IMPACT OF CUSTOMER RESPONSE ON INVENTORY AND UTILIZATION POLICIES, THE

Journal of Business Logistics, 2006 by Gonçalves, Paulo

Drawing on extensive fieldwork at a semiconductor manufacturer, this research provides a framework for understanding how customer response and long production delays interact, leading to increased demand amplification across a company's supply chain. Investigating the impact resulting from the higher demand amplification, suggestions are derived for the company's capacity utilization and inventory policies

Key Words: Capacity Utilization; Customer Response; Demand Amplification; Inventory Policy; Simulation

Due to parts shortages, Boeing stopped production of its 747 airplane and delayed the final assembly of the 737, leading to "more late deliveries, higher costs, upset customers and depressed profits" (Holmes 1997, p. C-12). Faced with high demand for its Pentium III processors and unable to meet demand, Intel planned to introduce a new fabrication facility. However, in the following year, Intel scrapped the project blaming an economic slowdown and order cancellations (Gaither 2001). "Five months after health officials rationed [flu] vaccine because of a shortage, now there's a glut with one manufacturer and major distributors facing lost revenue totaling hundreds of millions of dollars" (Henderson 2005, p. A1). These stories share a few commonalities. First, they highlight that despite the emphasis on effective supply chain management during the last decade, companies in diverse industries still struggle with supply chain glitches. Hendricks and Singhal (2003) suggest that glitches (e.g., parts shortages, order changes by customers, production and ramp-up and roll-out problems) cause up to a 10% reduction in shareholder value. second, the stories involve upstream companies, hinting that these companies may be particularly vulnerable to supply chain glitches due to higher demand variability upstream (i.e., the bullwhip effect). Finally, the industries mentioned (pharmaceuticals, airplane, and semiconductor manufacturing) have manufacturing delays in the order of several weeks or months, suggesting that long production delays affecting the company's ability to maintain adequate inventory levels can compound demand variability and cause supply chain glitches. This study explores how demand variability, supply chain instability, and long manufacturing delays interact and how this interaction may affect inventory and utilization policies.

With that purpose, a model is presented based on a year-long, in-depth field study of Intel's supply chain. The supply chain model captures the material flows associated with a hybrid push-pull production system (composed of fabrication, assembly and finished goods) and includes the customer response to the availability of a low-end product (e.g., Celeron processors). The model incorporates two separate feedback effects associated with customer response. First, a sales effect captures the balancing feedback whereby product shortages cause customers to seek alternate sources of supply, reducing demand and easing the shortage. Alternatively, it captures how an unexpected decrease in demand improves the manufacturer's short-term ability to fill orders, allowing it to satisfy customers, increasing its attractiveness and also future demand. Second, the production effect captures the reinforcing feedback by which changes in demand have a delayed impact on the manufacturer's production decisions. A short-term decrease in demand causes manufacturers to reduce demand forecasts and capacity utilization to avoid excess inventory. Lower production leads to lower future inventory and poor service level, reducing future customer demand.

Customer response to inventory availability, through the balancing and reinforcing feedbacks from the sales and production effects, affects the dynamic behavior of the model and the inventory and utilization policies adopted by the manufacturer. Influenced by the emphasis on lean production systems and just-in-time manufacturing, many firms attempt to maintain low inventory levels and run lean supply chains, allowing them to reduce inventory costs. However, the interaction of supply chain glitches and demand variability in companies faced with long manufacturing delays increases the likelihood of shortages and poor service level, reducing the attractiveness of lean inventory policies. Furthermore, adoption of a flexible capacity utilization policy to quickly reduce production when demand decreases can be detrimental if the demand decreases are caused by supply shortages and poor service levels. This research suggests that when customers respond to inventory availability, the supplier should maintain higher safety stock and reduce the responsiveness utilization to changes in customer demand. The model analyzed in this paper gives insights into the costs of lean inventory strategies and responsive utilization policies in the context of production systems with long delays subject to customer response.

RESEARCH SITE

The results reported here draw on a year-long, in-depth analysis of Intel Corporation's supply chain performed during 2000 and 2001. Intel's research in silicon, advanced process technology, and manufacturing has allowed them to achieve and maintain industry leadership in semiconductor manufacturing. Intel has consistently transitioned to processes that significantly reduce the line width of the metal circuits (e.g., from 0.18- to 0.15- to 0.13 and to 0.09-microns), allowing it to pack more chips per wafer. A line width of 0.09-microns allows Intel's microprocessors to contain some 330 million transistors. In parallel, the company has adopted larger silicon wafers. The new generation 300-millimeter (12-inch) diameter silicon wafer yields almost two and one-half times as many chips as the earlier generation 200-mm (8-inch) diameter wafers.