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Supply Chain Management: A Strategic Perspective
Learning Objec ves A er comple ng this chapter, you should be able to:
Define supply chain management. Explain the consequences that occur when informa on is not shared, and describe some of the informa on that can be shared in a supply chain. Discuss various op ons in supply chain structure. Compare insourcing, outsourcing, and ver cal integra on. Compare agile supply chains to lean supply chains. Discuss the impact of e-commerce on supply chain management. Explain how ERP facilitates e-commerce.
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Describe some supply chain performance measures. Discuss global issues in supply chain management.
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Apple is the focal firm in its supply chain. A focal firm is the most important organiza on in the supply chain and the firm that o en interfaces with the final consumer.
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5.1 Foundations of Supply Chains
The term supply chain is commonly used to refer to the network of organiza ons that par cipate in producing goods or providing services. A supply chain encompasses all ac vi es associated with the flow and transfer of goods and services, from raw material extrac on through use by the final consumer. The ac ons of the par cipants in the supply chain are coordinated by the focal firm, which directs the flow of informa on much like a conductor coordinates the ac vi es of an orchestra. The be er the focal firm is at moving informa on among par cipants, the be er the supply chain will perform. The focal firm is o en, but not always, the firm that interfaces with the final consumer. The focal firm designs and manages the supply chain by selec ng suppliers. For example, Apple is the focal firm in its supply chain. Apple is primarily a product design and marke ng focused firm with no manufacturing ac vi es, yet it is the focal firm because its brand dominates the market. There are also cases where the most important firm does not sell directly to the consumer. For example, the oil industry is shi ing from a model in which one firm owns the oil fields, pipelines, refineries, and retail gasoline sta ons to a model in which independent companies operate the retail opera ons. Bri sh Petroleum, commonly known as BP, has been reducing the number of retail outlets in the United States for several years. In this example, the company that owns the refinery and the oil fields is the focal firm because it controls the key resource in the supply chain.
A supply chain may be contained within a single organiza on as shown in Figure 5.1. Exxon Mobil owns oil fields, refineries, distribu on networks, and retail gasoline sta ons that deliver fuel to the consumer. Owning mul ple assets in a supply chain is called ver cal integra on. The more assets a company owns, the greater the degree of ver cal integra on.
Figure 5.1: Example of a ver cally integrated internal supply chain
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Traditional Supply Chains
In most cases, different companies own the assets in a supply chain as shown in Figure 5.2. For example, suppose a consumer purchases a DVD player from a retailer. The retailer obtained that DVD player through a distributor, which originally purchased the player from the manufacturer. All of those different companies, as well as the consumer, are part of the supply chain. However, the supply chain does not end there. The manufacturer purchased component parts from various er 1 suppliers, who have purchased materials from er 2 suppliers, such as companies that produce the chemicals for making plas c. Finally, those er 2 suppliers could have also purchased the raw materials to make those chemicals from er 3 suppliers who extract petroleum from the earth. The supply chain also includes companies that move these items, such as trucking companies, railroads, and shipping companies, as well as warehouses or distribu on centers where items may be temporarily stored during movements within the supply chain. Logis cs involves managing the movement of materials and components from point to point in the supply chain.
Figure 5.2: Example of an external supply chain
In addi on to materials, informa on flows through a supply chain. If a DVD player model is selling extremely well and the retailer wants to stock more of them, then that retailer provides informa on to Processing math: 0%
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the distributor to ship more of that model. The distributor informs the manufacturer to make more, and the manufacturer no fies its suppliers to provide more of the component parts. Ideally, the informa on would be shared with the en re supply chain simultaneously, not only those companies with which each member deals directly. Taking ac ons to have all members of the supply chain work together, coordinate their ac vi es, and share informa on is known as supply chain management.
When it is necessary to return defec ve products to the manufacturer for repair or replacement, the process is known as reverse logis cs. Reverse logis cs includes efforts to reuse and recycle materials. In Europe, the role of reverse logis cs is being expanded beyond tradi onal recycling. The no on is that manufacturers who create a good are responsible for it at the end of the product's useful life. This requires that producers of goods have a vested interest in crea ng designs, selec ng materials, and using manufacturing processes that facilitate recycling. Because firms are responsible for the end-of-life recycling cost, they will make decisions that lower the cost of recycling. There is no legal requirement for companies to do this in the United States, but the idea of designing to facilitate recycling is sound.
Walmart, Dell, Toyota, and The Home Depot have fine-tuned their supply chains to provide a strong compe ve advantage in terms of service and price. This chapter discusses how these companies and others have used supply chain management to their advantage.
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Globaliza on allows products and services to reach all corners of the world and results in increased compe on. Few companies have been as successful at globalizing their brands as Coca-Cola.
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Wal-Mart Manages Logis cs; The Age of Wal-Mart: Inside America's Most Powerful Company
5.2 Overview of Supply Chain Management
Tradi onally, each company in a supply chain acted in its own best interests, not those of the en re supply chain. Informa on was not adequately shared among members of the supply chain. Only limited informa on was shared between a company and its immediate suppliers and between that company and its customers. As a result, important decisions including how much to produce, store, and move along the supply chain were based on local condi ons rather than what was best for the supply chain. Several factors have emerged that encourage companies to adopt supply chain management as part of their compe ve strategy. Those factors are:
Increasing globaliza on More intense compe on Shorter product life cycles Developments in informa on technology and data communica on
Globaliza on has led to new markets, but also to more companies producing and selling compe ng products—Toyota sells cars in the United States, Intel sells computer chips worldwide, Goldman
Sachs provides financial services in the United Kingdom, and Caterpillar sells construc on equipment in China. These are but a few examples of the increase in global compe on and global trade since the 1960s. Established markets have become more compe ve as companies iden fy new ways of winning market share through process improvements that lower cost, improve product performance, and increase product quality. Some firms have opted to increase market share by introducing new products. As firmsProcessing math: 0%
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introduce new products and their compe tors respond, market change accelerates and product life cycles become shorter. This means that new products must be profitable quickly and pay the needed return on investment in less me than prior products. Be er supply chain management is one way to do this. Informa on and communica on technologies have opened up new ways of buying and selling through the Internet and mobile devices. This has also allowed companies to obtain and disseminate informa on much more rapidly than before, thereby providing the consumer
with more informa on—not just price and features, but availability, delivery op ons and ming, service a er the sale, repair services, and more.
Because of these changes, companies have been forced to be more compe ve. Supply chain management can make a company more compe ve by coordina ng all supply chain ac vi es to ensure that the customer obtains the desired product at the desired me for a compe ve price. Companies should work together to minimize costs over the en re supply chain, thus benefi ng all the members. Supply chain management is the integrated coordina on of all components of the supply chain—from raw materials to the final customer—so that informa on and materials flow smoothly.
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5.3 The Role of Information Sharing
Tradi onally, limited informa on has been shared between adjacent supply chain pairs. For example, a retailer may order a certain number of units from a distributor, informing the distributor only of the number of units wanted at that me and when those units should be delivered. Very li le informa on, such as expected future changes in demand, would be shared between the retailer and the distributor. The small amount of informa on that was shared would be shared only by those two members of the supply chain. This limited approach to informa on sharing does not op mize the performance of the supply chain, and can even lead to detrimental results such as the "bullwhip effect."
The Bullwhip Effect
The bullwhip effect is an example of what can happen when informa on is not fully shared in a supply chain or when forecasts are updated, causing an unan cipated shi in expected demand. This effect is further complicated by batching orders that concentrate demand at one point in me, price fluctua ons that change demand, and a empts to ra on product or otherwise game the system. The bullwhip effect is caused when a retailer experiences a slight increase in demand and increases its order quan ty to avoid running out of a product. The distributor also no ces the increased order from its customer (the retailer) and, also to avoid running out, increases its order to the factory by a larger amount. The factory, in turn, will further increase its orders to suppliers of raw materials. The end result is that a slight increase in demand at the retail level increases nearly exponen ally, crea ng a huge demand increase at the supplier level, as shown in Figure 5.3. This increase in demand may cause the supplier to work over me, thereby increasing costs. When the retailer places the next order, which is the same size as the prior order (more or less), each par cipant in the supply chain will have too much inventory, so a cut back is required. The supplier, who overes mated the most (see Figure 5.3), will dras cally reduce produc on. As a result, the supplier may lay off staff because much of the demand can be met from inventory. In this system that uses sequen al communica on, the supplier at the end of the chain is "whipped" from one extreme to the other, from high demand requiring over me costs to low demand leading to layoffs or excess inventory. Both of these op ons increase the supplier's costs.
Figure 5.3: The bullwhip effect
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To avoid problems such as the bullwhip effect, informa on must be shared via real- me communica on methods rather than me delayed, sequen al communica on. The hub and spoke approach is one way to do this. Each spoke represents a connec on to a member of the supply chain. All members of the supply chain transmit informa on to a central hub, and each member has access to the informa on. The focal firm o en determines the informa on that must be shared in this manner. For example, if a company wants to supply components to a Chrysler assembly plant, it must provide the informa on determined by Chrysler, or the supplier will not be accepted. By sharing this informa on, all supply chain partners see changes occurring anywhere in the supply chain, and respond to those changes accordingly. The following sec ons indicate some ways for data to be shared. Electronic data interchange (EDI) is a method of exchanging relevant informa on between suppliers and customers in real me. Collabora ve planning, forecas ng, and replenishment (CPFR) goes beyond the exchange of data to include joint planning efforts.
Electronic Data Interchange
Electronic data interchange (EDI) connects the databases of different companies. In one early use, EDI allowed companies u lizing material requirements planning (MRP) to inform suppliers of upcoming orders by providing them with access to the database of planned orders. Although this approach was innova ve at the me, it s ll represented only limited sharing of informa on between adjacent links in the supply chain. In supply chain management, EDI is a way to share informa on among all members of a supply chain. Shared databases can ensure that all supply chain members have access to the same informa on, providing visibility to everyone and avoiding problems such as the bullwhip effect.
Collabora ve Planning, Forecas ng, and Replenishment (CPFR)
Theore cally, informa on is shared easily among all partners in a supply chain. In prac ce, however, the process o en does not work very smoothly. As a result, members of the supply chain may make assump ons about future ac ons of other supply chain members. For example, each supplier must forecast the demand of its customers. Collabora ve planning, forecas ng, and replenishment (CPFR) is a Processing math: 0%
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Like long-range forecasts offered in the annual Old Farmer's Almanac, companies also predict forecasts for the future. The condi ons predicted can be drama cally different from what actually happens.
©Brian Snyder/Reuters/Corbis
process that accomplishes more than data exchange. It seeks to minimize the lack of informa on through enabling collabora on among supply chain partners that jointly develop a plan specifying what is to be sold and how, where, and during what me period it will be marketed and promoted. Sharing of informa on is facilitated by using a common set of communica on standards. All partners are involved in the development of plans and forecasts for the en re group. Because these plans and forecasts have been jointly agreed upon, considerable uncertainty is removed from the process.
Real World Scenarios: Eroski Supermarkets
Eroski operates supermarkets and hypermarkets in Spain and France. Henkel, a German company, is one of the suppliers for Eroski stores. Although Henkel had u lized EDI with its customers to improve inventory reordering, Eroski stores con nued to run out of Henkel products on a regular basis. The two companies decided to pursue CPFR, beginning with joint demand forecas ng, which requires them to work together to es mate demand. Before implemen ng CPFR, about one-half of Henkel's forecasts of demand had been miscalculated by 50% or more. As a result, Eroski's supermarkets ran out of Henkel's products. A er implementa on of CPFR, 75% of forecasts were within 20% of actual demand, and Henkel products were in stock at Eroski stores 98% of the me.
CPFR (pronounced C-P-Far) requires that all supply chain par es be commi ed to the plans developed jointly and that they be commi ed to upda ng the plan on a regular basis. A retailer will share informa on about demand forecasts and planned product promo ons with its suppliers. Likewise, the suppliers share informa on about possible limita ons on supply or periods during which produc on facili es may be shut down. Once a plan is developed, suppliers can begin produc on knowing that their customers in the supply chain have commi ed to those orders. Plans must be revisited regularly to ensure that adjustments are made when appropriate.
Forecast Accuracy
One problem with sharing informa on is that some of that informa on may not be accurate, especially forecasts. For example, a retailer may forecast future sales of a par cular clothing line. When demandProcessing math: 0%
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actually occurs, it may differ significantly. If the forecast was too high, then the retailer may be le with excess inventory that must eventually be sold at a loss. On the other hand, a forecast that is too low can mean unmet demand and lost sales.
Simply realizing that forecasts are likely to be inaccurate can lead to improving supply chain management. For instance, quick response is one technique that the fashion industry has developed to address uncertainty in demand. In general, any me a firm can reduce the lead me between a customer order and its delivery, responsiveness is improved and forecas ng errors become less relevant.
Historical informa on about forecast accuracy can be used to develop a confidence interval for demand. The supplier may be able to predict that there is a certain probability that demand will not vary from the forecast by more than a specific amount. This informa on can help the supplier to plan for a certain range of possible demand values.
Real World Scenarios: Walmart
Walmart is one company that has used EDI to improve forecast accuracy. Vendors who provide products to Walmart can use Walmart's satellite network system to directly access real- me, point- of-sale (POS) data coming in from the cash registers at Walmart stores. Vendors can use this up-to- the-minute informa on to improve forecasts by spo ng trends the moment they occur.
Also, most forecasters know that it is easier to forecast demand as the me horizon is shorter. If the supplier has Walmart's up-to-the-minute demand for Sauder television stands, it can respond quickly to any demand change. There is no me delay in ge ng an order because Sauder has the most recent sales data. If Sauder can combine this with a shorter lead me—that is, they can be more responsive—errors in forecas ng will be less important. If Sauder takes two weeks from the me it receives an order un l it delivers the product, a forecas ng error is more likely to cause a supply disrup on than if Sauder can respond in three days. With a two-week response me, Sauder's customer may be out of stock for several days to as much as two weeks. With a three-day response
me, Walmart is far less likely to be out of stock, and if an inventory shortage occurs, it is likely to be only a day or two before more inventory arrives at the retail outlet.
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5.4 Structure of Supply Chains
As shown in Figure 5.2, the upstream supply chain includes suppliers, which may be er 1, er 2, or er 3. Each er of the upstream supply chain may include mul ple suppliers for the same good or service. The upstream side of the supply chain also includes produc on planning and purchasing as well as logis cs, which is responsible for moving materials between supply chain members. On the downstream side, supply chain partners are divided into echelons. For example, echelon 1 includes organiza ons, such as distributors, importers, or exporters that receive the product directly from the organiza on that produces it. Echelon 2 organiza ons would receive the product from those at echelon 1. Echelon 2 may include retailers, dealers, or final consumers.
It is important to realize that Figure 5.2 is a greatly simplified diagram of a supply chain. There are many more organiza ons that provide required goods and services and move materials and informa on than can be shown in Figure 5.2. How these numerous organiza ons are arranged and relate to one another is what determines supply chain structure. The next sec on will briefly discuss how supply chains can be structured.
Number of Suppliers
At each er of the upstream supply chain, companies can decide whether to use many suppliers for a par cular good or service or few suppliers. Using many suppliers o en allows a company to take advantage of compe on among those suppliers to meet the company's demands for cost, quality, and delivery. If one supplier goes out of business or is unable to provide the good or service as requested, it is a simple ma er to use another supplier.
On the other hand, there are some advantages to having only a few suppliers, or even one supplier for a good or service. Chief among these is the long-term partnership arrangements that can be developed. Such rela onships enable both par es to work together for greater integra on of the supply chain and for development of methods that can improve quality and lower costs. These close partnerships o en lead to high levels of dependency between the customer and the supplier.
Highlight: TMD and Chrysler Toledo Assembly Complex
TMD's Toledo facility is the sole source of instrument panels for the Jeep Wrangler, which is produced at Chrysler's Toledo Assembly Complex (CTAC). All of the output from TMD's Toledo opera ons is delivered to CTAC, which is located less than three miles from the assembly facility, thereby keeping shipping costs low. Because of close interac on and very short travel me, the inventory of instrument panels is enough to sa sfy demand at CTAC for only a couple of hours. These two organiza ons have developed such a close rela onship that there have been very few
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Due to low labor costs in developing na ons, global outsourcing has dras cally increased in the past decade as firms seek to find low-cost suppliers.
iStockphoto/Thinkstock
Striking a Regulatory Balance
supply disrup ons, administra ve and accoun ng costs are low, and quality is high. The rela onship has worked well for both. Because these companies are highly dependent, they have worked hard to develop con ngency plans to deal with unexpected problems.
Insourcing Versus Outsourcing
Organiza ons use a wide range of goods and services when making and delivering products. If those goods and services are provided by the organiza on itself, they are insourced. Goods and services obtained from outside suppliers are outsourced. One reason companies decide to outsource is that the goods or services can o en be obtained less expensively from outside suppliers. Outside suppliers may specialize in producing that good or service, enabling them to maintain high quality while keeping costs low. Suppliers may have proprietary technology
that provides them a compe ve advantage.
In the past decade or more, global outsourcing has grown drama cally as firms seek to find low-cost suppliers. This push, driven primarily by low labor costs in developing economies such as Mexico, China, India, and Vietnam, has lengthened the supply chain, which increases transporta on and inventory costs. With longer supply chains as well as poli cal uncertainty and cultural differences, there is also an increased risk of supply chain disrup on. Yet, the allure of lower costs is a powerful force. As some of the disadvantages of global sourcing are being examined, including concerns about quality and rising labor costs in some developing countries, there are signs of produc on returning to the United States. It is too early to tell if these instances are the beginning of a growing trend. It should be Processing math: 0%
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clear that global outsourcing is not just a manufacturing phenomenon. Engineering work, informa on systems development, and examina on of medical images are being outsourced to developing countries.
Vertical Integration
Supply chain management requires close coordina on with suppliers, but if those suppliers are separate organiza ons, there may be difficulty coordina ng among one another. One way to promote coordina on is for a company to own its suppliers. This is called backward ver cal integra on.
Highlight: Henry Ford and Backward Ver cal Integra on
The early Ford Motor Company provides a classic example of backward ver cal integra on. Henry Ford believed that owning his sources of supply was the best way to guarantee an uninterrupted supply of compe vely priced component parts and raw materials to build his Model T. He purchased iron mines, rubber planta ons, and shipping companies. In order for this complex system to be efficient without the informa on and communica on technology that is present today, it required centralized planning with long lead mes to move product from raw materials to create the finished automobile. As a result, Ford's massive system eventually became unwieldy and inflexible, resul ng in severe problems when compe tors began offering product variety that Ford was unable to provide. Could Ford's approach work today given that informa on and communica on technologies give real- me access to data that supports decision making? There are s ll significant issues to overcome including the level of exper se required to manage diverse holdings such as iron mines and rubber planta ons. Demand must be large enough to generate economies of scale when producing each component or raw material. It is challenging to build an efficient and responsive organiza onal structure that can manage such a large organiza on, so in some cases it is be er to let market forces drive compe on between suppliers.
At the other end of the supply chain, a company can own the distribu on systems and retail outlets that sell their products; this is forward ver cal integra on. Many large grocery chains, such as Kroger, Publix, and Safeway, own their distribu on networks as well as the retail stores. These companies may own all aspects of the distribu on system, including transporta on.
Highlight: La-Z-Boy Furniture and Forward Ver cal Integra on
La-Z-Boy Furniture has used its worldwide brand appeal to build a chain of retail outlets in approximately 50 countries including Jakarta, Indonesia and Bogotá, Colombia. Its strong brand recogni on draws customers into these retail outlets to buy La-Z-Boy products as well as products from other companies. Its high level of demand is the founda on for genera ng a high level of sales
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in each store. These two factors, high brand recogni on and sales volume, provide La-Z-Boy with the opportunity for forward ver cal integra on.
Virtual Organizations
Today, outsourcing is gaining popularity because of cost advantages and the opportuni es for greater coordina on that have been provided by the improved communica on technologies of e-commerce. The applica on of this technology has led to virtual corpora ons, that is, companies that exist only as an administra ve shell, with all other func ons outsourced. Outsourcing provides a great deal of flexibility because the company can change sources as the requirements of its products or markets change. Apple is not a virtual corpora on because it has product design capabili es, marke ng, accoun ng, and other func ons. Apple does have virtual manufacturing opera ons through suppliers from around the globe.
Real World Scenarios: Amazon.com as a Virtual Retailer
Amazon.com is a large online retailer that buys and sells books and hundreds of other items. Amazon.com acts like a virtual organiza on when it opens its website to other companies who want to list their products. Amazon.com holds the informa on about the loca on and the cost of books or other items, but it never takes possession or owns the items. When a customer locates an item on Amazon.com's website, the order is placed with Amazon.com and payment is collected by Amazon.com. The informa on about the order, including the item iden fier, the ship to address, and the payment (less Amazon.com's commission), is sent to the firm that owns and possesses the merchandise. The firm then sends the item to the customer. In this example, Amazon.com took no risk, owned no property, and incurred no cost except those related to lis ng the item on its site. It has used the power of its brand to drive both buyers and sellers to its site, thereby ac ng as an intermediary.
Disintermediation
An intermediary is a business en ty that exists between a customer and a supplier. For example, travel agents are an intermediary between the travelers who buy airline ckets and the airlines that sell those
ckets. A growing trend today is to achieve efficiencies in the supply chain by elimina ng some intermediaries. This process is known as disintermedia on. Airlines now have their own websites through which travelers can purchase ckets directly from the airline, without using a travel agent's services. For the traveler, this process may be advantageous because the traveler can readily compare all different flight mes and rou ng op ons, browse special promo ons that are currently being offered by the airline, and even compare prices among different airlines by visi ng other websites. Ge ng flight informa on and pricing from a travel agent may be more difficult. Some companies have made theProcessing math: 0%
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search process more efficient by pu ng nearly all airline prices on one website.
Real World Scenarios: Travelocity
Travelocity has created a successful business by using the Internet to provide travelers with easily accessible informa on from airlines, hotels, and car rental companies. The advantage of Travelocity is that it enables a customer to compare prices offered by many different travel service suppliers on one single website. In response, a group of major airlines began compe ng directly with Travelocity through its own website, Orbitz. Orbitz was started by American Airlines, United Airlines, and Delta Air Lines and promised to provide airfares that are lower than those through Travelocity, thus seeking to eliminate Travelocity as an intermediary. Kayak, Expedia, and Cheapflights have also begun to compete in this market. With limited barriers to entry, this space has become crowded.
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The fashion industry is con nuously evolving; therefore, an agile supply chain is u lized because it is able to rapidly respond to new products and changes in demand.
iStockphoto/Thinkstock
5.5 Supply Chain Strategies
As top managers have begun to understand the value of effec ve supply chain management, it has gained recogni on as a strategically important issue. Becoming successful when managing supply chains requires the support and involvement of top management. Various approaches to managing supply chains have been developed. Many of these strategies can be used together, although some may be more relevant to certain types of supply chains or certain structures.
Agile Supply Chains
Markets such as fashion and technology are characterized by frequent innova on, making product demand unpredictable and, therefore, requiring the en re supply chain to respond quickly as new products are introduced and demand changes. The supply chain must be able to transmit customer responses to new products and informa on about what customers would like to see in future products.
A par cular type of supply chain, known as an agile supply chain, is needed to meet these requirements. Members of such a supply chain are selected based upon their speed and flexibility, and their capacity to transit informa on reliably, accurately, and quickly from the marketplace to supply chain members. An agile supply chain a empts to assess in great detail the needs of its customers so it can provide customized products that be er meet the customers' expecta ons. An agile supply chain is more than transferring data between companies (EDI) or replenishing inventory more effec vely and efficiently (CPFR). An agile supply chain is a coopera ve rela onship; supplies help to design and develop new products that can meet individual customer needs be er. It creates a flexible and responsive produc on process that allows the supply chain to deliver differen ated products. It also allows companies to work on quality improvement projects that affect the company and its suppliers, and allows all members of the supply chain to work together to keep costs aligned with customer expecta ons. Agile supply chains are frequently used in the fashion industry.
Real World Scenarios: Sport Obermeyer
Sport Obermeyer is a maker of fashion skiwear. When designs are created, suppliers help Sport Obermeyer to iden fy new material that can be used in its innova ve and fashionable designs, andProcessing math: 0%
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Products such as can openers that have a long product life cycle, stable demand, and a low profit margin use lean supply chains because they keep costs down.
©BananaStock/Thinkstock
to create produc on systems that can respond to changing customer demands. Product mix flexibility is the agility to shi produc on from one product to another with very limited lost me or very small cost increases. Product volume flexibility is the agility to increase produc on levels if demand is greater than expected or to reduce produc on volume if demand is less than expected. This agility in the supply chain allows Sport Obermeyer to respond quickly and efficiently once customers vote with their money and decide that they like one style and color of ski equipment over another. Agility allows Sport Obermeyer to keep inventory at op mum levels. When produc on begins, the company can only es mate how many units of each product will actually be sold. If the supply chain cannot adjust, Sport Obermeyer will have too many units of products that are not selling well and not enough of high-demand items, resul ng in excessive inventory, high inventory carrying costs, and lost sales.
Vendor Managed Inventory (VMI)
Instead of a retailer following the tradi onal approach of placing inventory replenishment orders with its suppliers, the suppliers can use informa on from the retailer regarding product sales to determine when they should replenish the supplier's inventory. Walmart and other larger retailers, in conjunc on with suppliers such as Procter & Gamble, have implemented vendor managed inventory (VMI). Under VMI, the vendor, or supplier, can be er coordinate its own produc on with the replenishment of supplier inventory, thus reducing costs and improving delivery performance between the supplier and the retailer. To make this work, the suppliers receive daily point-of-sale (POS) data from the retail stores, and they also have access to retailer's inventory files. In this way, the supplier (Procter & Gamble) has sales data and on-hand inventory at the retailer (Walmart). The supplier can plan produc on to keep the retailer stocked with its product and effec vely manage its produc on to keep costs low. Customers benefit because the product they want is in stock, the retailer benefits because it has product to sell and inventory cost is low, and the supplier benefits because it sells more product while keeping produc on costs low.
Some companies such as Bose, which manufactures audio components, have further u lized vendor managed inventory by having personnel from their suppliers work within Bose's purchasing department. Bose has called this approach Just-in-Time II (JIT II). In the past, Bose's purchasing personnel handled all Processing math: 0%
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purchasing from outside suppliers. But, because the Bose personnel worked with many different suppliers, they were not fully knowledgeable about the full range of products offered by each supplier, nor were they aware of the inventory levels and produc on plans of those suppliers. Under JIT II, employees of major suppliers work in the Bose purchasing department and handle all purchases from their companies. These employees are aware of all products offered by their companies. Thus, they are o en able to suggest be er alterna ves. Furthermore, because these personnel are employees of the suppliers, they are aware of all supplier informa on, such as current inventory levels of products and plans for future produc on. This knowledge enables personnel to foresee possible shortages and avoid problems before they occur.
Lean Supply Chains
A very different approach is needed for products that are standard func onal items, such as power drills or can openers. These products have long product life cycles, stable and predictable demand, and minimal innova on. They are also o en characterized by low profit margins. For these products, the supply chain must focus on opera ng efficiently to minimize costs. Such supply chains are known as lean supply chains, and the members are chosen based upon their ability to keep costs down and minimize inventory in the system.
Real World Scenarios: Black & Decker's Lean Supply Chain
Black & Decker produces a variety of small appliances and hand tools for use in the home. Success in that market is predicated on manufacturing standard products that have high quality and low cost and a modest amount of variety. Designs for these appliances and tools change slowly and demand for these products can be characterized as steady. A lean supply chain focuses on opera ng issues as it a empts to eliminate non-value-added opera ons. A lean supply chain supports the reduc on of setup mes to enable the economic produc on of small quan es. This enables the supply chain to keep inventory costs low and achieve manufacturing cost reduc ons, in part, by enabling opera ons to switch quickly among products.
Consider Black & Decker's 3/8-inch variable speed reversing drill, which is one of its most popular products. This tool is sold primarily to homeowners who use it infrequently to hang a shelf or repair a table. Each major component in the drill is a standard product. To create a successful supply chain, component suppliers must adopt lean manufacturing and its con nuous improvement philosophy. These suppliers must achieve an efficient combina on of flexibility and cost reduc on. Flexibility is needed because there are several different models of drills as well as other hand tools and appliances that require similar components. Cost reduc on is also essen al because products, such as drills, are produced by many compe tors, and customers are price sensi ve. Cost reduc ons can be achieved when suppliers purchase large volumes of basic materials, such as steel for the gear manufacturer, or copper for the electric motor producer. Streamlining the flow of materials andProcessing math: 0%
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informa on through the supply chain to drive out inventory and non-value-added steps can also reduce cost. Because drills have low profit margins maintaining high sales and produc on volumes is cri cal for profitability for all members in the supply chain. Black & Decker can switch from one supplier of electric motors to another with rela ve ease, which is significant mo va on for suppliers to seek con nuous improvements in both component part cost and quality.
Postponement
In an a empt to meet customers' requests as closely as possible, firms and their supply chains may offer a product with many different op ons. For example, a par cular model of automobile may be able to be built in two million or more combina ons of paint color, trim package, engine, transmission, interior colors, and other op ons. Because of this large number of possibili es, manufacturers find it extremely difficult to accurately forecast demand for each possible combina on of op ons. Inaccurate forecasts mean that the company may end up with a large inventory of unsold products consumers do not want, and a small inventory of the products consumers do want. Building sufficient inventory in each of the many op ons results in excessive inventory levels and costs. Conversely, wai ng to produce a product un l the customer actually wants it may disrupt the efficiency of the produc on process and entail very long lead mes.
To overcome these problems, companies may use either product or process postponement. Electronics manufacturers such as Hewle -Packard (HP) use product postponement, also known as delayed differen a on, by producing a generic product at the central manufacturing facility, then adding specific components needed to customize the product for the final consumer at the latest possible point in the distribu on system. Thus, product postponement delays the final configura on of a product un l the last possible step in the supply chain.
The elements of a printer, which are common to all configura ons of the printer, are produced and assembled at a central loca on. These undifferen ated units are shipped to distribu on centers around the world as needed. At the distribu on centers, the electric module with the correct voltage, amperage, plug, so ware, and instruc ons are added to the unit. In this example, differen a on takes place just prior to a product's arrival at retail opera ons rather than at the factory that assembles the printers. In this way, the produc on process is very efficient and inventories are kept very low. If demand is unexpectedly high in China and low in Europe, HP can adjust shipments at its factory because the product is s ll undifferen ated.
Product postponement is also u lized to some extent by automobile manufacturers. Certain op ons are added to automobiles, customizing them for the U.S. market a er the cars are received in the United States. Carmakers in the United States offer detail packages that add special trim or increase performance. These upgrades can take place a er the vehicle exits the assembly line and before it reaches the dealer, or they may happen a er purchase from the dealership and before the customerProcessing math: 0%
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takes delivery.
In process postponement, certain steps in the produc on process are delayed un l the last possible moment. Instead of maintaining an inventory of finished products, a company will maintain inventory of component parts and then process the products when orders are received. Ideally, the finished product will be produced only a er customer orders have been received. This is commonly used in "sit-down" restaurants rather than in fast-food restaurants. For example, if the menu lists a perch dinner, the customer may be able to choose whether the fish is fried, baked, broiled, or blackened, and whether the accompanying potatoes are deep fried, baked, or home fried. Restaurants can offer these op ons because the me that a customer expects to be in the restaurant is long enough to fix the food using a different process.
When process postponement is implemented there are many op ons for finished products with few components so less diverse inventory is held. A restaurant can offer four different fish op ons and three different potato op ons, or 12 different meal choices, and it only needs to inventory perch and potatoes. For this approach to work effec vely, the lead mes for making finished products must be short enough that they will be acceptable to customers. That is why process postponement does not work in fast-food restaurants.
Cross Docking
One objec ve of supply chain management is to reduce inventory throughout the supply chain. Distribu on centers, which receive shipments from a factory, break down those shipments into smaller quan es that are shipped to retailers, who are the customers of distribu on centers. This represents a major investment in inventory because receipt of shipments from the factory is not coordinated with shipments to retailers. Thus, a large shipment of a product may be received from the factory. Next, it is placed into inventory un l orders are received from retailers that gradually decrease the inventory.
Cross docking seeks to coordinate inbound and outbound shipments so that li le inventory is kept at the distribu on center. As a shipment is received from the factory and broken down, each unit of the inbound shipment is moved to a loca on awai ng outbound shipment to a retailer. A er each outbound shipment is fully assembled, it is sent on to the retailer. Consequently, the distribu on center primarily serves as a loca on for breaking down incoming shipments and redistribu ng the items into outgoing shipments. Unlike the tradi onal approach, the distribu on center used for cross docking does not serve as a site for storing inventory. Target is one of dozens of retailers that have used cross docking effec vely to decrease costs and reduce inventory. Distribu on centers that use cross docking will have many items that never leave the conveyor system. A pallet of Gatorade may go from the delivery truck onto a high-speed automated conveyor system to the truck taking the product to the retail store. Scanners, cameras, and bar code readers sort and direct the pallet through the distribu on center. As a result, more than 50% of products fed into the system spend a few minutes to a couple of hours in the distribu on center, and never leave the conveyor. Much of the product, 70–80%, leaves the distribu onProcessing math: 0%
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center in 24 hours or less.
Third Party Logistics (3PL)
To improve the efficiency of supply chains, some companies have developed partnerships with third party logis cs (3PL). An outside supplier, also known as a third party, handles all of the logis cs ac vi es between supplier and customer. Third party logis cs (3PL) is, therefore, the outsourcing of logis c services. These logis cs ac vi es can include inventory control, material handling, and transporta on. United Parcel Service (UPS) is a 3PL provider for health care, retail, and automo ve opera ons. It o en makes good financial sense to allow specialists who know the best ways to move goods from place to place to handle logis cs.
Real World Scenarios: Penske and Navistar Strike up a Partnership
Penske Logis cs and Navistar truck producers have formed a 3PL partnership under which Penske Logis cs is responsible for reducing supply chain costs and improving performance. The new approach has included centralizing shipping opera ons, improving supplier training, establishing new bidding requirements for carriers, and implemen ng a proprietary logis cs management system. Navistar chose 3PL because Penske Logis cs has exper se and experience that Navistar does not have. Navistar could develop this exper se, but the cost of doing so would be higher than using Penske Logis cs and the results may not be as good. The advantage of 3PL is that companies such as Penske Logis cs have specialized knowledge regarding the best methods and techniques to move parts from one place to another. Furthermore, Penske Logis cs is able to combine shipments from many different suppliers and many different customers, taking advantage of opportuni es for cross docking and reduced transporta on costs.
Radio Frequency Identification (RFID)
Radio frequency iden fica on (RFID) is a wireless system that uses radio frequencies to transmit data from a small device that is a ached to an item to a receiver that tracks the item. The small device contains informa on that can be read from a distance of a few inches to 100 feet or more, depending upon the power output. Hospitals use this to track medical equipment, pa ents, and medica on. While data transmission systems like bar codes require a scanner and a line of sight, RFID does not need to be within a line of sight.
RFID is used on automated toll lanes such as E-ZPass and to pay for gasoline at the gas pump using Speedpass. It is also used to secure items so they cannot be moved without the owner's knowledge, such as when securing expensive clothing in a shopping mall, moving cri cal parts within a chemical supply chain, or storing laptop computers at an office. The use of RFID in supply chains is growing rapidly. Processing math: 0%
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Radio frequency iden fica on (RFID) is used on automated toll lanes like E-ZPass and to pay for gas using Speedpass.
Daniel Hulshizer/ASSOCIATED PRESS/AP Images
Enterprise Resource Planning (ERP)
Supply chain management aims to achieve be er integra on, coordina on, and communica on among members of the supply chain. These efforts, however, are o en stymied by the separate databases used by the individual members of the supply chain. Enterprise resource planning (ERP) can eliminate delays caused by separate databases either by allowing companies to access one another's databases or, ideally, through the use of one common database.
To understand the problems that can be experienced when separate databases are used, consider a company that directly sells to the final customer. Suppose a customer calls the company's marke ng department to inquire about the status of an order. The marke ng database will probably show only informa on specific to marke ng, such as the date the order was entered. If that order is in produc on, then either someone from marke ng or the customer will need to contact the produc on department to find out the status of the order. Suppose the order has been completed and shipped. The produc on database would probably show only comple on of the order, but no shipping informa on. To obtain the shipping informa on someone would need to contact distribu on or logis cs. Because the company uses separate databases, no one in any area of the company has access to all company informa on. Thus, the customer is bounced from one department to another to get the answer to a simple ques on about order status.
A second problem with separate databases is that they may contain conflic ng informa on. For example, suppose the customer order described above has been shipped, and the logis cs database indicates this, but the produc on database has not yet been updated, so it shows the order is s ll at the last processing opera on. Produc on may tell the customer that the order is s ll in processing when, in reality, it was already shipped.
The purpose of ERP is to avoid the problems described in this example by combining databases into one common database for the en re organiza on—and possibly for the en re supply chain. The advantage of a common database is that all personnel within the organiza on have access to all informa on. For example, someone in marke ng could see if an order was delayed in produc on awai ng a component part from a supplier. Furthermore, if the ERP system integrates the en re supply chain, then personnel in marke ng could determine the loca on of the part within the supplier's produc on system. Using one common database can effec vely eliminate problems caused by conflic ng informa on among separate databases.Processing math: 0%
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Because food has a rela vely short shelf life, it is essen al
iStockphoto/Thinkstock
Figure 5.4 shows part of a typical ERP system configura on. Informa on is stored centrally in the database servers, which are accessed by individual servers. Users access informa on on their personal computers. Newer configura ons of ERP are Internet-based. The database servers shown in Figure 5.4 can be accessed and updated by members of the supply chain via the Internet over secure connec ons. For example, the German company SAP now offers mySAP.com as its e-business pla orm.
Figure 5.4: Part of a typical ERP system
ERP can be expensive in terms of purchase cost or in terms of the disrup on that such a major change can have on an organiza on. For example, it took Owens Corning two years to install an ERP system at a cost of $100 million. A recent survey found that the average cost of an ERP system was $15 million, although companies in that survey spent a minimum of $400,000 and a maximum of $300 million. There have also been some high-profile ERP failures. The Hershey's Company spent $112 million only to find that the ERP system they had installed delayed shipments to customers. Allied Waste Industries stopped implementa on of its $130 million ERP system a er the company decided the system was too expensive and too complicated to operate.
One complica on from ERP implementa on results from using a common database, which o en requires that procedures be completed differently than they previously were. For example, in the past, personnel in the marke ng department may have been responsible for selling a product and then entering orders into the computer system. It was the produc on department's responsibility to meet the promised delivery data, and finance's responsibility to decide whether to offer the customer credit. With an ERP system, marke ng personnel may findProcessing math: 0%
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to keep delivery and inventory aligned with consump on pa erns.
that they now are responsible for not only entering orders but also for determining whether a delivery date can be met and
whether a customer's credit ra ng is sufficient to jus fy offering credit. Such changes may require extensive retraining and a long break-in period un l people can perform their tasks efficiently in the new way.
While ERP systems are o en difficult to implement, the advantages of having an integrated, real- me system to assist customers and to work with suppliers is very appealing. When success is achieved, the benefits are substan al.
Service Operations
Because many people think about supply chain management as moving goods from point to point in the produc on process, these topics are o en associated with manufacturing. However, supply chain, logis cs, inventory, and purchasing are important topics in service opera ons. Retail and wholesale opera ons, which are classified as services, move goods from producers to customers via systems of distribu on centers, warehouses, brick-and-mortar retail stores, and Internet-based retailers.
Supply chain management is cri cal in restaurants. A restaurant is like a factory that transforms raw materials into finished goods. It cuts, dices, chops, cooks, and serves food to customers. Some restaurants focus on specialized high-end food, while other focus on fast food. In either case, the restaurant faces the same challenges with supplier quality, delivery reliability, and costs that are found in manufacturing. Food has a very short shelf life so delivering in a mely manner and aligning inventory with consump on are essen al tasks.
Health care is also becoming a service business where supply chains and supply chain management are important. From a tradi onal perspec ve, a hospital has suppliers who provide food, linens, medicine, equipment, and maintenance services for facili es. Health care organiza ons have suppliers, including doctors, who act as service providers to the hospitals. In this environment, pa ents, doctors, and hospital clinical staff exchange informa on and work together to understand problems and to develop solu ons or treatments. This is a highly interac ve process where value is created by all of the par cipants. It is based on trust, commitment, and a shared vision among the par cipants. These same elements are vital in a tradi onal manufacturing supply chain.
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Chapter Summary
Supply chain management is an approach in which all members of the supply chain work together, coordinate their ac vi es, and share informa on. The bullwhip effect, in which disrup ons in demand are magnified through the supply chain, is one of the consequences of not sharing informa on. Some of the informa on that can be shared in a supply chain includes demand informa on, forecasts, planned orders, and sales. Ver cal integra on allows a company to own various components of the supply chain. Under outsourcing, those components of the supply chain are provided by independent companies. Supply chain structure includes having many versus fewer suppliers, insourcing versus outsourcing products and services, ver cal integra on of the supply chain, and the use of virtual organiza ons and disintermedia on. Supply chain strategies include agile versus lean supply chains, vendor-managed inventory, postponement, cross docking, 3PL, and radio frequency iden fica on. Agile supply chains focus on quickly ge ng innova ve products to market. Efficient supply chains emphasize reducing supply chain costs for func onal products. Lean supply chains focus on opera ng efficiently to minimize costs and keep inventory low. They o en produce products that have long product life cycles, stable and predictable demand, and minimal innova on. Enterprise resource planning (ERP) is an a empt to provide integrated, real- me access to informa on about the firm and possibly the supply chain. In this way, customers contac ng the supply chain can find the answers to ques ons with one e-mail or phone call. Supply chains and supply chain management are applicable in service businesses. Retail and wholesale business, restaurants, and health care establishments are three examples.
Case Study
Medical Equipment Devices LLC
Medical Equipment Devices LLC (MED) currently makes a few dozen different sophis cated, high-quality medical devices that are used in surgical, tes ng, and treatment procedures. These items can be customized to the needs of the doctor or hospital and are o en purchased in small quan es. MED will some mes keep a small quan ty of finished products on hand, but most sales are made to order. The products are high cost, high profit-margin items that require substan al follow-up and field support. MED's suppliers must respond rapidly to MED's needs for products because MED's customers want delivery as fast as possible. In addi on to speed, high quality, flexibility, and innova on are essen al characteris cs of MED's suppliers. Keeping costs low is always an issue, but it is less important than these factors. MED is doing well and has generated substan al profits, which it is using to seek addi onal investment opportuni es. Processing math: 0%
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Basil Diode, the chief financial officer of MED, has requested proposals for opportuni es to start a new business or acquire a business in the medical field. He does not want to go outside of the company's area of exper se, so he has asked for proposals in the broad area of health care. He has received a proposal to purchase and operate a company called MedSurgItems Corp. (MSI) that produces several hundred different standard medical and surgical items such as syringes, gowns, gloves, and tongue depressors. These items are typically made to stock, profit margins are small, and company profits are driven by sales volumes. MSI suppliers must be able to meet these needs.
To evaluate this and other proposals received, Basil has assembled a cross-func onal team of experts from various disciplines including marke ng, accoun ng, finance, and opera ons and supply chain management. You are the representa ve of the opera ons and supply chain management func on. Basil has asked you to provide detailed responses with appropriate jus fica on to the following ques ons. Keep in mind he does not want yes or no answers.
Iden fy the important performance characteris cs in MED's current business, and iden fy them for the MSI business to be acquired.
1.
Are these compa ble? Are there economies of scale in produc on? Will there be synergy in product design?
2.
What, if any, problems do you see in managing the supply chains that support MED's current business and the MSI business to be acquired?
3.
Provide a recommenda on to Basil with support for that recommenda on.4.
Discussion Ques ons
Click on each ques on to reveal the answer.
List the factors that now require companies to emphasize supply chain management. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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The factors that now require companies to emphasize supply chain management are: – Increasing globaliza on – More intense compe on – Shorter product life cycles – Developments in informa on technology and data communica on
Explain how the bullwhip effect may occur for a fashion retailer. (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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In general, the bullwhip effect is caused by batching of orders and delays in transmi ng this informa on up the supply chain. This is certainly true in retail fashion industries, but there are other reasons. For a fashion retailer, the bullwhip effect could occur as follows. Suppose the retailer decides to hold a special promo on of a par cular item and places a larger order than usual for that item. The distributor, seeing the larger order may think that demand for this item is suddenly taking off. Because that distributor probably serves several different retailers, the distributor will increase its order from the manufacturer by enough to cover increased demand from all the retailers it supplies. The manufacturer, seeing this sudden jump in demand from one of its distributors may also incorrectly assume that increased orders will be coming from all the distributors it supplies, and thus decide to increase produc on drama cally. Because the manufacturer will probably decide to produce this item in a very large quan ty, it will order enough materials from its suppliers to meet this an cipated large increase in demand over an extended period of me. Consequently, the amount being ordered from suppliers will suddenly jump by much more than is jus fied by the one retailer that decided to hold a special promo on.
What ac ons can firms take to prevent the bullwhip effect from occurring? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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To minimize the bullwhip effect, informa on must be shared via real me communica on rather than me delayed, sequen al communica on. The hub and spoke approach is one way to do this. Each spoke represents a connec on to a member of the supply chain. All members of the supply chain transmit informa on to a central hub, and each member has access to the informa on. The informa on that must be shared in this manner is o en determined by the focal firm. Electronic Data Interchange (EDI) connects the databases of different companies. In supply chain management, EDI is a means of sharing informa on among all members of a supply chain. Shared databases can ensure that all supply chain members have access to the same informa on, providing visibility to everyone and avoiding problems such as the bullwhip effect. Collabora ve Planning, Forecas ng, and Replenishment (CPFR) is more than exchanging data. It seeks to minimize this guessing game through collabora on among supply chain partners to jointly develop a plan that specifies what is to be sold, how it will be marketed and promoted, where, and during what me period. Because these plans and forecasts have been jointly agreed upon, considerable uncertainty is removed from the process.
O en forecasts of future demand are not accurate. How can firms address this problem in its supply chains? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons /cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons
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Keys to coping with forecas ng uncertainty are to move informa on about actual demand to the suppliers as quickly as possible and to ask the suppliers to reduce lead me by building flexible produc on systems that can produce what is in demand. Flexibility allows the supplier to switch produc on cheaply and quickly to high demand items. The Walmart feature in this chapter illustrates these points.
Describe the supply chain that might exist for an automobile manufacturer and discuss some informa on that might flow through the supply chain. Do the same for a fast-food restaurant. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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5.
An automobile manufacturer's supply chain would involve the following. Consumers buy the product from dealers, who receive it from the manufacturer's factories. Depending upon the loca on of those factories, the logis cs used for distribu on could include trucks, railroads, and ships. Manufacturing facili es would include assembly plants that assemble the final product. In addi on, the manufacturer might operate its own plants to fabricate parts, such as engines or body panels. Other parts are obtained from suppliers. Tier 1 suppliers provide components such as electronics, interiors, and res. These er 1 suppliers obtain their component parts from er 2 suppliers, which could include steel companies or chemical companies. Tier 3 suppliers, which serve the er 2 suppliers, could include companies that mine the iron ore for making steel.
A fast-food restaurant works with raw materials like an automobile manufacturer. It sells its products directly to the final consumer, so there is no distribu on system for the product. However, there can s ll be several ers of suppliers. For example, hamburger buns are probably purchased from a bakery, which would be a er 1 supplier. That bakery buys its flour from a milling company, which is a er 2 supplier. The wheat for the flour comes from farmers who would be er 3 suppliers. The
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logis cs in this system could include railways and barges that move the grain and flour, and trucks that transport the hamburger buns to the fast-food restaurant.
Iden fy some organiza ons that are ver cally integrated and some that use extensive outsourcing. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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6.
An example of a ver cally integrated company would be an oil company such as ChevronTexaco. ChevronTexaco sells its products directly to consumers through its gasoline sta ons. The company also operates its own refineries, which process crude oil into finished products. Furthermore, ChevronTexaco operates its own wells, which extract oil from the earth, and even has its own drilling and explora on teams to find more oil.
Apple is an example of a company that uses outsourcing extensively. It outsources the produc on of most of its components on worldwide basis. Apple and others are reexamining global outsourcing because of the rising cost of transporta on and the nega ve impacts on the environment.
Should a firm a empt to have fewer or more suppliers? What are the advantages and disadvantages of each approach? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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By using many suppliers, a company can take advantage of compe on among those suppliers to meet the company's demands for cost, quality, and delivery. If one supplier goes out of business or is unable to provide the good or service as requested, it is a simple ma er to use another supplier. On the other hand, there are some advantages to having only a few suppliers or even one supplier for a good or service. Chief among these is the long-term partnership arrangements that can be developed. Such rela onships enable both par es to work together for greater integra on of the supply chain and for development of methods that can improve quality and lower costs. These close partnerships o en lead to high levels of dependency between the customer and the supplier.
Describe agile supply chains, including the characteris cs of the products they produce. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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8.
Markets like fashion and technology are characterized by frequent innova on, making product demand unpredictable and requiring the en re supply chain to respond quickly as new products are introduced and demand changes. The supply chain must be able to transmit customer responses to new products and informa on about what customers would like to see in future products. An agile supply chain, can respond to these requirements. Members of such a supply chain are selected based on their speed and flexibility and their capacity to transit informa on reliably, accurately, and quickly from the marketplace to supply chain members. An agile supply chain a empts to assess in great detail the needs of its customers so it can provide customized products that be er meet the customers' expecta ons. An agile supply chain is a coopera ve rela onships where supplies help to design and develop new products that can meet individual customer needs be er, create a flexibleProcessing math: 0%
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and responsive produc on process that allow the supply chain to deliver differen ated products, work on quality improvement projects that affect the company and its suppliers, and work together to keep costs in line with customer expecta ons.
Describe lean supply chains, including the characteris cs of the products they produce. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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Products with long life cycles, stable and predictable demand, and minimal innova on o en require a lean supply chain. They are also o en characterized by low profit margins. For these products, the supply chain must focus on opera ng efficiently to minimize costs. Supply chain members are chosen based on their ability to keep costs down and to minimize inventory in the system. Black and Decker produces a variety of small appliances and hand tools. Success depends on manufacturing standard products that have high quality and low cost and a modest amount of variety. Designs for these appliances and tools change slowly and demand for these products can be characterized as slow and steady. A lean supply chain focuses on opera ng issues as it a empts to eliminate non-value added opera ons. A lean supply chain supports the reduc on of setup mes to enable the economic produc on of small quan es. This enables the supply chain to keep inventory costs low and achieve manufacturing cost reduc ons, in part, by enabling opera ons to switch quickly among products.
Outsourcing, especially to low labor-cost countries, has grown substan ally. What are the advantages and disadvantages of outsourcing? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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One important reason companies decide to outsource is that the goods or services can o en be obtained less expensively from outside suppliers. Outside suppliers may specialize in producing that good or service, enabling them to maintain high quality while keeping costs low. Suppliers may have proprietary technology that gives them a compe ve advantage. In the past decade or more, global outsourcing has grown drama cally as firms seek to find low cost suppliers. This push, driven primarily by low labor costs in developing economies such as Mexico, China, India, and Vietnam, has lengthened the supply chain, which increases transporta on and inventory holding costs. With longer supply chains as well as poli cal uncertainty and cultural differences there is also an increased risk of supply chain disrup on. Yet, the allure of lower costs is a powerful force. As some of the disadvantages of global sourcing are being examined, including concerns about quality and rising labor costs in some developing countries, there are signs of produc on returning to the U.S.
Is Amazon.com a virtual organiza on? Find as much informa on as you can about the company, and then use that informa on to support your argument. (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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11.
Some aspects of Amazon.com certainly are very close to being a virtual organiza on. The company uses technology to handle fulfillment, distribu on and other logis c ac vi es, and it does not manufacture its own products. However, it does maintain its own distribu on centers. In some waysProcessing math: 0%
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Amazon is very similar to a standard retailer, except that all customer transac ons take place over the Internet. Amazon is also offering marke ng services for many small companies that cannot afford the sophis cate web site to display its products and collect the payment. Amazon provides access to millions of customers worldwide. Amazon will sell the product, no fy the company who arranges shipment, collects the money, takes a por on for its services, and send the balance to the small company.
List some products that would be most appropriate for an agile supply chain. Do the same for a lean efficient supply chain. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Products appropriate for an agile supply chain include any items with short product lives and vola le demand. These could include many electronics items, including computers, as well as fashion goods. Lean supply chains deal with products that have fairly constant demand and for which price is an important considera on. Such products can include grocery items, building materials, or gasoline.
Explain how companies that make the materials used in the apparel industry (e.g., denim) may use postponement. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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Several approaches can be used in the fashion industry. For example, the popularity of different colors can o en change quickly. In the past, fabric makers o en dyed cloth ahead of me, then stored the dyed cloth in inventory. However, as fashions changed, some colors could go out of style, leaving the fabric maker with a large supply of material with li le demand. Today, many companies store undyed cloth in inventory, then wait un l orders are received to dye the material.
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14.
Supply chain, logis cs, inventory, and purchasing are important topics in services opera ons. Retail and wholesale opera ons, which are classified as services, move goods from producers to the customers via systems of distribu on centers, warehouses, brick and mortar retail stores, and Internet based retailers. Supply chain management is cri cal in restaurants, which is like a factory that transforms raw materials into finished goods. It cuts, dices, chops, cooks, and serves food to customers. Some restaurants focus on specialized high-end food while other focus on fast food. In either case, the restaurant has the same issues with supplier quality, delivery reliability, and costs that are found in manufacturing. Healthcare is also becoming a service business where supply chains and supply chain management are important. From a tradi onal perspec ve, a hospital has suppliers who provide food, linen, medicine, equipment, and maintenance service for facili es. Healthcare organiza ons have suppliers, including doctors who act as service providers to the hospitals. In this environment, pa ents, doctors, and hospital clinical staff exchange informa on and work together to understand the problem and to develop solu ons or treatments.
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Key Terms
Click on each key term to see the defini on.
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A type of supply chain that focuses on quickly responding to changes in demand for various products.
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When a company owns the organiza ons that perform ac vi es in the upstream supply chain.Processing math: 0%
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An example of what can happen when informa on is not shared in a supply chain. It occurs when a slight increase in demand at the retailer level increases nearly exponen ally, resul ng in a huge increase in demand at the raw material supplier level.
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Facilitates coordina on among supply chain partners by jointly developing plans and schedules for what is to be sold, produced, and delivered. Processing math: 0%
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Coordina on between inbound and outbound shipments so that li le, if any, inventory must be kept at a distribu on center.
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The process of elimina ng some func ons in a supply chain to improve its efficiency, such as when a manufacturer sells directly to the final consumer.
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A designa on for the part of the supply chain through which a company's products are sold, such as distributors, retailers, dealers, or final consumers.
electronic data interchange (EDI) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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The use of electronic transmissions, such as telephone lines or the Internet, to share data among members of a supply chain.
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The use of one common database for all func ons of an organiza on, or all members of a supply chain.
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The most important organiza on in the supply chain, and o en the firm that interfaces with the final consumer. The focal firm designs and manages the supply chain.
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When a company owns the organiza ons that cons tute the downstream side of the supply chain.
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When a company internally produces the goods or services that it uses in its own opera ons.
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A type of supply chain that emphasizes cost minimiza on and efficiency.
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The management of the movement of materials and components from point to point in the supply chain.
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Contrac ng with another company to do work that was once done by the organiza on itself.
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Data collected directly from the cash registers in a store.
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When certain steps in the produc on process are delayed un l the last possible moment such that the finished product will be produced only a er customer orders have been received.
product postponement (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Producing a generic product at the central manufacturing facility, then producing specific components needed to customize the product for the final consumer, which are added at the latest possible point in the distribu on system.
radio frequency iden fica on (RFID) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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A wireless, contact-less system that uses radio frequencies to transfer data from a tag a ached to an object to a system that tracks the item.
reverse logis cs (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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The ability to return a product to the manufacturer for repair or replacement. It is also being employed to recycle products at the end of their useful life.
supply chain (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons /cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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All ac vi es associated with the flow and transfer of goods and services from raw material extrac on through use by the organiza on that sells to the final consumer.
supply chain management (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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The integra on of supply chain ac vi es through improved supplier rela onships to achieve sustainable compe ve advantage for all members in the supply chain.
third party logis cs (3PL) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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An outside supplier that handles all the logis cs ac vi es between supplier and customer; theProcessing math: 0%
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outsourcing of logis cs services.
er 1 suppliers (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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Companies in a supply chain that sell component parts to the company that makes the finished product.
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Companies in a supply chain that sell component parts or raw materials to a er 1 supplier.
er 3 suppliers (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 Processing math: 0%
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Companies in a supply chain that usually sell raw materials to a er 2 supplier.
upstream (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons /cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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A designa on for the part of the supply chain that includes suppliers, produc on planning, and purchasing.
vendor managed inventory (VMI) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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An inventory replenishment approach in which a supplier makes inventory management decisions about the products it sells for the company that buys those products.
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When a firm owns the producing assets up and down the supply chain. The more assets owned, the greater the degree of ver cal integra on.
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Companies that provide only coordina on ac vi es and outsource all other ac vi es involved in producing and distribu ng a product.
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©iStockphoto/Thinkstock
Models and Forecasting
Learning Objec ves A er comple ng this chapter, you should be able to:
Define a model and describe how models can be used to analyze opera ng problems. Discuss the nature of forecas ng. Explain how forecas ng can be applied to problems. Describe methods of forecas ng, including judgment and experience, me-series analysis, and regression and correla on. Construct forecas ng models. Es mate forecas ng errors.
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6.1 Introduction to Models and Decision Making
In order for an organiza on to design, build, and operate a produc on facility that is capable of mee ng customer demand for services (such as health care) or goods (such as ceiling fans), it is necessary for management to obtain an es mate or forecast of demand for its products. A forecast is a predic on of the future. It o en examines historical data to determine rela onships among key variables in a problem and uses those rela onships to make statements about the future value of one or more of the variables. Once an organiza on has a forecast of demand, it can make decisions regarding the volume of product that needs to be produced, the number of workers to hire, and other key opera ng variables. A model is an abstrac on from the real problem of the key variables and rela onships in order to simplify the problem. The purpose of modeling is to provide the user with a be er understanding of the problem and with a means of manipula ng the results for what-if analyses. Forecas ng uses models to help organiza ons predict important parameters. Demand is one of those parameters, but cost, revenue, profits, and other variables can also be forecasted. The purpose of this chapter is to discuss models and describe how they can be applied to business problems, and to explain forecas ng and its role in opera ons.
Stages in Decision Making
Organiza onal performance is a result of the decisions that management makes over a period of me: decisions about what markets to enter, what products to produce, what types of equipment and facili es to acquire, and where to locate facili es. The quality of these decisions is a func on of how well managers perform (see Table 6.1).
Table 6.1: Stages in decision making
Stage Example
Define the problem and the factors that influence it
A hospital is having difficulty maintaining high-quality, low-cost food service. The quality and cost of incoming food and the training of staff are influencing factors.
Select criteria to guide the decision; establish objec ves
The hospital selects cost per meal and pa ent sa sfac on as the criteria. The objec ves are to reduce meal cost by 15% and improve pa ent sa sfac on to 90%, based upon the hospital's weekly surveys.
Formulate a model or models
The model includes mathema cal rela onships that indicate how materials (food) and labor are converted into meals. This model includes an analysis of wasted food and the standard amount of labor required to prepare a meal.
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Model airplanes and buildings have physical characteris cs similar to full-scale versions and can be used to test design characteris cs.
Uwe Lein/ASSOCIATED PRESS/AP Images
Collect relevant data Data on food costs, the amount of food consumed, the number of meals served, and the amount of labor are collected. Pa ent preferences are inves gated so that meals meet nutri onal requirements and taste good.
Iden fy and evaluate alterna ves
Alterna ves include subcontrac ng food prepara on, considering new food suppliers, establishing be er training programs for the staff, and changing management.
Select the best alterna ve
One of the alterna ves or some combina on of alterna ves is selected.
Implement the alterna ve, and reevaluate
The selected alterna ve is implemented, and the problem is reevaluated through monitoring costs and the pa ent survey data to see if the objec ves have been achieved.
A model is a way of thinking about a problem. Decision makers use models to increase their understanding of the problem because it helps to simplify the problem by focusing on the key variables and rela onships. The model also allows managers to try different op ons quickly and inexpensively. In these ways, decision making can be improved.
Types of Models
Models are commonly seen for airplanes, cars, dams, or other structures. These models can be used to test design characteris cs. Model airplanes can be tested in wind tunnels to determine aerodynamic proper es, and a model of a hydroelectric dam can help architects and engineers find ways of integra ng the structure with the landscape. These models have physical characteris cs similar to those of the real thing. Experiments can be performed on this type of model to see how it may perform under opera ng condi ons. With technology, such as computer simula on systems, virtual models can be rendered and tested quickly
and less expensively. The aerodynamic proper es of an airplane can be tested in a virtual wind tunnel that exists only inside the memory of a computer. Models also include the drawings of a building that display the physical rela onships between the various parts of the structure. All of these models are simplifica ons of the real thing used to help designers make be er decisions. Processing math: 0%
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Computer-based technology has been used for many years to design cars, buildings, furniture, and other products. It is moving quickly into the field of medicine. Medical schools teach students about anatomy using 3-D computer generated models. Students can see the nervous system, the blood vessels, the lymph nodes, and glands along with the skeleton. The so ware can show each separately and put them all together in one 3-D picture. The so ware can take input from various medical tests and generate 3-D models of a pa ent to diagnose medical condi ons faster and be er.
In addi on to these physical and virtual models, managers use mathema cal abstrac on to model important rela onships. The break-even point calcula on that is taught in accoun ng and finance is an example of applying a mathema cal model. The use of drawings and diagrams is also modeling. The newspaper graph that illustrates stock market price changes in the last six months is a way to help the reader see trends in the market. Models do not have to be sophis cated to be useful. Most models can be grouped into four categories, and computers play a cri cal role in the development and use of each type.
Mathema cal models include algebraic models such as break-even analysis, sta s cal models used in forecas ng and quality control, mathema cal programming models, and calculus-based models. Graphs and charts are pictorial representa ons of mathema cal rela onships. They include a visual representa on of break-even analysis, a pie chart that illustrates market share, a graph of stock prices over me, or a bar graph that indicates the demand for energy for the last five years. Diagrams and drawings are pictorial representa ons of conceptual rela onships. They include a precedence diagram that represents the sequence required to assemble a building, a drawing of a gear that is part of a transmission in a car, a diagram that represents the logic of a computer program, and a drawing of an aircra carrier. Scale models and prototypes are physical representa ons of an item. They include a scale model of an airplane and the first part produced (prototype), which is normally used for tes ng purposes. These models are o en built and analyzed inside a computer system. Three-dimensional technology called stereolithography allows computers to create solid models of parts. This is done by successively "prin ng" very thin layers of a material, which cures quickly to form a sold part.
Mathema cal models, graphs and charts, and diagrams are most commonly used by business and management professionals, so the discussion in this chapter focuses on these types of models.
Application of Models
Many people use models frequently without realizing it. At a pizza party, the host will probably determine how much pizza to order by mul plying the number of people expected to a end by the amount each person is expected to consume. The host is likely to then mul ply the an cipated cost per pizza by the number ordered to determine the cost. This is a simple mathema cal model that can be used to plan a small party or major social event.
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In mathema cal models, symbols and algebra are used to show rela onships. Mathema cal models can be simple or complex. For example, suppose a family is planning a trip to Walt Disney World in Orlando, Florida. To es mate gasoline costs for the trip, family members check a road atlas (one type of model), or go online to get direc ons and a map (another type of model). They determine that Orlando is approximately a 2,200-mile round trip from their home. From knowledge of the family car (a database), the family es mates that the car will achieve 23 miles per gallon (mpg) on the highway. The average cost of a gallon of gasoline is es mated at $3.80. Using the following model, they make an es mate of gasoline cost.
*Throughout this text, to enlarge the size of the math equa ons, please right click on the equa on and choose "se ngs" then "scale all math" to increase the viewing percentage.
Cost = (trip miles)(cost per gallon)/miles per gallon = = $363.48
A mathema cal model can be used to answer what-if ques ons. In the previous example, costs could be es mated with a $.30 increase in the price of a gallon of gas, as shown in the following:
Cost = = $392.17
The model could also be used to es mate the cost of the trip if the car averaged only 20 miles per gallon, as shown in the following:
Cost =
= $418.00
Models cannot include all factors that affect the outcome because many factors cannot be defined precisely. Also, adding too many variables can complicate the model without significantly increasing the accuracy of the predic on. For example, on the trip to Florida, the number of miles driven is affected by the number of rest stops made, the number of unexpected detours taken, and the number of lane changes made. The number of miles per gallon is influenced by the car's speed, the rate of accelera on, and the amount of me spent idling in traffic. These variables are not in the model. The model builder should ask if adding the variables would significantly improve the model's accuracy and usefulness.
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Technology Forecas ng; TEDTalks: Chris Anderson —Technology's Long Tail
Technology Forecasting From Title: TEDTalks: Chris Anderson—Technology’s Long Tai... (https://fod.infobase.com/PortalPlaylists.aspx?wID=100753&xtid=48088)
© Infobase. All Rights Reserved. Length: 01:56
6.2 Forecasting
Forecas ng is an a empt to predict the future. Forecasts are usually the result of examining past experiences to gain insights into the future. These insights o en take the form of mathema cal models that are used to project future sales, product costs, adver sing costs, and more. The applica on of forecas ng is not limited to predic ng factors needed to operate a business. Forecas ng can also be used to es mate the cost of living, housing prices, the federal debt, and the average family income in the year 2025. For organiza ons, forecasts are an essen al part of planning. It would be illogical to plan for tomorrow without some idea of what could happen.
The cri cal word in the last sentence is "could." Any competent forecaster knows that the future holds many possibili es and that a forecast is only one of those possibili es. The difference between what actually happens and what is predicted is forecas ng error, which is discussed later in this chapter. In spite of this poten al error, management should recognize the need to proceed with planning using the best possible forecast and should develop con ngency plans to deal with the possible error. Management should not assume that the future is predetermined, but should realize that its ac ons can help to shape future events. With the proper plans and execu on of those plans, an organiza on can have some control over its future.
Stages of Forecast Development
The forecas ng process consists of the following steps: determining the objec ves of the forecast, developing and tes ng a model, applying the model, considering real-world constraints on the model's applica on, and revising and evalua ng the forecast (human judgment). Figure 6.1 illustrates these steps.
Figure 6.1: Steps in forecas ng Processing math: 0%
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Determining the objec ves. What kind of informa on does the manager need? The following ques ons should be considered:
What is the purpose of the forecast?1. What variables are to be forecast?2. Who will use the forecast?3. What is the me frame of the forecast—long or short term?4. How accurate should the forecast be?5. When is the forecast needed?6.
Developing and tes ng a model. A model should be developed and then tested to ensure that it is as accurate as possible. Several techniques including moving average, weighted moving average, exponen al smoothing, and regression analysis for developing forecas ng models are discussed later in this chapter. In addi on to these quan ta ve approaches, it is o en useful to consider qualita ve factors, which are also discussed later in this chapter.
Applying the model. A er the model is tested, historical data about the problem are collected. These data are applied to the model, and the forecast is obtained. Great care should be taken so that the proper data are used and the model is applied correctly. Processing math: 0%
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Real-world constraints. Applying any model requires considera on of real-world constraints. A model may predict that sales will double in the next three years. Management, therefore, adds the needed personnel and facili es to produce the service or good, but does not consider the impact this increase will have on the distribu on system. A so ware company expands its product offerings by hiring addi onal programmers and analysts, but it does not provide the capability to install the so ware on customers' systems. If a manufacturer is planning to expand produc on to address an increase in demand: Should it consider raw-material availability? Will compe tors react by cu ng prices so that demand is less than expected? Where can the firm find the skilled labor to do the work? Forecast should not be taken as fact. A forecast is one scenario that managers must ground in reality. A forecast is not a complete answer, but rather one more piece of informa on.
Revising and evalua ng the forecast. The technical forecast should be tempered with human judgment. What rela onships may have changed? In the case of the electric u lity industry, a fundamental change in the rate of growth greatly affected the accuracy of es mates for future consump on. Forecasts should not be treated as complete or sta c. Revisions should be made as changes take place within the firm or the environment. The need for revision may be occasioned by changes in price, product characteris cs, adver sing expenditures, or ac ons by compe tors. Evalua on is the ongoing exercise of comparing the forecast with the actual results. This control process is necessary to a ain accurate forecasts.
Highlight: Forecas ng for Quarry-Front Ice Cream Stand
In a small Midwest town, the Quarry-Front Ice Cream Stand operates in a small spot of land that is adjacent to an old stone quarry now used for swimming, and baseball fields used for T-ball, Pee Wee, Li le League, and PONY league baseball. The owner is preparing a plan to operate the stand for the coming summer months, which she is basing upon informa on gathered about prior years of opera on.
Objec ve: The owner needs to forecast demand, so she can order enough milk product, sprinkles, and other items as well as schedule enough staff to meet demand. As expected for an ice cream stand in the Midwest, the demand is highly seasonal, so the me period for the forecast is from early in May when baseball begins un l Labor Day. This stand closes for the rest of the year.
1.
Developing and Tes ng the Model: The owner has sales receipts by day for the last five summers. The owner decides to use a simple average to project demand for the coming year. She averages the daily receipts for the 5-year period. As she tests her forecast with the actual sales data over the past five years, she finds that her projec ons are not very good. As she examines the data, she sees that there are major differences among the days of the week. For example, demand on Sunday is much lower. She recalculates the averages by day of the week, so she has a projec on for Monday based upon the average of all Mondays, for Tuesdays based upon all Tuesdays, etc. Demand on Mondays, shows big differences; some Mondays are very busy, but others are not. She is unsure how to u lize this data, but she moves forward with a plan based upon the daily
2.
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forecast. Applying the Model: As the ice cream stand opens, the owner decides to ask her staff to keep a simple tally for the first month of opera ons. She provides each of them with a sheet that is has a single column with the rows designated by 30-minute increments star ng at 11:00 a.m. when the Quarry-Front Ice Cream Stand opens, and ending when it closes at night 10:00 p.m. The staff is to place a tally mark for each customer served. As she studies the results, she no ces strong demand in the early a ernoon, which she deduces is most likely driven by kids from the quarry who want lunch or a snack. She also no ces a strong demand in the evenings, which is associated with teams and baseball players' parents purchasing a postgame ice cream treat. There is also a very big demand in early June when the small town has its homecoming parade and fes val. The owner gets the opera ng schedule from the quarry and for the Baseball Associa on to use that data to adjust her inventory and staffing to be er meet the pa erns of demand.
3.
Real World Constraints: The quarry and the baseball leagues are part of real world constraints, but there are other factors as well. Weather greatly reduces demand because the quarry may be closed and the baseball games rained out. Games scheduled before school is dismissed also cut demand because parents want their kids home early on weeknights.
4.
Real World Scenarios: 1973 Oil Embargo
In 1973, an oil embargo hit the United States, and energy prices climbed substan ally in only a few weeks. The costs of all forms of energy increased, including gasoline, natural gas, and electricity. The embargo caused a na onwide effort to conserve energy. The demand for fiberglass insula on soared; fiberglass companies did not have sufficient capacity because their planning models were based upon much slower growth rates. Higher energy prices made spending money to conserve energy an a rac ve investment. Conversely, the growth in demand for electricity dropped from about 3% annually, to near zero. In a rela vely short me it rebounded to about 1% per year. The embargo changed the pa ern of growth in the industry. Electrical u li es had planned for a significantly higher growth rate and did not react quickly enough to the change. Many u li es con nued to build new power plants. The result was a surplus of electrical genera on capacity and the cancella on of orders for nuclear power plants.
In the 1990s, the growth rate for electricity rebounded in part because of the growing demand for computer technology, including the prolifera on of computer servers. Once again, the forecas ng models, this me using the slower growth rates of the late 1970s and 1980s, underes mated the need for electricity. This resulted in a brownout in some parts of the United States in the late 1990s and early 2000s.
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Forecas ng involves more than developing a model and conduc ng analysis. Because the future may not accurately represent the past, the results from a model should take into account the forecaster's judgment and experience.
©Tyler E Nixon/Flickr/Ge y Images
Application of Models
Before becoming immersed in the details involved with preparing a forecast, it is important to know that forecas ng requires more than developing the model and performing an analysis. The results from the model should be tempered with human judgment. The future is never perfectly represented by the past, and rela onships change over me. Thus, the forecast should take into account judgment and experience.
Many techniques exist for developing a forecast. It is impossible to cover all the techniques effec vely in a short me. En re books are devoted to forecas ng, and some university students major in forecas ng as others major in marke ng, accoun ng, or supply chain management. In the following sec ons, qualita ve, me-series, and regression analysis methods of forecas ng are discussed. Regression analysis can be used to project me-series and cross- sec onal data. There are several varia ons of these methods:
Qualita ve methods Buildup method Survey method Test markets Panel of experts (Delphi Technique)
Time-series methods Simple moving average Weighted moving average Exponen al smoothing Regression and correla on analysis (simple and mul ple regression)
Qualitative Methods
Mathema cal models are known as quan ta ve methods, while more subjec ve approaches are referred to as qualita ve. Although mathema cal models are useful because they help management make predic ons, qualita ve approaches can also be helpful. Qualita ve forecasts that are based upon subjec ve interpreta on of historical data and observa ons are frequently used. A homeowner who Processing math: 0%
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decides to refinance his or her home has made an implicit predic on that home mortgage rates cannot be lower, and are likely to remain constant or to increase in the future. Similarly, a manager who decides to purchase extra materials because of uncertainty in supply has made an implicit predic on that a strike or other ac on may disrupt the flow of materials. There are many different qualita ve methods for making forecasts. The buildup method, surveys, test markets, and the panel of experts are discussed briefly, next.
Buildup Method
The buildup method requires star ng at the bo om of an organiza on and making an overall es mate by adding together es mates from each element. For example, a brokerage firm could use this approach to forecast revenues from stock market transac ons. If the buildup method is used for predic ng revenue, the first step is to ask each representa ve to es mate his or her revenue. These es mates are passed on to the next-higher level in the organiza on for review and evalua on. Es mates that appear too high or too low are discussed with the representa ve so that management can understand the logic that supports the predic on. If the representa ve cannot convince the supervisor, a new predic on based upon this discussion is made. The predic on is then passed on to the next level in the organiza on.
As these subjec ve judgments are passed up the organiza on, they are reviewed and refined un l they become, in total, the revenue forecast for the en re organiza on. It is top management's responsibility to make the final judgment about the forecast's validity. Once top management has decided on the forecast, it becomes an input used in making capacity, produc on planning, and other decisions.
Survey Method
In some cases, organiza ons use surveys to gather informa on from external sources. A survey is a systema c effort to elicit informa on from specific groups and is usually conducted via a wri en ques onnaire, a phone interview, or the Internet. The target of the survey could be consumers, purchasing agents, economists, or others. A survey may a empt to determine how many consumers would buy a new flavor of toothpaste, or consider a maintenance service that comes to their home to complete minor repairs on their car. Currently, surveys of purchasing agents are conducted to assess the health of the economy. Surveys are o en used to prepare forecasts when historical data are not available, or when historical data are judged not to be indica ve of the future. Surveys can also be used to verify the results of another forecas ng technique.
Test Markets
Test marke ng is a special kind of survey. In a test market, the forecaster arranges for the placement of a new or redesigned product in a city believed to be representa ve of the organiza on's overall market. For example, an organiza on that wants to test the "at-home" and "at-work" market for an oil change service could offer the service in one or two ci es to determine how customers may respond. TheProcessing math: 0%
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analyst examines the sales behavior in the test market and uses it to predict sales in other markets. Test marke ng can be expensive, but the results tend to be more accurate than those complied from a survey because the consumers in a test market actually use the product.
Highlight: Assessing Demand for Car Repair Services
Jordan's car repair service center is planning to launch its "At-Home – Car Services" business beginning in the summer of the coming year. The business model is based upon providing car repairs and rou ne service at a customer's home or work place instead of at a repair shop. Before launching the new business, Jordan would like to know something about demand such as the kind of at-home services customers want, the level of demand for these desired services, if there is a seasonal or other pa ern to the demand, and whether customers would be willing to pay a small premium for this convenient service. Using mathema cal modeling to project demand will not likely provide a good forecast because Jordan has no history of demand for this new business and there are no other businesses like it; therefore there is no demand data. Jordan has decided to design a short survey to collect data about demand from three different groups of poten al customers. First, he will seek input from his ac ve customers to see if they would like to use the new service. While this group is easy to access because they use the service center regularly, the group provides only li le, if any, new revenue because they are already supplying Jordan with their business. He may a ract, at best, a small increase in business from this group, or he may prevent them from choosing a compe tor in the future. Second, and more financially lucra ve, Jordan would like to iden fy people who are not currently using his services. This is new business that is likely to support the at-home service, and if the new customers like the at-home service, they may bring their vehicle to the service center for work that cannot be easily performed at-home. This creates synergy between the two parts of his business. Third, if the business is ini ally successful, Jordan would like to expand the at-home service to include neighboring towns. If he can build an at-home service in these towns, he may be able to open an addi onal service center there.
If Jordan decided to launch this at-home service, he would do this in a limited way. For example, he could limit the geography to provide only rou ne maintenance to part of his current service area. He could also limit the services offered to oil changes, air filters, and lubrica on. This would allow him to keep his ini al investment low and also gather data about demand, which could be used to project demand for his full-service opera on. A smaller investment reduces his risk.
Panel of Experts
A panel of experts is comprised of people who are knowledgeable about the subject being considered. This group a empts to make a forecast by building consensus. In an organiza on, this process may involve execu ves who are trying to predict the level of informa on technology applied to banking Processing math: 0%
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Organiza ons o en employ subject experts who a empt to make forecasts by building consensus.
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opera ons, or store managers who are trying to es mate labor costs in retail opera ons. The panel can be used for a wide variety of forecasts, and with this method, forecasts can o en be made very quickly.
The Delphi Technique uses a panel of experts and surveys in a par cular manner. The members of the panel provide a sequence of forecasts through responses to ques onnaires. This sequence of ques onnaires is directed at the same item or set of items. A er each forecast, results are compiled, and the individuals are given summary sta s cs such as the median response and the 50th percen le of the item or items being forecasted. This provides a reference point for the par cipants, who can decide whether or not to change their es mate based upon this informa on. Because responses are gathered by ques onnaire rather than by group
interac on, the par cipants do not meet face-to-face. As a result, a few par cipants, who may be overly conserva ve or overly op mis c, cannot dominate the discussion and bias the results. The Delphi process assumes that as each forecast is conducted and the results disseminated among the panel members, the range of responses diminishes and the median represents the "true" consensus of the group.
Time-Series Methods
The historical data used in forecas ng can be cross-sec onal data, me-series data, or a combina on of the two. Cross-sec onal data samples across space, such as height of adults in the United States, Europe, and Asia. The simplest way to illustrate the differences in these data is with an example. One Pacific Coast Bank wants to project usage of its automated teller service. It has collected data from ATM systems in Stockton, San Jose, Santa Cruz, and Berkeley for the last two years. The study has both me-series and cross-sec onal elements, as shown in Table 6.2. The me-series data are the two years of data that are available for the banks. The cross-sec onal element is represented by the data from more than one bank.
Table 6.2: Time-series and cross-sec onal data
Jan. Feb. Mar. . . . Dec. Jan. Feb. Mar. . . . Dec.
Stockton
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San Jose
Santa Cruz
Berkeley
Forecas ng sales, costs, and other relevant es mates usually involves me-series data, and the techniques discussed here are useful in predic ng such data. See Figure 6.2 for the me line and nota on used in forecas ng. Each point on the me line has associated with it an actual value, which is represented by x and a subscript. Each point on the line also has a forecasted value, represented by f and a subscript. Every period has a forecasted value when it is in the future; as me passes, it will have an actual value.
Figure 6.2: Forecas ng me line
Simple Moving Average
One approach to forecas ng is to use only the most recent me period to project the next me period. This system, however, can introduce a significant error into a forecast because any odd occurrence in the previous period will be completely reflected in the predic on. Suppose that in one month a temporary price cut caused sales to be significantly greater than normal. If these ac ons are not repeated in the next month, then using the previous month's sales as the forecast will provide a biased predic on.
The purpose of the simple moving average is to smooth out the peaks and valleys in the data. In the data set shown in Figure 6.3, the data fluctuate significantly. Basing a projec on on the prior quarter's result could provide a significant error. A moving average will smooth these peaks and valleys and provide a more reasoned predic on. In the moving average model, the forecast for the next period is equal to the average of recent periods.
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ft+1 =
the forecast for me period t + i, that is, the next me period when i = 1
xt–i = the observed value for period t – i, where t is the last period for which data are available and i = 0, . . ., n–1
n = the number of me periods in the average The longer the me—that is, the greater the n—the more smoothing that will take place. The selec on of n is a management decision based upon the amount of smoothing desired. A small value of n will put more emphasis on recent predic ons and will more completely reflect fluctua ons in actual sales. In fact, if n = 1, then the most recent me period's actual results will become the next period's forecast.
Figure 6.3: Graph of imports
Example: Following are the data shown in Figure 6.3:
Year: Quarter Imports ($000,000)
2012:1 4,100
2012:2 2,000
2012:3 5,700
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2013:1 7,300
2013:2 9,200
2013:3 6,300
To calculate a seven-quarter moving average for imports, sum the most recent seven quarters, and divide by seven. Please observe that the nota on "year: quarter" is used in the subscript here. The fourth quarter of 2013 is noted as "13:4."
f13:4 =
= 5,300
A three-quarter moving average is calculated as follows:
f13:4 =
= 7,600
Which es mate is likely to be er represent the future? Which predic on should be used? It depends upon whether the forecaster feels the last three quarters be er predict what is to come than the prior seven months. If so, use the 3-month moving average. If the last three months reflect some unusual condi ons that are unlikely to recur, use the 7-month moving average to smooth the high values in the last three quarters. Forecas ng models do not provide complete answers to ques ons. Managerial judgment plays a cri cal role.
This technique is called a moving average because to forecast the next quarter, the most recent quarter's actual imports are added ande the oldest quarter's actual imports are subtracted from the total. In a way, the average moves. Refer again to the import example. Assume that actual imports for the fourth quarter of 2013 are $7,500 million. A three-quarter moving average for the first quarter of 2014 would drop the $7,300 million, which is the actual value for the first quarter of 2013, and add the most recent quarter. The following illustrates the calcula on for the first quarter of 2014:
f14:1 =
= 7,667
Weighted Moving Average
In a simple moving average, each me period has the same weight. With a weighted moving average, it is possible to assign different weights to each period. The equa on for determining the weighted moving average is:
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wt–i = the weight for period t–i, where t is the last period for which data are available and i = 0,. . . , n–1. The weights for all n periods must sum to 1.0.
Example: Five-period weighted moving average for the fourth quarter of 2013
Year: Quarter Weight Imports ($000,000)
2012:1 — 4,100
2012:2 — 2,000
2012:3 0.10 5,700
2012:4 0.15 2,500
2013:1 0.20 7,300
2013:2 0.25 9,200
2013:3 0.30 6,300
If the weights for each period are set at 0.20, then the weighted moving average and the simple moving average using five quarters will be equal. Try this for yourself.
The weights for each period need to be selected in some logical way. Usually the most recent periods are weighted more heavily because these periods are thought to be more representa ve of the future. If there is an up or down trend in the data, a weighted moving average can adjust more quickly than a simple moving average. S ll, this form of the weighted moving average is not as accurate as regression analysis (discussed later in this chapter) is in adap ng to trends.
Exponen al Smoothing
Exponen al smoothing is another form of a weighted moving average. It is a procedure for con nually revising an es mate to include more recent data. The method is based upon averaging (smoothing) past values. To start a forecast using exponen al smoothing, the forecast for the first period, Exponen al smoothing is another form of a weighted moving average. It is a procedure for con nually revising an es mate to include more recent data. The method is based upon averaging (smoothing) past values. To start a forecast using exponen al smoothing, the forecast for the first period, ft+1 would be based upon the actual value for the most recent period, xt. (See equa on 6.1.) The forecast for the second period, ft+2 is equal to the actual value of the previous period, xt+1 mes the smoothing constant, A, plus (1 – A)
mes the prior period's forecast, ft+1. (See equa on 6.2.) Remember, the prior forecast, ft+1, is simply theProcessing math: 0%
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actual value from period t. The forecast in equa on 6.2 is A mes the prior period's actual value plus (1 – A) mes the prior period's forecast, ft+1.
ft+1 = xt (6.1)
ft+2 = A(xt+1) + (1 – A)ft+1 (6.2)
ft+3 = A(xt+2) + (1 – A)ft+2 (6.3)
. . .
. . .
. . .
. . . ft+n = A(xt+n – 1) + (1 – A)ft+n – 1
where
n = some number of periods in the future
Consider one more equa on in detail. Equa on 6.3 uses the prior period's actual value mes the weigh ng factor, A, plus (1 – A) mes the prior period's forecast. Exponen al smoothing carries all the historical actual data in the prior period's forecast.
How should the smoothing constant A be selected? First, A must be greater than or equal to zero and less than or equal to one. Within this range, a manager has discre on. What will happen if a manager selects a smoothing constant at an extreme? If A = 1, then according to equa on 6.2, the forecast will be based solely on the actual value from the prior period. In this case, no smoothing takes place. The forecast for the next period is always the last period's actual value. If the smoothing constant is set to 0, then the prior period's actual value is ignored. Once the forecas ng pa ern gets started, the forecast is so smooth that it will never change. No actual amounts can enter the equa on because A = 0. Neither of these alterna ves is acceptable.
There are no specific rules about choosing the value of A. If the forecaster wants to put more weight on the most recent me period, then A should be set closer to 1. If the manager desires a smoother forecast that will not react dras cally to short-term change, A should be set closer to 0. Values between 0.1 and 0.3 are most commonly used. Typically, values in this range are selected so the forecast does not overcompensate for sudden changes in the data. For example, if weather was extremely warm in the last
me period and demand was high, the forecast for the next me period would not be pushed to an extreme level if a value of A is selected that is within this range. The forecast would be smoothed because more weight is placed on the historical data, meaning the data that are prior to the sales value for the most recent me period.
Example: Exponen al Smoothing Processing math: 0%
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Use exponen al smoothing to forecast imports from the previous example. To illustrate the impact of the smoothing constant, use A = 0.1 and A = 0.6. To begin, there can be no forecast for the first quarter of available data because no history is available. The forecast for the second quarter is the prior quarter's actual value because no forecast is available for the first quarter. In Figure 6.4, 4,100 is the forecast for both A = 0.1 and A = 0.6. A er that, the forecasts are significantly different because of the large difference in smoothing constants and the large fluctua ons in demand. The third quarter's forecast follows the equa ons described previously because an actual value and a forecasted value are available for the prior quarter. Despite that the actual demand is available through the third quarter of 2013, the forecasted values were calculated to illustrate the difference between the two forecasts and the poten al for inaccurate forecasts when historical demand varies significantly.
For A = 0.1
f12:3 = A(x12:2) + (1 – A)f12:2
= 0.1(2,000) + 0.9(4,100)
= 3,890
For A = 0.6
f12:3 = 0.6(2,000) + 0.4(4,100)
= 2,840
Year: Quarter Imports ($000,000) Forecast A = 0.1 Forecast A = 0.6
2012:1 4,100
2012:2 2,000 4,100 4,100
2012:3 5,700 3,890 2,840
2012:4 2,500 4,071 4,556
2013:1 7,300 3,914 3,322
2013:2 9,200 4,253 5,709
2013:3 6,300 4,748 7,804
2013:4 4,903 6,902
The forecasts are significantly different. The forecast with A = 0.1 does not react abruptly to sudden changes. The forecast with A = 0.6 does respond but the response is delayed. This can be seen graphically in Figure 6.4 where the actual value and the two forecasts are plo ed.
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Figure 6.4: Exponen al smoothing examples
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6.3 Advanced Statistical Methods
Correla on analysis measures the degree of rela onship between two variables, and regression analysis is a method to predict the value of one variable based upon the value of other variables. The coefficient of correla on is a measure of the strength of linear rela onship between variables. If there is no rela onship, then the coefficient of correla on is 0. Perfect posi ve correla on is 1.0, and perfect nega ve correla on is –1.0 (see Figure 6.5). Between the limits of perfect posi ve and perfect nega ve correla on, there are many levels of strength. Examples are shown in Figures 6.5 and 6.6.
Figure 6.5: Sca er diagrams showing zero, perfect posi ve, and perfect nega ve correla ons
Figure 6.6: Sca er diagrams showing examples of correla on
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Regression analysis can be used to forecast both me-series and cross-sec onal data. Regression analysis is o en used to es mate the slope of a trend line for me-series data. Regression analysis can be either simple or mul ple. Simple regression analysis involves the predic on of only one variable (the dependent variable) and uses only one variable for predic on (the independent variable). Mul ple regression analysis has only one dependent variable, but can have more than one independent variable.
Regression and Correlation Analysis
The equa on for simple regression follows. Y is the dependent variable, and X is the independent variable. The variable b is the slope of the line, which is es mated by equa on 6.4, and variable a is the Y-intercept, which is es mated by equa on 6.5.
where
Y = the dependent variable. It depends on the variables X, a, and b.
X = the independent variable
n = the number of data points in the sample
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b = (6.4) a = (6.5) r = (6.6)
Example: Regression
When working with me-series data, it is usually easier to convert the me variable from the month/day/year format to simpler numbers. There are many possible ways of coding. Here, the number 1 is used to represent the first me period for which data are available. Following periods will be consecu vely numbered. In this example, the assump on is that demand (Y) depends on
me (X), the independent variable. The import data from an earlier example are used for analysis.
Year: Quarter
Coded Value for Year: Quarter (X)
Imports ($000,000) (Y) XY X2 Y2
2012:1 1 4,100 4,100 1 16,810,000
2012:2 2 2,000 4,000 4 4,000,000
2012:3 3 5,700 17,100 9 32,490,000
2012:4 4 2,500 10,000 16 6,250,000
2013:1 5 7,300 36,500 25 53,290,000
2013:2 6 9,200 55,200 36 84,640,000
2013:3 7 6,300 44,100 49 39,690,000
Sum 28 37,100 171,000 140 237,170,000
Interpre ng the results of the model requires an understanding of the original units of the data as well as the slope/intercept method of represen ng a straight line. The last quarter of 2013 is coded as "8" because the quarters are consecu vely numbered. The imports are given in millions of dollars. As a result, the imports are projected to increase $807.1 million per quarter. The intercept is $2,072 million, and it represents the point on the regression line for the quarter prior to the first quarter of 2012. Project the imports for the last quarter of 2013 where the es mated value is represented by Ye. The predic ve model follows.
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Thus, the projec on for imports is $8,528 million.
Goodness of Fit
How well does the equa on determined by regression analysis fit the data? The principles on which simple regression analysis and mul ple regression analysis are constructed are similar. The regression model es mates the Y-intercept (a) and the slope of the line (b) that best fits the data. The criterion that is used to determine the "best fit" line minimizes the squared distance from each point to the line. This is o en called the least squares method. These distances are labeled di in Figure 6.7, with i equal to 1, . . ., n. The method used to derive the parameters of the best fit line is based upon differen al calculus and is not covered in this text. The equa ons that determine the parameters of the slope (b) and the Y- intercept (a) are 6.4 and 6.5, respec vely.
Figure 6.7: Regression line
The coefficient of correla on calculated in the prior example (r = 0.671) indicates a high degree of rela onship between the dependent and independent variables. The higher the coefficient of correla on (closer to 1), the more confident the forecaster can be that varia on in the dependent variable (imports) is explained by the independent variable ( me). This can be observed by looking at the sca er diagram in Figure 6.8. A measurement of this varia on about the regression line is the standard error of the es mate, sy/x. It is the difference between each observed value, Yo, and the es mated value, Ye. The equa on for the standard error of the es mate follows. An alterna ve formula that is easier to use with Processing math: 0%
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a calculator is provided in Figure 6.8.
Simple regression models can be constructed for cross-sec onal data. The mechanics are similar.
Figure 6.8: Sca er diagram and regression line for import problem
Computer Applica on of Simple Regression Analysis
Many different computer so ware packages are available for doing both simple and mul ple regression analyses. Table 6.3 is the computer-based output for regression analysis. The coefficients calculated by so ware are the same (with allowances for rounding) as the coefficients calculated by hand. The standard error of the es mate is also the same as the value calculated by hand. The computer output also provides addi onal informa on. The standard error of the coefficients, 1,784.800 and 399.093, are standard devia ons for the coefficients. They can be used to test the null hypotheses that the actual values of the coefficients are equal to zero. The t-values are the calculated t-sta s cs for the hypothesis tests. The two-sided significant probabili es are the levels that alpha or Type 1 error would have to be set at in order to fail to reject the null hypothesis. In this example, the trend coefficient would be significant if alpha error is set at 0.1 or higher. On the other hand, the coefficient for the intercept would be significant if alpha error is set at 0.3 or higher.Processing math: 0%
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Table 6.3: Regression coefficients for imports
Variable Coefficient Std. Error t-value Two-sided Sig. Prob.
Constant 2,071.42900 1,784.8000 1.16059 0.298204
YRS/OUT 807.14290 399.09340 2.02244 0.099061
Standard error of es mate = 2111.804
Mul ple Regression Model
Mul ple regression has only one dependent variable, but can have many independent variables.
Y = a + b1 x1 + b2 x2 + . . . + bk xk
where
Y = the dependent variable. It depends on the variables X1 through Xk and the model parameters a, b1, b2. . ., bk , where k is the number of independent variables. (Equa ons for the parameters are not given here. There are many available computer packages, such as EXCEL, SPSSX, SAS, or MINITAB to do the necessary calcula ons.)
xi = an independent variable, with i = 1, . . ., k. Each independent variable will have n observa ons or data points.
Minimizing squared distances from each observed point to the best fit regression line is s ll useful. However, because mul ple regression requires more than two dimensions, two-dimensional graphs cannot be used. Computerized sta s cal models are used to make the calcula ons.
Problem
The prior examples use only one independent variable ( me) to predict imports. Most rela onships are not that simple, because other factors will also affect the dependent variable. To expand the previous example, disposable income and the consumer price index are added to the model.
Imports ($000,000)
Year: Quarter Code Value For Year: Quarter (Xi)
Disposable Income (Billions of $) (X2)
Consumer Price Index (X3)
4,100 2012:1 1 65 110
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5,700 2012:3 3 73 113
2,500 2012:4 4 61 113
7,300 2013.1 5 70 117
9,200 2013.2 6 77 118
6,300 2013:3 7 78 117
The mul ple regression output is shown in Figure 6.9. The equa on for predic ng imports is
ye = –141,000 – 1,387.6x1 + 206.35x2 + 1,205.4x3
Figure 6.9: Mul ple regression output
To predict imports for the fourth quarter of 2013, assume that disposable income is $78 billion and the consumer price index is 118 for the fourth quarter.
ye = –141,000 – 1,387.6(8) + 206.35(78) + 1,205.4(118) = 6,232
The predic on is $6,232 million worth of imports in the fourth quarter of 2013.
Measuring Forecasting Error
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When using a forecas ng model, it is cri cal to have a way to determine the model's propensity for error.
iStockphoto/Thinkstock
model's propensity for error. If an organiza on has been using a par cular model to forecast sales for some me, has the model been performing well? How large is the error? One approach is to simply subtract the forecast for one me period from the actual value for the same me period. This can be repeated so that the forecaster has differences for many periods. Differences are posi ve when the forecast is less than the actual value, and nega ve when the forecast is greater than the actual value. In raw form, these differences tell the forecaster li le. If these are added, the nega ve errors and the posi ve error will cancel and therefore underes mate the error. A common method used by forecasters to avoid this problem is to calculate the mean squared error. The mean squared error (MSE) is the average of all the squared errors. The differences are squared and added together, and then that total is divided by the number of observa ons. The following calcula ons help illustrate the method.
Problem
Month Actual Sales ($) Forecasted Sales ($)
Error ($) Squared Error
January 419,000 448,000 – 29,000 841,000,000
February 480,000 481,000 – 1,000 1,000,000
March 601,000 563,000 + 38,000 1,444,000,000
April 505,000 525,000 – 20,000 400,000,000
May 462,000 490,000 – 28,000 784,000,000
June 567,000 519,000 + 48,000 2,304,000,000
TOTAL 5,774,000,000
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Some mes the square root of the mean squared error is used to measure the error. This is analogous to the standard error of the es mate, which is discussed in the sec on on regression analysis.
It is also possible to use mean absolute devia on (MAD), which is similar to MSE, to es mate forecas ng error. MAD is calculated by adding together the differences between the actual and forecasted value once the nega ve and posi ve signs are removed. If MAD is not calculated, a large nega ve error would offset a large posi ve error, so the total error would be greatly underes mated. Try summing the "Error" column in this example with the signs included. The total error is $8,000 because the nega ve and posi ve errors cancel each other. Once the signs are removed, the total error is $164,000, which is divided by the number of data points n, as was done for MSE. The MAD is $164,000/6, which equals $27,333. The MAD is easier to interpret than MSE because MAD is the average error for the prior six forecasts. As a result, MAD can be used to es mate future forecas ng errors.
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Chapter Summary
A model is an important way to think about problems. It is an abstrac on from a real problem of the key variables and rela onships in order to simplify the problem and improve understanding. There are many different types of models, including prototypes used in product design; scale models used in architecture; diagrams and drawings used by scien sts, engineers, managers, and others; and mathema cal models used in many disciplines. Models are used to assist managers and others in answering what-if ques ons by changing a parameter in the model. There are qualita ve and quan ta ve methods for developing a forecast. Forecas ng is a type of mathema cal model that can be used to predict the future. It is an important part of the planning process in an organiza on The forecas ng process consists of determining the objec ves of the forecast, developing and tes ng a model, applying the model, considering real-world constraints in the applica on of the model, and revising and evalua ng the forecast. Forecas ng techniques typically use historical data to develop the model that is used to make the projec on. If the rela onships in the data change over me, the model may no longer predict the future accurately. Forecasters require a way to measure the amount of forecas ng error.
Case Studies
Blast-Away Housecleaning Service
Blast-Away Housecleaning Service uses powerful water jets to clear loose paint from residen al buildings and to clean aluminum siding. The company is trying to arrive at a fast and accurate way of es ma ng cleaning jobs. The following simple formula is its first a empt. It includes a fixed charge for coming to the job plus me requirements, which are a func on of the exterior of the house measured in square feet (sf).
Es mated cost = $15 + ($.06/sf)(sf)
A er one year of experience, Blast-Away has lost $50,000 on sales of $250,000. At first, the owner, Hadley Powers, could not understand the reasons for his losses. His employees worked hard, and Blast-Away could barely meet with demand. In fact, Powers was planning to add another crew this year, but if he cannot determine the reason for the losses and find a solu on, his investors would be reluctant to provide him with addi onal capital. What caused the loss?
He learned from his accountant that the model he used had not included a recovery of his investment in the equipment used on the jobs. Powers had invested $60,000 in equipment at the beginning of the first Processing math: 0%
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year and expected it to last three years. His accountant recommended that Powers increase the price charged per job to generate an extra $20,000 per year to cover equipment costs. If Powers were able to do this, his losses would be $30,000 if all other factors remained the same. He had to look further for answers to the problem.
Powers has hired you to carefully examine last year's job ckets, which contain the quoted price; distance from headquarters; size of the house; type of exterior, such as painted wood, aluminum, or brick; and style of the house, such as ranch, two-story, or split-level. You also have the operator's logbook that lists travel me and the me necessary to complete each house. As you analyze the job ckets, you no ce that a substan al number of the jobs that Blast-Away gets are for small, split-level or two-story homes located in the suburbs and surrounding rural area. Many of the homes have wooden siding, which is the most difficult type of siding to clean to the customer's sa sfac on.
In addi on to the equipment recovery problem, what is causing Blast-Away to lose money?1. What would you recommend Powers do to correct the problem?2. What data would you want to collect to verify your recommenda ons?3.
Lucy's Lamps-R-Us
Lucy Mertz has opened a specialty lamp shop in a suburban shopping mall. Mertz's shop has an excellent loca on next to the entrance to the largest and most popular department store in the five-county area. A er a slow beginning, business picked up nicely, and the lamp shop had made a nice profit. To plan for the next year, Mertz decided to use sales for the last eight months to forecast next year's sales. She has asked you to use the following data to project sales. The forecast listed here, which is for last year, was based upon judgment. Mertz wants you to use a quan ta ve approach.
Time Period
Forecasted Sales
Actual Sales
May $5,000 $8,300 June 5,200 10,200 July 5,600 9,900 August 6,200 10,200 September 6,900 9,800 October 7,800 11,400 November 8,500 12,800 December 9,000 14,500
How much error existed in the old forecast?1. Project the sales for January, February, and March of next year.2.
It is now the end of March, and the actual sales for the first three months are available. The results are disappoin ng. In January, sales declined because of returns from the Christmas buying season and an increase in bargain hun ng. Also, the large department store that anchored Mertz's end of the shoppingProcessing math: 0%
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mall closed at the end of January because of opera ng losses by the parent company.
Time Period Actual Sales January 7,500 February 6,000 March 6,100
Why did the model give Mertz a poor forecast?3. What would you recommend to Mertz regarding the forecast for the next three months?4.
Discussion Ques ons
Click on each ques on to reveal the answer.
What is model building, and why is model building important for managers? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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1.
A model is an abstrac on from the real problem of the cri cal variables and rela onships in order to simplify the problem. Managers should use models to gain a be er understanding of the problem. Models also permit the manager to analyze a given situa on by asking "what if" ques ons.
A model is an important way of thinking about a problem. Decision makers use models to increase their understanding of a problem. A model helps managers simplify the problem by focusing on the key variables and rela onships in the problem.
Discuss the different types of models. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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2.
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Many different types of models are possible. Models can be used to test design characteris cs such as tes ng the aerodynamic proper es of an airplane in a wind tunnel. Mathema cal and graphical models are also possible.
a. Mathema cal models include algebraic models such as break-even analysis, sta s cal models used in forecas ng and quality control, and calculus based models such as the economic order quan ty.
b. Graphs and Charts are pictorial representa ons of mathema cal rela onships. They include a graphical representa on of break-even analysis, a pie chart that illustrates market share in an industry, and a graph of stock prices for the past four months.
c. Diagrams and drawings are pictorial representa ons of conceptual rela onships. They include such things as precedence diagrams that represent the sequence required to assemble a building, a drawing of a gear that might be part of a transmission in a car, and a diagram that represents the logic of a computer program.
d. Scale models and prototypes are physical representa ons of an item. They include a scale model of an airplane and the first part produced (prototype) which is used for tes ng purposes.
Describe how models can be used to answer what-if ques ons. (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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3.
A model can be used to answer "what if" ques ons by changing one of the assump ons in the model. For example, in the model of gasoline costs on the trip to Florida, an increase in the cost per gallon of gasoline caused the cost of the trip to increase and a decrease in the miles per gallon, which the car would a ain, caused the cost to increase. In a physical model, such as the airplane example, the designers could change the angle or shape of the wing to determine the impact of the change on the performance of the plane.
How are models used in business and opera ons? (h p://content.thuzelearning.com/books/AUBUS644.13.24. Processing math: 0%
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Models are widely used in opera ons and in other areas within the organiza on. Financial managers use net present value and internal rate of return models to analyze investment alterna ves. Informa on systems personnel use flow diagrams to understand the logic required to develop a computerized inventory control system. Accountants use ra os such as the current ra o to measure an organiza on's ability to pay its short-term bills. Opera ons managers use models extensively to forecast sales, understand the cost-volume-profit rela onship, assign tasks to work sta ons, decide to make or buy a product, and to set the order size.
What is forecas ng, and why is it important to an organiza on? (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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5.
Forecas ng is an a empt to predict the future. Forecasts are usually the result of examining past experience to gain insight into the future. These insights o en take the form of mathema cal models. Forecas ng is essen al to the success of an organiza on because organiza ons must prepare for the future and a forecast provides some insights as to the condi ons, which the organiza ons might encounter.
Describe the forecas ng process. (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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To begin the forecas ng process, the modeler should determine the objec ves of the forecast. This should lead to a discussion of the purpose of the forecast, the variables to be forecast, who will use the forecast, the me frame of the forecast (long, medium, or short term), the level of accuracy needed, and when the forecast is needed. A technique or method for doing the forecast must be selected and the forecas ng model should be developed and tested. When the model is applied, the results should be considered with respect to constraint in the "real-world." For example, a forecast of sales that predicts a 20 percent increase in sales must be balanced against a company's ability to produce at that level. Finally, the forecast should be evaluated to determine how well it is predic ng the future. Have assump ons upon which the forecas ng model was built changed to the point that the model is no longer valid? If the assump ons have changed, then the model should be revised.
Discuss the qualita ve approaches to forecas ng. (h p://content.thuzelearning.com/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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7.
Qualita ve approaches to forecas ng are usually based on the judgment and experience of people who are knowledgeable in the area being forecast. Qualita ve approaches are usually based on historical data because the judgment and experience of the people involved are affected by events in the past. The buildup method for predic ng sales involves star ng at the bo om of an organiza on. Sales representa ves from each sales territory predict their sales. These es mates are passed up to the next level of the organiza on for review and evalua on. A er agreement is reached at that level, the sales are passed up to the next level in the organiza on. When the sales figures reach the top of the organiza on, they can become the target for the en re organiza on.
A survey is a systema c effort to elicit informa on from specific groups and is usually conducted via a wri en ques onnaire, Internet survey, or phone interview. The target of a survey could be consumers, purchasing agents, or economists. A survey could a empt to determine the demand forProcessing math: 0%
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a new or exis ng product. The use of a survey is not limited to es ma ng demand for product. It could be used to measure the overall health of the economy or the support level of a poli cal candidate on a par cular issue.
In a test market the actual product is distributed in a small geographical area and demand for the product is carefully monitored. The test market area should be representa ve of the overall market if the results are to be useful. Test markets are used to es mate sales.
A panel of experts involves people who are knowledgeable about a subject. This group a empts to make a forecast by building consensus. The Delphi Technique uses a panel of experts in a par cular manner. The panel of experts can be used to predict a wide variety of items from the cost of a raw material to the chance for nuclear disarmament.
How does the Delphi Technique work? What are its advantages? (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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8.
The Delphi Technique uses a panel of experts and surveys. The members of the panel do not interact directly with one another. They provide a sequence of forecasts through responses to ques onnaires. A er each forecast, results are compiled and the individuals on the panel are informed as to the 25th, 50th, 75th percen le and/or other relevant data points for the item being forecast. Because the response is by ques onnaire rather than by group interac on, which can be dominated by a few individuals, undue conserva sm or op mism and argumenta on are avoided. The Delphi Technique assumes that as each forecast is conducted and the results disseminated among the panel members, the range of responses diminishes and the median moves to a posi on represen ng the "true" consensus of the group.
How is regression analysis different from the moving average, the weighted moving average, and exponen al smoothing? (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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There are obvious differences between the way regression analysis parameters are calculated and the ways that moving average, weighted moving average, and exponen al smoothing are calculated. The difference, which the ques on is a emp ng to address, is that regression analysis actually es mates the amount of trend in the data. In simple regression analysis, this is the slope coefficient b. The other techniques predict the next me periods value without es ma ng the trend. As a result, these techniques will consistently underes mate sales when sales are rising at a constant or accelera ng rate period a er period and will consistently overes mate sales when sales are declining in this manner.
Regression analysis (simple or mul ple regression) is a cause and effect model that considers independent variable(s) to determine the dependent variable. The (simple) moving average, weighted moving average, and exponen al smoothing models use me series data to predict the next period. However, me can be a dependent variable in regression analysis as well. Regression analysis can es mate a trend.
What is forecas ng error, and why should it be measured? (h p://content.thuzelearning.com/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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10.
Forecas ng error is the difference between the forecasted value for an item and the actual value. There are many different ways to es mate the error, and Mean Squared Error (MSE) and Mean Absolute Devia on (MAD) are common ways. Both methods take the difference between the forecast and the actual values for all observa on. For MSE, these differences are squared and summed; then, the sum is divided by the total number of observa ons. For MAD, the absolute value of these differences is determined and the errors are summed. The sum is divided by the total number of observa ons. Without a way to measure forecas ng error, it would be difficult to determine when a forecast is no longer representa ve of what is actually driving the factor being forecasted.
Problems
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Blast-Away Housecleaning Service uses powerful water jets to clear loose paint from residen al buildings and to clean aluminum siding. The company is trying to arrive at a fast and accurate way of es ma ng cleaning jobs. The following simple formula is its first a empt. It includes a fixed charge for coming to the job plus me requirements, which are a func on of the exterior of the house measured in square feet (sf).
Es mated cost = $15 + ($0.06/sf)(number of sf)
How much should Blast-Away charge to clean a house that is a rectangular 40-by-28 feet? The distance from the roof line to the bo om of the siding is 9 feet.
a.
Suppose Blast-Away's labor costs increase and the cost per square foot increases to $0.064. How much should it charge for the house in Part a?
b.
What other factors may Blast-Away include in the pricing model to improve the precision of the model?
c.
1.
As a service to its customers, Turbo Natural Gas Company will es mate the amount of natural gas required (NGR) in hundreds of cubic feet (CCF) to heat your home. This is done by a mathema cal model that considers the square footage on the first floor (sf1), the square footage on the second floor (sf2), and the temperature se ng on the thermostat. The temperature se ng entered into the model should be the difference between the temperature se ng in the home and 65 degrees (td). Make sure to keep the minus sign if the se ng is less than 65 degrees. The model builder assumed that the homes have 8-foot ceilings, an average number of good-quality windows, 3.5 inches of insula on in each wall, 6 inches of insula on in the a c, and a typical Midwestern winter.
How much natural gas will an 1,800-square-foot ranch home (one floor only) use if the thermostat is set at 70 degrees?
a.
How much natural gas will a two-story home with a total of 2,400 square feet use if the thermostat is set at 63 degrees? There is 1,000 square feet on the second floor.
b.
What happens to the natural gas cost in Parts a and b if the model is revised and the usage for the first floor increases to 0.60 CCF/sf from 0.50 CCF/sf.
c.
2.
It appears that the imports of beef have been increasing about 10% annually on the average. Project the 2002 imports using linear regression.
Year Imports of Beef (Thousands of Tons)
2003 82 2004 101 2005 114 2006 126 2007 137 2008 151
3.
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2009 164 2010 182 2011 189
Mighty-Maid Home Cleaning Service has been in opera on for eight months, and demand for its products has grown rapidly. The owner, who is also the manager, of Mighty-Maid is trying to keep pace with demand, which means hiring and training more workers. She believes that demand will con nue at the same pace. She needs an es mate of demand so she can recruit and train the workforce. The following represents the history of Mighty-Maid:
Time Hours of Service Rendered
December 300 January 750 February 650 March 920 April 1,300 May 1,400 June 1,200 July 1,500
Es mate the trend in the data using regression analysis.
4.
Use the regression model calculated in the Mighty-Maid problem to es mate the hours of service for December through July. Now that both the actual and the forecasted values are available, answer the following ques ons:
What are the MSE and MAD for the forecast?a. Is the forecas ng model a "good" model?b.
5.
The figures below indicate the number of mergers that took place in the savings and loan industry over a 12-year period.
Year Mergers Year Mergers 2000 46 2006 83 2001 46 2007 123 2002 62 2008 97 2003 45 2009 186 2004 64 2010 225 2005 61 2011 240
Calculate a 5-year moving average to forecast the number of mergers for 2012.a. Use the moving average technique to determine the forecast for 2005 to 2011. Calculate measurement error using MSE and MAD.
b.
Calculate a 5-year weighted moving average to forecast the number of mergers for 2012. Usec.
6.
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weights of 0.10, 0.15, 0.20, 0.25, and 0.30, with the most recent year weighted being the largest. Use regression analysis to forecast the number of mergers in 2012.d.
Find the exponen ally smoothed series for the series in Problem 6, (a) using A = 0.1 and then (b) using A = 0.7, and plot these me series along with the actual data to see the impact of the smoothing constant.
7.
The me series below shows the number of firms in an industry over a 10-year period.
Year Firms Year Firms 2002 441 2007 554 2003 468 2008 562 2004 481 2009 577 2005 511 2010 537 2006 551 2011 589
Find the 5-year moving average for this series.a. Find the 3-year weighted moving average for this series. Use the following scheme to weight the years:
Weight Most recent year 0.5 Two years ago 0.3 Three years ago 0.2
b.
Determine the amount of measurement error in the forecast. Use the weighted moving average technique (with the weights from Part b to forecast for 2005 to 2011.) Then use that 7-year period to calculate measurement error (both MSE and MAD).
c.
Find the exponen ally smoothed forecast for this series with A = 0.2.d.
8.
The quarterly data presented here show the number of appliances (in thousands) returned to a par cular manufacturer for warranty service over the last five years.
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 5 years ago 1.2 0.8 0.6 1.1 4 years ago 1.7 1.2 1.0 1.5 3 years ago 3.1 3.5 3.5 3.2 2 years ago 2.6 2.2 1.9 2.5 1 year ago 2.9 2.5 2.2 3.0
Find the equa on of the least squares linear trend line that fits this me series. Let t = 1 be the first quarter five years ago.
a.
What would be the trend-line value for the second quarter of the current year—that is, two periods beyond the end of the data provided?
b.
9.
The following are AJV Electric's sales of model EM-5V circuit assemblies over the last 16 months (in thousands of units):
10.
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Month Sales (Thousands of Units)
Month Sales (Thousands of Units)
Sept. 2010 55 May 2011 63 Oct. 2010 53 June 2011 53 Nov. 2010 60 July 2011 51 Dec. 2010 49 Aug. 2011 60 Jan. 2011 48 Sept. 2011 58 Feb. 2011 61 Oct. 2011 52 Mar. 2011 61 Nov. 2011 51 Apr. 2011 53 Dec. 2011 63
Use the moving average technique to forecast sales of AJV's model EM-5V for January 2012 (use a 3-month base). Does the model appear to be appropriate? Why or why not?
Employ the single exponen al smoothing technique to forecast sales of AJV's model EM-5V for January 2012 (use A = 0.8). Does the model appear to be appropriate?
11.
U lize the single exponen al smoothing technique to forecast sales of AJV's model EM-5V for January 2012 (use A = 0.1). How do the results compare with those from problem 11? Is one be er than another? Why or why not?
12.
Using linear regression, forecast the sales of AJV's model EM-5V for January 2012 through June 2012.13. Thri y Bank and Trust is trying to forecast on-the-job performance by its employees. The bank administers an ap tude test to new employees. A er the employee training period and an addi onal six months on the job, the bank measures on-the-job performance. The following data have been gathered from the last eight people hired:
Employee Number Transac ons Score per Hour 1 90 36 2 70 29 3 85 40 4 80 32 5 95 42 6 60 23 7 65 29 8 75 33
Fit a line to the data using regression analysis. What is the meaning of the parameters that were es mated by the regression analysis model?
a.
How well does the model fit the data?b. How many transac ons per hour would you expect from someone who scored 87 on the ap tude test?
c.
14.
The data in the following table were collected during a study of consumer buying pa erns.15.
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Observa on X Y 1 154 743 2 265 830 3 540 984 4 332 801 5 551 964 6 487 955 7 305 839 8 218 478 9 144 720 10 155 782 11 242 853 12 234 878 13 343 940
Fit a linear regression line to the data using the least squares method.a. Calculate the coefficient of correla on and the standard error of the es mate.b. How could the coefficient of correla on and the standard error of the es mate be used to make a judgment about the model's accuracy?
c.
Perfect Lawns intends to use sales of lawn fer lizer to predict lawn mower sales. The store manager feels that there is probably a six-week lag between fer lizer sales and mower sales. The per nent data are shown below.
Period Fer lizer Sales (Tons)
Number of Mowers Sold (Six-Week Lag)
1 1.7 11 2 1.4 9 3 1.9 11 4 2.1 13 5 2.3 14 6 1.7 10 7 1.6 9 8 2.0 13 9 1.4 9 10 2.2 16 11 1.5 10 12 1.7 10
Use the least squares method to obtain a linear regression line for the data.a. Calculate the coefficient of correla on and the standard error of the es mate.b. Predict lawn mower sales for the first week in August, if two tons of fer lizer sold six weeks earlier
16.
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Click here to see solu ons to the odd-numbered problems. (h ps://media.thuze.com/MediaService /MediaService.svc/constella on/book/AUBUS644.13.2/{pdf}bus644_ch06_odd_problem_solu ons.pdf)
Key Terms
Click on each key term to see the defini on.
buildup method (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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An approach to forecas ng that starts at the bo om of an organiza on and makes an overall es mate by adding together es mates from each element.
coefficient of correla on (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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A measure of the strength of a rela onship between variables. If there is no rela onship, the coefficient of correla on will be zero. A perfect posi ve correla on is 1.0 and a perfect nega ve correla on is 1.0.
correla on analysis (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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A measure of the degree of rela onship between two variables.
Delphi Technique (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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A forecas ng procedure that uses a panel of experts and surveys to build consensus regarding future events. It is an itera ve process for consensus building.
dependent variable (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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The variable in regression analysis that is being predicted.
exponen al smoothing (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Another form of a weighted moving average. It is a procedure for con nually revising an es mate to include more recent data. The method is based on averaging (smoothing) past values.
forecast (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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An es mate of future events.
forecas ng (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons /cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover
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The process of a emp ng to predict the future.
forecas ng error (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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The difference between the forecasted value and the actual value.
independent variable (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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A variable in regression analysis which is used to predict the dependent variable.
mean absolute devia on (MAD) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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The average of absolute error. The differences between the actual value of a variable and the forecasted value are added a er the plus and minus signs are removed. This total is divided by the number of observa ons.
mean squared error (MSE) (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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The average of all the squared errors. The differences between the actual value of a variable and the forecasted value are squared, added together and divided by the number of observa ons.
model (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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An abstrac on from the real problem of the key variables and rela onships in order to simplify the problem. The purpose of modeling is to provide the user with a be er understanding of the problem, and with a way to manipulate the results for "what if" analysis.
mul ple regression analysis (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Regression analysis that uses two or more (independent variables) to predict one dependent variable.
panel of experts (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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An approach to forecas ng that involves people who are knowledgeable about the subject. This group a empts to make a forecast by building consensus.
regression analysis (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2 /sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2
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A method to predict the value of one variable based upon the value of one or more variables. It is based upon minimizing squared distances from the data points to the es mated regression line.
simple moving average (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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A method to smooth out the peaks and valleys in the data by using the most recent actual values to predict the next period. The average moves because as me passes the next period becomes the current period so the actual value for the oldest period is dropped and the most recent actual value is added.
simple regression analysis (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Regression analysis that uses only one variable (independent variable) to predict a single dependent variable.
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survey (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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A systema c effort to elicit informa on from specific groups and is conducted via a wri en ques onnaire, phone interview or the Internet.
t-sta s c (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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Measures the distance from the mean to a point in the t-distribu on represented by standard devia ons.
t-value (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover /books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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The calculated t-sta s c used in hypothesis tes ng.
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A special kind of survey in which the forecaster arranges for the placement of a new product or an exis ng product that has been modified and data on actual sales are collected.
weighted moving average (h p://content.thuzelearning.com/books/AUBUS644.13.2/sec ons/cover/books /AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books/AUBUS644.13.2/sec ons/cover/books
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A method that is similar to the simple moving average. In the simple moving average, the weight for each historical me period is equal. In the weighted moving average, different weights can be assigned to each historical period. The weights assigned must sum to 1.0.
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