which will decrease order cycle time but result in higher transportation costs than those incurred by using motor carriage. The supplier’s logistics analysis must balance the improved service level the customer desires and the benefits the supplier might gain from possible increased revenue versus the cost of providing that service. Every incremental improvement in service (e.g., on-time delivery) will require some incremental level of investment from the supplier. This investment could be in faster and more reliable transportation or in additional inventories. An assumption is that for every incremental improvement in service there is an incremental increase in revenue for the supplier from the customer. With the cost and revenue parameters identified, a return on investment (ROI) can be calculated. Figure 8-9 attempts to illustrate that the ROI from service improvement increases at a decreasing rate. In other words, as service continues to improve, the marginal cost of providing the improved service increases, while the marginal increase in revenue decreases. At some point, the cost of service will far outweigh the incremental revenue gained from that service, providing a negative ROI. This is why it is impractical for most firms to provide 100 percent service levels. Therefore, suppliers must recognize the importance of balancing the tradeoffs between service and cost. 9. Discuss the nature and importance of the four logistics-related elements of customer service. From the perspective of logistics, customer service can be viewed as having four distinct dimensions: time, dependability, communications, and convenience. The time factor is usually order to cash, particularly from the seller’s perspective. On the other hand, the buyer usually refers to the time dimension as the order cycle time, lead time, or replenishment time. To many buyers, dependability can be more important than the absolute length of lead time. Three types of communication exist between the buyer and the seller: pre transaction, transaction, and post-transaction. Convenience is another way of saying that the logistics service level must be flexible. 10. Effective management of customer service requires measurement. Discuss the nature of performance measurement in the customer service area. The four traditional dimensions of customer service from a logistics perspective—time, dependability, convenience, and communications—are essential considerations in developing a sound and effective customer service program. These dimensions of customer service also provide the underlying basis for establishing standards of performance for customer service in the logistics area. Table 8-6 expands these four elements into a format that has been used by organizations in developing customer service policy and performance measurement standards. The traditional performance metrics that have been used are stated in the right-hand column. Typically, such metrics were stated from the perspective of the seller, for example, orders shipped on time, orders shipped complete, product availability when an order was received, order preparation time, and so on. Using Figure 8-6 as a reference, traditional logistics metrics would measure performance after the completion of Step D1.10. The new supply chain environment for customer service has resulted in much more rigorous standards of performance. Logistics performance metrics today are now stated from the buyer’s point of view: • Orders received on time • Orders received complete • Orders received damage free • Orders filled accurately • Orders billed accurately Again, using Figure 8-6, the supply chain perspective would measure performance after the completion of Step D1.12. If the seller is concerned only with customer service prior to shipping, as per traditional metrics, the buyer might not be satisfied and the seller might not know it, because of problems occurring during the delivery process. Furthermore, the seller using traditional metrics would have no basis upon which to evaluate the extent and magnitude of the problem. The supply chain approach, focusing on measurement at the delivery level, not only provides the database to make an evaluation, but it also, and perhaps more importantly, provides an early warning of problems as they are developing. For example, if the standard for on-time delivery is 98 percent and it decreases during a given month to 95 percent, an investigation might show that a carrier is not following instructions or even that the buyer is at fault by not being ready to accept shipments. 11. What events might occur when an organization is out of stock of a needed product? How might the cost of a stockout be calculated? A stockout occurs when desired quantities of finished goods are not available when or where a customer needs them. When a seller is unable to satisfy demand with available inventory, one of four possible events might occur: (1) the buyer waits until the product is available; (2) the buyer back-orders the product; (3) the seller loses current revenue; or (4) the seller loses a buyer and future revenue. From the perspective of most organizations, these four outcomes are ranked from best to worst in terms of desirability and cost impact. Theoretically, scenario 1 (customer waits) should cost nothing; this situation is more likely to occur where product substitutability is very low. Scenario 2 would increase the seller’s variable costs. Scenario 3 would result in the buyer canceling a portion of or the entire order, thus negatively impacting the current revenue of the seller. Scenario 4 is the worst situation for the seller and the most difficult to calculate because it results in the loss of future revenue from the buyer. 12. Assume an organization’s current service level on order fill is as follows: Current order fill = 80% Number of orders per year = 5,000 Percent of unfilled orders back-ordered = 70% Percent of unfilled orders cancelled = 30% Back order costs per order = $150 Lost pretax profit per cancelled order = $12,500 a. What is the lost cash flow to the seller at this 80 percent service level? b. What would be the resulting increase in cash flow if the seller improved order fill to 92 percent? c. If the seller invested $2 million to produce this increased service level, would the investment be justified financially? Case Studies Case 8.1: Telco Corporation 1. How should Telco approach segmenting its customers? That is, on what basis (cost to service, profitability, etc.) should the customers be segmented? Students can use the four-step process discussed in this chapter to segment Telco’s customers. An Activity-Based Costing (ABC) methodology should be used to segment by profitability. 2. How should Telco tailor its service offerings to each customer segment? Students can decide what service offerings each segment gets using Tables 8.1 and 8.2 as guidelines. 3. Should certain customers be asked to take their business elsewhere? Companies do not, as a practice, ask customers to take their business elsewhere. Two strategies exist for unprofitable customers. First, encourage these customers to change the manner in which they buy from Telco. This can include buying in larger quantities or buying through a different channel (e.g., distributors versus direct from Telco). Second, set the price for these customers to reflect their costs. 4. How should the revised service packages to each segment be introduced to that segment? By the sales force? Should all segments be done at the same time? Typically, the sales force will take on this responsibility and will start with the most profitable customers first. Students should take note that while some customers are not currently profitable, their revenue growth prospects for the future will make them profitable. Customer segmentation by profitability is a “first cut” at identifying important customers and provides a company a framework on which customers are currently profitable and which ones need to be protected since they will grow into profitability. 5. Each division has its own sales force, manufacturing facilities, and logistics network. As such, common customers (those who buy from more than one division) place separate orders with each division, receive multiple shipments, and receive multiple invoices. Would it make sense for Telco to organize around customer rather than around product? If so, how would this be done? What would the new organizational metrics look like? In a multi-division company like Telco where customers can buy from multiple divisions, organizing around customer is the best strategy but difficult to accomplish. Individual division profit and loss (P&L) statements must be replaced with customer P&L’s which would require a single P&L for Telco as a corporation. The new metric would be customer profit rather than division profit. Case Study 8.2 Webers, Inc. 1. Create process maps for the “before” and “after” order management processes. Use Figure 8.15 as a guide. Start from when the consumer places the order and end when the shipment is made. Students can use Figure 8.15 as a framework for their analysis. There is no one correct answer for this question. 2. From these process maps, identify where the major changes to the order management process occur. Same answer as Question 1. Emphasis must be placed on how the information systems (WMS, TMS, OMS) need to change in how they communicate with each other. 3. Develop a new set of metrics that Webers can use to measure the performance of the new process. Use Figure 8.11 as a guide. The new focus of Webers is now on orders delivered on-time rather than shipped on-time. Students can use Figure 8.11 to develop metrics for the new process. Solution Manual for Supply Chain Management: A Logistics Perspective John J. Coyle, John C. Langley, Robert A. Novack, Brian J. Gibson 9781305859975