Faculty of Business &

Management Sciences
Subject Guide 2023
Post Graduate Diploma in Supply Chain Management
Subject: MVC580S
Managing the Value Chain Network
NQF LEVEL: 8
“ Chapter 6 - Lesson 8
Designing Global Supply Chain
Networks
”
 Designing Global
Supply Chain
Networks
LEARNING OBJECTIVES
 1. Identify factors that need to be included in total cost
when making global sourcing decisions.
 2. Define uncertainties that are particularly relevant when
designing global supply chains.
 3. Explain different strategies that may be used to mitigate
risk in global supply chains.
 4. Understand decision tree methodologies used to evaluate
supply chain design decisions under uncertainty.
 Designing Global
Supply Chain Networks
Globalization has offered tremendous opportunity as
well as increased risk in the development of supply
chains.
High-performance supply chains such as Nokia and Zara
have taken full advantage of globalization.
In comparison to several supply chains have found
themselves unprepared for the increased risk that has
accompanied globalization.
As a result, managers must account for both
opportunities and uncertainties over the long term
when designing a global supply chain network. In this
section, we identify sources of risk for global supply
chains, discuss risk mitigation strategies, detail the
methodologies used to evaluate network design
decisions under uncertainty, and show how they
improve global supply chain decisions
 Designing Global Supply
Chain Networks
THE IMPACT OF GLOBALIZATION ON SUPPLY CHAIN
NETWORKS
Globalization offers companies opportunities to
simultaneously grow revenues and decrease costs.
In its 2008 annual report, P&G reported that more than a
third of the company sales growth was from developing
markets with a profit margin that was comparable to
developed market margins.
By 2010, sales for the company in developing markets
represented almost 34 percent of global sales.
Similarly, Nokia’s two largest global markets in 2009, in
terms of net sales, were China and India. Sales in these
two countries represented almost 21.5 percent, and sales
in the BRIC countries (Brazil, Russia, India, and China)
represented more than 28 percent of Nokia’s global sales
in 2009.
Clearly, globalization has offered both P&G and Nokia a
significant revenue enhancement opportunity.
 Designing Global Supply Chain Networks
Attire and consumer electronics are two areas in which globalization has offered significant cost reduction
opportunities.
Consumer electronics focuses on small, lightweight, high-value items that are relatively easy and inexpensive
to ship.
Companies have exploited large economies of scale by consolidating production of standardized electronics
components in a single location for use in multiple products across the globe.
Contract manufacturers like Foxconn and Flextronics have become giants with facilities in low-cost countries.
Apparel manufacture has high labor content, and the product is relatively lightweight and cost effective to
transport.
Companies have exploited globalization by shifting much apparel manufacturing to low-labor-cost countries,
especially China.
One must keep in mind, however, that the opportunities from globalization are often accompanied by
significant additional risk.
In a survey conducted by the consulting company Accenture in 2006, more than 50 percent of the executives
surveyed believed that supply chain risk had increased as a result of their global operations strategy.
 Designing Global Supply Chain Networks
Crude oil spot price and exchange rate fluctuations in 2008 illustrate the extreme volatility that global supply
chains must deal with.
The only constant in global supply chain management seems to be uncertainty.
Over the life of a supply chain network, a company experiences fluctuations in demand, prices, exchange
rates, and the competitive environment.
A decision that looks good under the current environment may be quite poor if the situation changes.
Between 2000 and 2008, the euro fluctuated from a low of $0.84 to a high of almost $1.60.
Clearly, supply chains optimized to $0.84 per euro would have difficulty performing well when the euro
reached $1.60.
Uncertainty of demand and price drives the value of building flexible production capacity at a plant.
If price and demand do vary over time in a global network, flexible production capacity can be reconfigured to
maximize profits in the new environment
Designing Global Supply Chain Networks
The Accenture survey categorized risk in
global supply chains as shown in the Table
and asked respondents to indicate the
factors that affected them. More than a third
of the respondents were impacted by natural
disasters, volatility of fuel prices, and the
performance of supply chain partners.
 Designing Global Supply Chain Networks
THE OFFSHORING DECISION: TOTAL COST
This importance of comparative advantage in global supply chains was recognized by Adam Smith in The Wealth
of Nations when he stated, “If a foreign country can supply us with a commodity cheaper than we ourselves can
make it, better buy it of them with some part of the produce of our own industry, employed in a way in which
we have some advantage.”
Cost reduction by moving production to low-cost countries is typically mentioned among the top reasons for a
supply chain to become global.
The challenge, however, is to quantify the benefits (or comparative advantage) of offshore production along
with the reasons for this comparative advantage.
Whereas many companies have taken advantage of cost reduction through offshoring, others have found the
benefits of offshoring to low-cost countries to be far less than anticipated and in some cases nonexistent.
The increases in transportation costs between 2000 and 2011 have had a significant negative impact on the
perceived benefits of offshoring.
Companies have failed to gain from offshoring for two primary reasons
(1) focusing exclusively on unit cost rather than total cost when making the offshoring decision and
(2) ignoring critical risk factors. In this section, we focus on dimensions along which total landed cost
needs to be evaluated when making an offshoring decision.
 Designing Global Supply Chain Networks
The significant dimensions of total cost can be identified by focusing on the complete sourcing process when
offshoring. It is important to keep in mind that a global supply chain with offshoring increases the length and
duration of information, product, and cash flows. As a result, the complexity and cost of managing the supply
chain can be significantly higher than anticipated.
It is suggested that companies should evaluate the impact of off-shoring on the following key elements of total
cost:
1. Supplier price: should link to costs from direct materials, direct labor, indirect labor, management,
overhead, capital amortization, local taxes, manufacturing costs, and local regulatory compliance costs.
2. Terms: costs are affected by net payment terms and any volume discounts.
3. Delivery costs: include in-country transportation, ocean/air freight, destination transport, and packaging.
4. Inventory and warehousing: include in-plant inventories, in-plant handling, plant warehouse costs, supply
chain inventories, and supply chain warehousing costs.
5. Cost of quality includes cost of validation, cost of performance drop due to poorer quality, and cost of
incremental remedies to combat quality drop.
6. Customer duties, value added-taxes, local tax incentives
7. Cost of risk, procurement staff, broker fees, infrastructure (IT and facilities), and tooling and mold costs.
8. Exchange rate trends and their impact on cost.
 Designing Global Supply Chain Networks

The Table identifies dimensions along which

each of the three flows should be analyzed for
the impact on cost and product availability.
Dimensions to consider when evaluating total
cost of Offshoring
 Designing Global Supply Chain Networks
In general, offshoring to low-cost countries is likely to be most attractive for products with high labor content,
large production volumes, relatively low variety, and low transportation costs relative to product value.
Given that global sourcing tends to increase transportation costs, it is important to focus on reducing
transportation content for successful global sourcing. Suitably designed components can facilitate much greater
density when transporting products.
It is also important to perform a careful review of the production process to decide which parts are to be
offshored.
One of the biggest challenges with offshoring is the increased risk and its potential impact on cost. This
challenge gets exacerbated if a company uses an offshore location that is primarily targeting low costs to
absorb all the uncertainties in its supply chain
Key Point: It is critical that offshoring decisions be made accounting for total cost. Offshoring typically lowers
labor and fixed costs but increases risk, freight costs, and working capital. Before offshoring, product design
and process design should be carefully evaluated to identify steps that may lower freight content and the need
for working capital. Including an onshore option can lower the cost associated with covering risk from an
offshore facility.
 Designing Global Supply Chain Networks
RISK MANAGEMENT IN GLOBAL SUPPLY CHAINS
Global supply chains today are subject to more risk
factors than localized supply chains of the past.
These risks include supply disruption, supply delays,
demand fluctuations, price fluctuations, and
exchange-rate fluctuations.
As was evident in the financial crisis of 2008,
underestimating risks in global supply chains and not
having suitable mitigation strategies in place can
result in painful outcomes.
Supply Chain Risk to be considered during
network design
Good network design can play a significant role in
mitigating supply chain risk. For instance, having
multiple suppliers mitigates the risk of disruption from
any one supply source.
 Designing Global Supply Chain Networks
Global supply chains should generally use a combination of
mitigation strategies designed into the supply chain along with
financial strategies to hedge uncovered risks.
A global supply chain strategy focused on efficiency and low cost
may concentrate global production in a few low-cost countries.
Such a supply chain design is vulnerable to the risk of supply
disruption along with fluctuations in transportation prices and
exchange rates.
In such a setting, it is crucial that the firm hedge fuel costs and
exchange rates because the supply chain design itself has no
built-in mechanisms to deal with these fluctuations.
In contrast, a global supply chain designed with excess, flexible
capacity allows production to be shifted to whatever location is
most effective in each set of macroeconomic conditions.
The ability of such a flexible design to react to fluctuations
decreases the need for financial hedges.
Operational hedges such as flexibility are more complex to
execute than financial hedges, but they have the advantage of
being reactive because the supply chain can be reconfigured to
best react to the macroeconomic state of the world
Tailored Risk Mitigation Strategies during Network design
 Designing Global
Supply Chain
Networks
Flexibility, Chaining, and Containment Flexibility plays an
important role in mitigating different risks and uncertainties
faced by a global supply chain.
Flexibility can be divided into three broad categories—new
product flexibility, mix flexibility, and volume flexibility.
New product flexibility refers to a firm’s ability to introduce
new products into the market at a rapid rate.
New product flexibility is critical in a competitive
environment wherein technology is evolving, and customer
demand is fickle.
New product flexibility may result from the use of common
architectures and product platforms with the goal of
providing a large number of distinct models using as few
unique platforms as possible.
 Designing Global Supply Chain Networks
Mix flexibility refers to the ability to produce a variety of products
within a short period of time.
Mix flexibility is critical in an environment wherein demand for
individual products is small or highly unpredictable, supply of raw
materials is uncertain, and technology is evolving rapidly.
The consumer electronics industry is a good example in which mix
flexibility is essential in production environments, especially as
more production has moved to contract manufacturers.
Modular design and common components facilitate mix flexibility.
Zara’s European facilities have significant mix flexibility, allowing
the company to provide trendy apparel with highly unpredictable
demand.
Volume flexibility refers to a firm’s ability to operate profitably at
different levels of output.
Volume flexibility is critical in cyclical industries.
Firms in the automotive industry that lacked volume flexibility were
badly hurt in 2008 when demand for automobiles in the United
States shrank significantly
Designing Global Supply Chain
Networks
Given that some form of flexibility is often used to mitigate
risks in global supply chains, it is important to understand
the benefits and limitations of this approach. When dealing
with demand uncertainty.
Key Point - Appropriate flexibility is an effective approach
for a global supply chain to deal with a variety of risks and
uncertainties. Whereas some flexibility is valuable, too
much flexibility may not be worth the cost. Strategies like
chaining and containment should be used to maximize the
benefit from flexibility while keeping costs low
 Designing Global Supply Chain Networks
DISCOUNTED CASH FLOWS
Global supply chain design decisions should be evaluated as a sequence of cash flows over the duration of time
they will be in place. This requires the evaluation of future cash flows accounting for risks and uncertainties
likely to arise in the global supply chain.
EVALUATING NETWORK DESIGN DECISIONS USING DECISION TREES
In any global supply chain, demand, prices, exchange rates, and several other factors are highly uncertain and
are likely to fluctuate during the life of any supply chain decision. In an uncertain environment, the problem
with using a simple DCF (Discounted Cash Flow) analysis is that it typically undervalues flexibility.
The result is often a supply chain that performs well if everything goes according to plan but becomes terribly
expensive if something unexpected happens.
A manager makes several different decisions when designing a supply chain network.
For instance:
 Should the firm sign a long-term contract for warehousing space or get space from the spot market as
needed?
 What should the firm’s mix of long-term and spot market be in the portfolio of transportation capacity?
 How much capacity should various facilities have? What fraction of this capacity should be flexible?
Designing Global Supply Chain Networks

If uncertainty is ignored, a manager will always sign long-term contracts (because they are typically
cheaper) and avoid all flexible capacity (because it is more expensive).

Such decisions, however, can hurt the firm if future demand or prices are not as forecast at the time of the
decision.

During network design, managers thus need a methodology that allows them to estimate the uncertainty in
their forecast of demand and price and then incorporate this uncertainty in the decision-making process.

Such a methodology is most important for network design decisions because these decisions are hard to
change in the short term.

In this section, we describe such a methodology and show that accounting for uncertainty can have a
significant impact on the value of network design decisions
 The Basics of Decision Tree Analysis - A decision tree is a graphic
device used to evaluate decisions under uncertainty. Decision trees
with DCFs can be used to evaluate supply chain design decisions
given uncertainty in prices, demand, exchange rates, and inflation.
The decision tree analysis methodology is summarized as follows:
1. Identify the duration of each period (month, quarter, etc.) and
the number of periods T over which the decision is to be
Designing 2.
evaluated.
Identify factors such as demand, price, and exchange rate
Global Supply whose fluctuation will be considered over the next Time
periods.

Chain 3. Identify representations of uncertainty for each factor; that is,

determine what distribution to use to model the uncertainty.

Networks 4. Identify the periodic discount rate for each period.

5. Represent the decision tree with defined states in each period
as well as the transition probabilities between states in
successive periods.
6. Starting at time period, work back to Period 0, identifying the
optimal decision and the expected cash flows at each step.
7. Expected cash flows at each state in a given period should be
discounted back when included in the previous period
 Designing Global Supply Chain Networks
Evaluating Flexibility at Trips Logistics
We illustrate the decision tree analysis methodology by using the lease decision facing the general manager at
Trips Logistics.
The manager must decide whether to lease warehouse space for the coming three years and the quantity to
lease.
The long-term lease is currently cheaper than the spot market rate for warehouse space.
The manager anticipates uncertainty in demand and spot prices for warehouse space over the coming three
years.
The long-term lease is cheaper but could go unused if demand is lower than anticipated.
The long-term lease may also end up being more expensive if future spot market prices come down.
In contrast, spot market rates are high and warehouse space from the spot market will be expensive if future
demand is high.
The manager is considering three options:
 Get all warehousing space from the spot market as needed.
 Sign a three-year lease for a fixed amount of warehouse space and get additional requirements from the
spot market.
 Sign a flexible lease with a minimum charge that allows variable usage of warehouse space up to a limit
 Designing Global Supply
Chain Networks
Evaluating the Spot Market Option, The manager first
analyzes the option of not signing a lease and obtaining all
warehouse space from the spot market.
Evaluating a fix Lease option
Evaluating a flexible Lease option
Key Point - Uncertainty in demand and economic factors
should be included in the financial evaluation of supply chain
design decisions. The inclusion of uncertainty typically
decreases the value of rigidity and increases the value of
flexibility.
 Designing Global Supply Chain Networks
MAKING GLOBAL SUPPLY CHAIN DESIGN DECISIONS UNDER UNCERTAINTY IN PRACTICE
Managers should consider the following ideas to help them make better network design decisions under
uncertainty.
Combine strategic planning and financial planning during global network design.
In most organizations, financial planning and strategic planning are performed independently.
Strategic planning tries to prepare for future uncertainties but often without rigorous quantitative analysis,
whereas financial planning performs quantitative analysis but assumes a predictable or well-defined future.
This chapter presents methodologies that allow integration of financial and strategic planning.
Decision makers should design global supply chain networks considering a portfolio of strategic options—the
option to wait, build excess capacity, build flexible capacity, sign long-term contracts, purchase from the spot
market, and so forth.
The various options should be evaluated in the context of future uncertainty
 Designing Global Supply Chain Networks
Use multiple metrics to evaluate global supply chain networks.
As one metric can give only part of the picture, it is beneficial to examine network design decisions using
multiple metrics such as firm profits, supply chain profits, customer service levels, and response times.
Good decisions perform well along most relevant metrics
Use financial analysis as an input to decision making, not as the decision-making process.
Financial analysis is a great tool in the decision-making process, as it often produces an answer and an
abundance of quantitative data to back up that answer.
However, financial methodologies alone do not provide a complete picture of the alternatives, and other
nonquantifiable inputs should also be considered.
Use estimates along with sensitivity analysis.
Many of the inputs into financial analysis are difficult, if not impossible, to obtain accurately. This can cause
financial analysis to be a long and drawn-out process. One of the best ways to speed the process along and
arrive at a good decision is to use estimates of inputs when it appears that finding an accurate input would
take an inordinate amount of time. A