The Concept Of Strategic Outsourcing

Define and explain the concept of strategic outsourcing in the context of designing and reconfiguring supply chain structures; discuss the decision process of outsourcing and influencing factors; explore what might be the difficulties and barriers in its operational implementation; and finally summarise the key benefits and potential risks.

Elucidate the critical importance of supplier relationship management for the supply chain competitiveness; by finding and referencing to a number of professional literatures critically review some relationship management frameworks, models and approaches; discuss how a business might decide on the most appropriate relationship portfolio and management approach.

Explain what the supply chain uncertainties and supply chain risks are; explore some already established theories and practices in managing them referencing to some relevant literatures. Discuss the phenomena and behaviour of the Forrester Effect as one of the models for demand uncertainty; further explore the countermeasures of Forrester Effect.


A content page and page numbering

To complete two separate reports on two chosen topics from the three above, indicating the question number.

Properly structure the discussion into sections and give subtitles for each section.

Use references (normally 3-5 professional journal articles for each report) to demonstrate the extended learning

Each topic is recommended to be around 2000 words in length.

No lengthy case study is required, but some short (a few sentences) real world examples may be adequate.


To be submitted electronically using the appropriate web-form available from and following the guidelines provided in your handbook BEFORE midnight (UK time) on 14 January 2013


1. PMAs received after 23:59 on the submission due date will be recorded as having arrived on the next working day.

2. Post Module Assignment which does not reach Warwick Manufacturing Group by the due date will be considered to be late. Penalties for lateness may be applied at the rate of 3 percentage points per University working day after the due date, up to a maximum of 14 days late. After this period the work may be counted as a non-submission.

Table of Content

Description Page No.

List of Tables 3

List of Figure 3

1 Answer for Question 1

1.1 Definition 4

1.1.1 Concept of strategic outsourcing 4

1.1.2 Supply Chain Structure 5 – 6

1.2 Decision process and its influencing factors 7

1.2.1 Initiate Outsourcing decision 7

1.2.2 Service Implementation in outsourcing 7 Decision logic of outsourcing 8 Matrix decision tool 9

1.2.3 Final Agreement on outsourcing 9

1.2.4 Periodically Review on outsourcing 9

1.3 Difficulties and barriers in implementation 9

1.4 Key benefits and potential risks 10 – 11

1.5 Conclusion 12 – 13

1.6 References 14

3 Answer for Question 3 (Put 3 not 2??)

3.1 Supply chain uncertainties and risks 15

3.1.1 Natures of uncertainty risks in the supply chain context 16 Environmental risk 16 Geopolitical risk 16 Economic risks 17 Technological risk 17

Table of Content

Description Page No.

3.2 Established theories and practices 17

3.2.1 Best Practices in Supply Chain Risk Management 17 Supply chain risk management (SCRM) 17 Supply risk identification 17 Supply chain risk monitoring 17 Supply chain risk assessment 18 Risk management coordination 18 Sourcing risk mitigation strategies 18 Crisis communication planning 19 Supply chain business rules 19 Supply chain information 20 Supply chain network 20

3.2.2 Supply chain organization reference (SCOR) 20

3.3 Phenomena and behaviour of the Forrester Effect 21

3.3.1 Four major causes of the Forrester Effect 22 Demand signal processing/forecast updating 22 Order batching or Burbidge Effect 22 Price Fluctuations or Promotion Effect 22 Rationing and short gaming or Houlihan Effect 23

3.4 Countermeasures of Forrester Effect 23

3.4.1 Methods of handling the 4 major causes 24

3.4.2 Impact on Supply Chain 24

3.5 Conclusion 25 – 27

3.6 References 28

List of Tables

Description Page No.

Table 1 Key benefit from outsourcing 11

Table 2 Potential risks from outsourcing 11

Table 3 SCOR process definition 21

Table 4 Supply Chain coordination initiatives (adopted from Lee et al.1997) 24

Table 5 A framework of collaborative supply chains based on the inventory

control policies (adopted from Holweg et al. 2005) 26

List of Figures

Figure 1 A simple Supply Chain 5

Figure 2 A new Supply Chain 5

Figure 3 Various jobs, tasks or functions can be outsourced 6

Figure 4 Supply Chain network 7

Figure 5 The decision logic of outsourcing (adopted from Nigel Slack 2010) 8

Figure 6 The matrix decision tool for outsourcing (adopted from Abbetti 1997) 8

Figure 7 In House vs Outsource (extracted from PRTM Survey 2010-2012 on

Global Supply Chain Trend) 12

Figure 8 Most frequent cause of relationship failures (extracted from

Outsourcing Center 2004 survey) 13

Figure 9 The relations between certainty and the levels of uncertainty

(adopted from Kyläheiko et al., 2002) 15

Figure 10 Levels of uncertainty risks in supply chain context 16

Figure 11 Risk Best Practice Categories 18

Figure 12 Risk identification 19

Figure 13 Bullwhip Effect 22

Figure 14 Four major causes of the Forrester Effect 23

Figure 15 Impact of supply chain collaboration and order smoothing on

operational performance and customer service level 25

Q1. Define and explain the concept of strategic outsourcing in the context of designing and reconfiguring supply chain structures; discuss the decision process of outsourcing and influencing factors; explore what might be the difficulties and barriers in its operational implementation; and finally summarise the key benefits and potential risks.

1.1 Definition of strategic outsourcing in the context of designing and reconfiguring supply chain structures (you can put it here or in the paragraph or it makes no sense to say definition and just put “it is”.

It is the capacity of an organization engaging external service provider or third party logistics (3PL) to manage essential ‘in-house’ task which can provide strategic objectives in terms of cost, time saving, and accessibility to expertise and help the organization to focus on their main core process.

1.1.1 Concept of strategic outsourcing

Strategic outsourcing can be a key driver to global competitiveness if the services (Should it be service or services??) provided by 3PL are beneficial to the organization. This can be a good strategy if the organization’s strategic goal is achieve and they are able to focus on their core competencies. Therefore, the key to outsourcing is to choose the right resource that can provide quality products or services beneficial to the organization.

To begin the decision to outsource any specific jobs, tasks or functions, it must be based on sound judgment and not just on cost factor, though cost saving is an integral part of an outsourcing decision. The subject of outsourcing, decision, justification and support to use this concept varies between different organization thus it is necessary to evaluate several details or conditions before deciding in outsourcing. While it is up to each company and their management to make the decision for outsourcing, there will be impact to the employees and the consumer when outsourcing strategy is used. Difficulties and barriers in implementing outsourcing will be discussed in section 1.3.

1.1.2 Supply Chain Structure

A company, its supplier and its customer formed the basic group of participants that forms a simple supply chain structure shown in Figure 1. However, most of the supply chain are more complex and often contains addition participants like supplier’s supplier and customer’s customer. With service provider in the new supply chain structure shown in Figure 2, they help to provide services to the various participants. They are also able to perform services more effectively and at a better price than participants themselves.

Figure 1. A simple Supply Chain

Figure 2. A new Supply Chain

Various jobs, tasks or functions that can be outsourced are divided into 2 main types of outsourcing in an organization and illustrated in Figure 3. Business Process Outsourcing (BPO) is a process where 3PL service provider takes up all the responsibilities of the business processes like sales and marketing, R & D, purchasing, operation, HR, training, customer service and legal process. The flexible work scope and improvement in production rate are easier to achieve as the people are paid for their services without the company having to invest in costly assets and equipments.

Figure 3. Various jobs, tasks or functions can be outsourced

Business Function Outsourcing (BFO) is where a 3PL service provider takes up the responsibilities of the limited business function like financial accounting and logistics. These activities are especially attractive for small and medium (SME) businesses which don’t have the luxury support and expertise in that area. By outsourcing these business functions, organizations can maintain their comparative advantage in their core competency and at the same time reducing costs associated with diverting resources into non-critical business functions.

The analogy to the flow of water in a river is often used to describe organization which is near to the source as Upstream and those near to the end customers as Downstream. This is illustrated in Figure 4. Upstream activities on the supply side are divided into different tiers of suppliers. A supplier that sends materials or information directly to the main operator is a first tier supplier; the one who send materials or information to a first tier supplier is a second tier supplier; and so on. Customers on the demand side are also divided into different tiers; one that buys products directly from the operators is a first tier customer; one that gets products from a first tier customer is a second tier customer; and so on.

Figure 4. Supply Chain network

1.2 Decision process and its influencing factors

At the start of any outsourcing decision, there will be a variety of ideas and opinions about the purpose and scope of the outsourcing, the final result and how the decision will be carried out. There are basically four stages in the process:

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1.2.1 Initiate Outsourcing decision

An organization must determine whether the job, task or function is a core competency and must go through three assumptions before outsourcing decision is possible. First, there is a need to outsource the organization processes when there are insufficient processes, equipment and capital to cater to customer needs within the company. Second, if the quality is unable to meet the customer expectations, the function should be outsourced. Finally, if the needs are short-term which mean if the marginal increase in capacity provided by 3PL meets the needs for the organization, then outsourcing can be considered. If all three of these assumptions are satisfied, then outsourcing is possible and workable.

1.2.2 Service Implementation in outsourcing

The management would look at the 3PL selection and decide on whether they are qualified. In order to qualify, they must have the processes, equipment, manpower and technological capabilities. Organization must communicate their requirements to the service providers so that both parties can agree on the expected output. Intellectual property concerns for both parties must be ironed out up front in order to prevent any disagreements from developing in the future. The quality of the output must be sufficient and should not significantly degrade after outsourcing. Many tools have been developed by academics and practitioners to help management in outsourcing decision. Two of these tools are shown Figure 5 and Figure 6.

Figure 5. The decision logic of outsourcing (adapted from Nigel Slack 2010) Decision logic of outsourcing

Deciding whether outsourcing an activity is a sensible option, several factors need to be taken into account. If an activity is a long term strategic importance, then this should be retained in-house. If a company has specialized knowledge or skills in producing their end products, then it is unlikely to outsource as it is unwise to ‘give away’ such capability. If its operations performance is too superior to potential supplier, it is unlikely to outsource too. A company may not even consider outsourcing even if its performance falls below the standard as they may consider improving the products or services themselves in order to allow their specialized knowledge, skills or technology to retain inhouse. (do you think we can add a sentence to say the reasons of company not outsourcing instead improve inhouse)

Figure 6. The matrix decision tool for outsourcing (adapted from Abbetti 1997) Matrix decision tool

The matrix in Figure 6 helps the management to decide which jobs, tasks or functions can be outsourced. By understanding this tool, 2 important factors are to be consider:

How strategically important is the job, task or function to business and

How is the job, task, or function impact on organization’s competitive position in the market.

By putting the job, task or function into one of the nine boxes in the matrix, management will be able to determine whether the outsourcing decision is possible or workable.

1.2.3 Final Agreement on outsourcing

The drafted contract produced at the initial stage is generally amended during negotiations and the final contract is then produced after completion of the negotiation cycle. In order to gain maximum benefit for the organization, the decision cycle should go through a formal closure. Staff will need to accept the new situation and move forward with key benefits and potential risks for outsourcing explained clearly to them. These will be discussed in section 1.4.

1.2.4 Periodically Review on outsourcing

However, the performance of the 3PL must be regularly measured against the goals and metrics set from the agreement. When the business environment changes over time, decisions made in the past may not be suitable for application in the most current situations. Those metrics should also be adjusted as the relationship grows and market demand changes. Switching to a new vendor or back to performing the function internally must also be included during reviewing the final outsourcing decision.

1.3 Difficulties and barriers in implementation

The effectiveness of the implementation will be a great challenge for organizations who decided to outsource. A constant resistance from employees will determine how successful an outsourcing decision is. Employees’ fear of losing jobs may cause them to lose faith in the management. Therefore, management must explain to their employees on the rationale of outsourcing and having effective systems that can reward employees according.

Achieving cost savings must be balanced against several investments like IT systems, re-education, recruitment and also in infrastructures. The impact on the interest groups involved must also be considered. Supply chain integration may influence parties from upstream to downstream in a way that no measurement can be derivate from quantitative data. Therefore, a proper management of the integration plays a important role in its implementation.

According to Matthyssens and Faes (1997), there are two main principles that determine the success. The domino principle suggests that others will follow easily when the first group of employees believe in the benefits of the change and the principle of inertia suggests that when the action is moving, it is hard to stop it.

Process changes have to go through several phases. Thus, a reasonable time frame will be needed. Kotter (2007) suggests that there are eight requirements in a successful business transformation.

The eight requirements are:

High management involvement will create a sense of urgency,

Powerful guiding coalition between organization and 3PL will support the change,

Similar vision between organization and 3PL,

Active communication between organization and 3PL,

Efforts needed to get rid of barriers to change,

Focus on short term profit gains and improved in rewarding systems,

Consolidate improvements in process innovations by taking on or developing employees who can implement the organization’s vision and

Institutionalise new approach by clarifying the connection between the new behaviour and the organization’s success to employees.

1.4 Key benefits and potential risks

A successful outsourcing arrangement mostly depends:

How the original contract is being structured,

how the relationship between customer and service provider is being managed and

How the end results are measured.

When the arrangement is implemented correctly, outsourcing can bring huge benefits and can prove to be a win-win situation for both the customer and the service provider.

It is impossible to list out every benefit due to the nature of the business but many of the benefits are general enough that can be shared across the rest of the organizations as shown in Table 1. As the table shows, the general key benefits listed may include realizing the same or even better service provided at a lower cost, increased flexibility and/or quality, access to the latest technology and recruitment of best talent, etc.

Table 1. Key benefit from outsourcing

By putting aside fears over the loss of control, visibility, competency and being too dependent on third party, investing time and resources in a proven outsource process can be balance with costs and risks. This will help the organizations to experience good payoffs and benefits of outsourcing.

Before any organization decides on the 3PL selection process, it is necessary to take care of certain risks in order to make the benefits of outsourcing a reality. Many of the potential risks associated with outsourcing are general enough and summarized in Table 2. As the table shows, the potential risks listed may include finding/attracting right quality partners, creating extra capacity may create downsizing of operations and quality of service may deteriorates, etc.

Table 2. Potential risks from outsourcing

1.5 Conclusion

Outsourcing is identified as one of the five key supply chain challenges by PRTM in their 2010-2012 Survey. It showed how the companies could benefit from the upturn if they deal with it with careful planning. The outsourced jobs, tasks or functions are on the rise as the companies are taking advantage of lower costs in emerging markets and also increasing the flexibility of their own supply chain. The numbers in Figure 7 suggest that outsourcing activities have reached a point where companies have found the right balance between internal and external production. By taking an outsourcing approach, there is always an opportunity to align strategy and decision mak­ing processes in the context of a demand driven market.

Figure 7. In House vs Outsource (extracted from PRTM Survey 2010-2012 on Global Supply Chain Trend)

Pressures and risks can determine the outcome of the outsourcing decision. A good and effective outsourcing decision is to carry out an in-depth analysis of internal process first before outsourcing. Often, managements are focusing on cutting costs without thinking of the impacts of other risk factors. They need to consider whether the outsource-to-be job, task or function is the core competency. The management must ensure that they are proven capable internally if it is a core competency, giving out a core competency to a supplier is basically giving away the business and not outsourcing. If it is not, then this shall be the prime reason for outsourcing, provided a potential supplier passes all the assumptions listed.

However, management must really know how to apply it across their business while looking for opportunities for cost savings. The types of business functions that can benefit from outsourcing need to be identified, along with new technologies, processes and structures that can help to enable effective outsourcing. Unfortunately, outsourcing relationships between parties involved are not always successful. Most causes of failed relationships are shown in Figure 8.

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Figure 8. Most frequent cause of relationship failures (extracted from Outsourcing Center 2004 survey)

According to 2004 survey by Outsourcing Center, the most often cited reasons for failure:

Unclear expectations from customers and poor cultural fit from providers,

Poor performance from providers,

Having multi-suppliers at the same time and

No mutual beneficial between parties.

Thus, in order for a company or organization to have a successful outsourcing process, they must select the most appropriate 3PL service provider with:

Capabilities of 3PL accurately determine,

Requirements to 3PL clearly communicate, and

Key performance measures on the contract clearly identify for 3PL.

To maintain a good relationship with 3PL is not to blame them for poor performance but to analyze and determine the causes of poor performance. Therefore, to re-design the decision process is worthy so that a leap to demand driven market supply chain is possible. To achieve a win-win situation, cooperation between involved parties will determine how good and effective the outsourcing decision is.

Word count: 2385

1.6 References

Alan Harrison and Remko Van Hoek. 3rd edition (2008), Logistics Management and Strategy: Competing through the supply chain. FT Prentice Hall

Articlesbase (18 may 2010), Logistic s Outsourcing: Tips for successful selection for 3PL [online], (, (Accessed on 26 Nov 2012).

Donalon (2011), How Supply Chain can help winning competitive advantage [online], (, (Accessed on 26 Nov 2012).

Inbound Logistics (July 2008), Determining When to Outsource Supply Chain Management Services [online], (, (Accessed on 26 Nov 2012).

Katrina Lintukangas, Satu Peltola, Veli Matti Virolainen, “Some issues of supply management integration”, Journal of Purchasing & Supply Management 15 (2009), pp. 240-248

Kotter,J.P. “Leading change. Why transformation efforts fail?”, Harvard Business Review 85 (2007), pp. 96-103

Martin Christopher. 3rd edition (2005), Logistics and supply chain management: Creating value-adding networks. FT Prentice Hall

Matthyssens, P. and W. Faes. “Coordinating Purchasing: Strategic and Organizational Issues” In H.G. Gemunden, Th. Ritter, and A. Walter (Eds.), Relationships and Networks in International Markets, Elsevier Science, London, 1997, pp. 323-341

Nigel Slack, Stuart Chambers, Robert Johnston. 6th Edition (2010),Operations Management. FT Prentice hall

PRTM management consultants, “Global Supply Chain Trends: Lessons Learned from the Global Recession”, Annual Survey 2010-2012

Outsourcing Decision Support, Supply Chain Management: An International Journal 11/6 (2006), pp. 467-482

Sameer Kumar and Jason H. Eickhoff, “IOS Press Outsourcing: When and how should it be done?”, Information Knowledge Systems Management 5 (2005/2006), pp. 245-259

Q3. Explain what the supply chain uncertainties and supply chain risks are; explore some already established theories and practices in managing them referencing to some relevant literatures. Discuss the phenomena and behaviour of the Forrester Effect as one of the models for demand uncertainty; further explore the countermeasures of Forrester Effect.

3.1 Supply chain uncertainties and risks

Uncertainty in supply chain illustrated in Figure 9 is attributed to Frank Knight (1921) and is also referred as Knightian Uncertainty. In his book ‘Risk, Uncertainty, and Profit’, Knight mentioned that supply chain uncertainties and risks are events that decision maker can identify for the future, but have no idea about what will actually happen with their relative likelihoods. If the outcomes occur with a probability that cannot even be estimated, then the decision maker will face uncertainty.

Knightian Uncertainty

Figure 9. The relations between certainty and the levels of uncertainty (adopted from Kyläheiko et al., 2002)

Substantive uncertainty was derived from the lack of information from environmental events and further divided into parametric and structural uncertainty. Events that had happened will reveal all the relevant factors and their relationships. However, exact values from the relevant factors are missed by decision makers and this is known as parametric uncertainty. As for structural uncertainty, all the relevant factors and their relationships are known but decision makers are unsure about it.

Whereas, procedural uncertainty was from the incapability of the decision makers to achieve their main objectives even with given information. Complexity uncertainty happened when the given information got too complex and is not well understood by decision maker.

3.1.1 Natures of uncertainty risks in the supply chain context

Taking into account of all the affecting factors from the environment and the unclear information and categorization of different level of uncertainties risks in order to enable better risk management strategy is illustrated in Figure 10.

Figure 10. Levels of uncertainty risks in supply chain context Environmental risk

Natural disasters such as volcano eruptions, earthquake, tsunami and floods are likely to cause systemic supply chain or transport disruptions.

As these disasters can cause damages in infrastructure, interrupt production flow and significantly impact financial performance in both private and public sectors.

Significant budget will need to be allocated for the reconstruction of destroyed areas. As such disasters are hard to predict or prevent, making the right investments decisions before the event happen will be the main focus. Geopolitical risk

Disruptions consist of several potential events like conflict and unrest, union strikes, terrorism, organized crime and corruption.

Conflict and political unrest, and even maritime piracy can cause disruption to major transport routes or production hubs. As union strike has been regionalized, threats to employee security and shipping companies increased.

With terrorism, organized crime and corruption as the main concerns, fear of triggering new legislation could have the same disruptive effect. Such disruptions are hard to manage and to influence effective outcomes with limited resources will be a great challenge. Economic risks

Currency fluctuating, border delays and ownership/investment restrictions are some of the main economic disruptions.

Currency exchange rate fluctuations cause a financial blow to many businesses in recent years.

Despite significant growth in international trade, movements between borders remain vulnerable to tax tariff, security concerns and even infrastructure.

However, the main concern will be the sudden new restrictions in ownership or investments to businesses. These administration concerns will need new initiatives to provide a good and effective risk management. Technological risk

IT and transport infrastructure are identified.

Highly reliance on IT systems and the growing trends in cyber attacks, could highly impact supply chain and transport networks globally.

The disruption or failure of critical infrastructure such as roads and power station is due to lack of investment and prioritization of future resiliency by the government.

3.2 Established theories and practices

3.2.1 Best Practices in Supply Chain Risk Management

Several best practices in Supply Chain Risk Management have emerged in recent years, with organizations starting to look at how to manage risk better. Ten practices have been identified under 4 categories shown in Figure 11. Supply chain risk management (SCRM)

A right approach for organizations to identify, monitor, and assess the potential disruptions in supply chain networks with the objective of reducing negative impact on the performance. Supply risk identification

Involves potential events that could harm any disruption of supply chain’s performance. There are about 12 identified risks as shown in Figure 12. Risk identification allows any organization to take precaution measures in order to manage risks. This is more cost effective then waiting for things to happen. Supply chain risk monitoring

Allows organization to monitor their environment either internally or externally. This can assists them in prediction of risky events that are likely to occur. It is best to monitor risk that will be happening than to be caught off handed. If the monitoring only starts after the first occurrence, then it will (Use ‘may’ better?? Because will like a very strong word here)be too late to respond and salvage the situation.

Figure 11. Risk Best Practice Categories Supply chain risk assessment

Will provide better understanding of what are the potential risks that may exist for management to prioritize resources for risk mitigation. Clarify the nature of the risk and its conditions may lead to understanding how frequent the events can happen or can be expected to happen, and the potential negative impact of such events. Risk assessment is typically made up of two measures:

Likelihood measures the probability that the event will occur and

Impact measures the consequences on the organization if the event occurs Risk management coordination

With partners allow a closer cooperation between partners with better information sharing capabilities. It will improve existing initiatives and removal of ineffective activities. Sourcing risk mitigation strategies

These strategies can be in many forms, for example:

Having many sources of suppliers can reduce the impact of shortage of resources when the specific supplier failed to fulfil the order,

Having strategic agreements or partnerships with suppliers can lead to continued service in the event of capacity constraints,

Having collaborative planning forecasting and replenishment can reduce risk in unforeseen demand or supply shortages, and

Having joint product design and delivery can reduce the risk of material non-performance or shortages.

Figure 12. Risk identification Crisis communication planning

Allows staff to ensure risk management activities are being managed effectively. Periodic meeting with partners in sharing of new initiatives allow them to identify risks and take appropriate actions before any crisis.

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Are established in order to reduce the likelihood of a disruption occurrence before it occurs. Examples of risk management business rules include:

Sharing orders across multiple suppliers in case of supply shortages,

Emergency response procedures in the event of transportation failure and

Customer prioritization to allocate limited resources during emergency. Supply chain information

The information is shared and agreed between partners to reduce the overall risk in the supply chain. Supply chain network

Within locations, transportation routes, etc. are all determined during risk assessment activities in order to minimize potential disruptions in delivery of end product and service to customer.

3.2.2 Supply chain organization reference (SCOR)

SCOR can be used in areas of planning, executing and enabling. Table 3 shows the definitions for SCOR process. This is used in identifying, measuring, reorganizing and improving supply chain processes. A typical supply chain is usually driven by company ability to:

Plan at different levels of information sources,

Source for supply from different locations,

Produce producs through(from) different methods,

Deliver inventory deployment and finished products through different channels

Return in different locations for services.

By maintaining focus in supply chain usually needs concentration on the performance of the supply chain and comparing against internal and external set goals. This is normally driven by company ability to –

Achieve target goal on-time, complete and without damage,

React quickly on customer demand,

Increase/decrease demand within a given time frame,

Control within supply chain cost and

Fulfil customer demand with available assets.

Realigning processes and practices need to be set in a changing business environment. This can be achieved through many established processes like:

Lean Manufacturing analysis,

Six-Sigma analysis,


Balanced SCOR cards and benchmarking, etc.

Table 3. SCOR process definition

3.3 Phenomena and behaviour of the Forrester Effect

A Forrester Effect (Forrester 1961) is a modest change of customer actual demand from downstream being distorted and amplified towards suppliers from upstream resulting undesired of increased of orders being placed. This phenomena is also called the Bullwhip Effect (Lee et al. 1997).

Illustration in Figure 13 show irregular orders can interrupt the smoothness of the supply chain process as each link in the supply chain will overestimate or underestimate the product demand resulting in exaggerated fluctuations.

The increased in variation of the order process of supply chain will then result in each function facility (supplier→ distributor→warehouse→customer) a need to maintain safety stock level, overstocking and incurs extra costs maintaining them, inefficiently use of resources due to poor planning and material shortages due to poor product forecasting.

Figure 13. Bullwhip Effect

3.3.1 Four major causes of the Forrester Effect

Four key causes of the Forrester Effect are illustrated in Figure 14. Demand signal processing/forecast updating

It determines a readjustment of demand forecasts by upstream players resulting in future product demand signal. Normally forecasting is usually based on the estimation of past history ordering from immediate customers. Order batching or Burbidge Effect

It uses inventory control measuring to monitor orders place by upstream participants. When demand arrives, inventory is depleted but the company may not place an order with the supplier immediately. It often accumulates their demands before issuing the next order in batches. Most of the time, the supplier cannot handle the order processing because of the lack in time and incur of addition cost. Price Fluctuations or Promotion Effect

It emerges when a product’s price is being tagged lower through special price schemes. Customers will tends to buy more of the products during this period and when the price reverts back to normal, customer will not be tempted to make any purchases as they may have to finish their inventories first. Rationing and short gaming or Houlihan Effect

It exaggerates the customer’s real needs when they order for rationing in case of supply shortage. This overreaction in anticipation of shortages will result when organizations make rash economic decisions in ‘gaming’ the potential rationing.

Figure 14. Four major causes of the Forrester Effect

The Four major causes of the Forrester Effect may affect the supply chain management in a number of ways, for example:

No coordination amongst participants from upstream to downstream demand forecasts;

Large demand and supply fluctuations result in high inventories to prevent stock outs;

Poor customer service as all demand might not be met on time;

Difficulties in production scheduling and planning due to large order swings;

Extra plant expansion to meet demand and can lead to large distortions and high costs;

High costs for large unexpected orders or supply problems.

3.4 Countermeasures of Forrester Effect

By understanding the causes of Forrester Effect can assist management to find the best strategies to combat or curb the inconsistencies. Various initiatives for the possible solution are based on the coordination mechanism. By sharing demand information and channel alignment can pursue to improve performance like reducing costs, lead-time and also improved operational efficiency. (Towill, 1996 and Fransoo and Wouters, 2000)

3.4.1 Methods of handling the 4 major causes

Different methods to handle the different causes of the Forrester Effect are summarized in Table 4. It is best if the companies can reduce all these uncertainties by sharing desired information along the whole supply chain.

Actual information should be provided on customer demand in order to reduce high dependency on sales forecasting. The increased in variation of customer demands can be improved by a pricing strategy which is consistent within market. Adopting lean manufacturing and reducing costs of batching orders can reduce lead time.

Table 4. Supply Chain coordination initiatives (adopted from Lee et al.1997)

3.4.2 Impact on Supply Chain

Supply chain collaboration between different parties impacts more than order smoothing on the overall supply chain performance and are summarized in Figure 15. Order smoothing limits inventory variability in term of either excessively stock-piling or backlogging.

However, it may have a negative impact in customer service. As the order smoothing increases, operational performance improves but level of customer service will drop. Despite the potential loss of customer service, information exchange in the supply chains can be an effective approach to the Forrester Effect. Supply chain collaboration provides inventory stability and improves customer service. The sound decisions made by management in synchronised supply chain can helps to eliminate inefficiencies and reduces inventory levels.

Strategic Dimension

Tactical Dimension

Low Collaboration

Low Order Smoothing

High Collaboration

Low Order Smoothing

Low Collaboration

High Order Smoothing

High Collaboration

High Order Smoothing

Improvement in Customer service level

Improvement in Operational performance

Figure 15. Impact of supply chain collaboration and order smoothing on operational performance and customer service level.

3.5 Conclusion

Best practices in supply chain risk management include information sharing and coordinating efforts within partners in the whole supply chain can produce significant results like reductions in inventory, costs and even total lead time. However, managements fail to realize that shared information must be accurate and relevant at all times or else adverse effects will occur. Furthermore, they do not realize the nature of the Forrester Effect and how to eliminate it completely.

The common understanding of collaboration can helps to eliminate the inefficiencies and improve operational efficiency when coordination between upstream players to downstream is lacking. According to Holweg et al. (2005), information flow is the key to improvement in coordination and a framework of collaborative supply chains based on the inventory control policies as illustrated in Table 5.

Planning collaboration refers to real-time sharing of market demand data for forecasting and inventory collaboration refers to real-time sharing of information on inventory levels and in-transit items for centralized replenishment.

Table 5. A framework of collaborative supply chains based on the inventory control policies (adopted from Holweg et al. 2005)

Being a decentralized supply chain in traditional supply chain and information exchange, each member produces their own plan based on their direct customer incoming orders. Traditional supply chain has no collaboration when they allow each level of players to issue orders and top up stocks without thinking for their partners. But, the Information exchange with planning collaboration allows each level of players to issue order independently but shared their information and plan with their partners.

Vendor managed replenishment is a centralized supply chain which allows each level order managed by supplier and with inventory collaboration. Suppliers on the downstream will plan based on their partner visibility inventory level. Things like reducing inventory and stock out will improve supply chain performance.

Synchronized supply allows each level of order to be taken care by its suppliers at operational level. With inventory and planning collaboration, synchronized supply in a centralized supply chain allows each member to jointly plan with their suppliers based on their partner visibility inventory level.

In summary, understanding the Forrester Effect is important but to develop strategies to counter it is a challenge. An efficient management from upstream players to downstream will definitely help to develop a smooth and effective supply chain network that can improve supply efficiency.

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