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Simulation of Retail Supply Chain Behaviour and Financial Impact in an Uncertain Environment K. Cha-ume and N. Chiadamrong* School of Manufacturing Systems and Mechanical Engineering Sirindhorn International Institute of Technology Thammasat University, Pathumthani, Thailand, 12121 e-mail: navee@siit.tu.ac.th *Corresponding author Abstract: Traditionally, attention has been focused on uncertainty in customer demand. However, uncertainty is also inherent in the market on the supply side, because the quantity and quality of raw materials delivered from external suppliers may differ from those requested. This paper quantifies the financial impact of having uncertainty in a retail supply chain. Having unstable inventory records leads to profit losses in a supply chain. These inventory records may not be correct due to various causes such as transaction errors, misplacement, etc. These inaccuracies are caused by the uncertainties in customer demand, parts supply, and variations in the process itself. The aim of this paper is to examine the relationship between inventory inaccuracy and financial performance. The results indicate that each type of uncertainty can have different impacts on the chain, and the elimination of uncertainty can more or less reduce supply chain costs and hence increase profit. Keywords: Uncertainty, Financial impact, Retail supply chain, Information inaccuracy, Simulation Reference to this paper should be made as follows: Cha-ume, K. and Chiadamrong, N. (201x) Simulation of Retail Supply Chain Behaviour and Financial Impact in an Uncertain Environment, Int. J. Logistics Systems and Management, Vol. x, No. x, pp. xx-xx. Biographical notes: Navee Chiadamrong is an associate professor at the School of Manufacturing Systems and Mechanical Engineering, Sirindhorn International Institute of Technology, Thammasat University, Thailand where he teaches and researches in the area of production planning and control methods and supply chain management. He received his Msc. Degree in Engineering Business Management from Warwick University and PhD in Manufacturing Engineering and Operations Management from University of Nottingham, UK. Some of his recent articles have appeared in International Journal of Production Economics, Computer and Industrial Engineering, International Journal of Manufacturing Technology and Management, European Journal of Industrial Engineering and TQM & Business Excellence. Kamolwon Cha-ume received her engineering degree in Industrial Engineering from Sirindhorn International Institute of Technology, Thammasat University, Thailand and her Msc. Degree in Supply Chain and Logistics Management from Warwick University, UK. She is currently PhD student at the Sirindhorn International Institute of Technology, Thammasat University. Her main research interests include collaboration and information sharing in supply chains and lateral transhipment problems.

1. Introduction In the modern business world, considerable emphasis has been placed on Supply Chain Management (SCM). A supply chain is generally viewed as a network of facilities linked or coordinated by the flow of goods and services from suppliers through production to end customers with an information flow through the network (Shahabuddin, 2011). Three subsystems are recognizable in the supply chain: procurement, production, and distribution subsystems (Petrovic et al., 1998). They are interrelated in a way that decisions made at one of the subsystems affect performance of the supply chain as a whole. In recent time, many companies focus only on improving their own supply chians performance to maximize their customer benefit without emphasizing on benefits to others players in the supply chain. Only if companies start focusing on the entire supply chain, can they realize maximum efficiency of a whole (Azadeh et al., 2011). Shahabuddin (2011) has stated that the purpose of the supply chain is to create value for customers by requiring all participants in the supply chain to work together in order to reduce the amount of inventory and facilitate a smooth flow of goods from the source to the end customer. As a result of this coordination, all the participants will be benefited. Currently many companies are faced with an increasing in risk exposure. This is mainly caused by a greater dependence between supply chain partners. (Kersten et al., 2011). To be competitive, the improvements in logistics and supply chain management are essential for all businesses (Diaz et al., 2011). One of the reasons why supply chain management is such a critical area of business is because there are many risks and uncertainties that can pose a serious threat to the integrity of the business. The collapse or inability to function of the supply chain can lead to disastrous results, and it is best that this is averted by any means possible (Merschmann, 2010). Therefore, in order to succeed in supply chain management, the understanding and assessment of these risks and uncertainties are the fundamental steps (Ganguly et al., 2011). 2. Literature Review A great deal of research has been done in the area of supply chain dynamics. A widely used approach to study supply chain dynamics has been based on the system dynamics methodology (Forrester, 1961; Towill, 1991; Sterman, 2000; Sodhi, 2001). This dynamic model is a deterministic mathematical description of the supply chain, which is then used to simulate supply chain dynamic behaviour. Another approach used to study supply chain dynamics has been based on modelling a supply chain as a discrete event system (Banks et al., 2002). Results of interesting research have been reported in Southall et al. (1988) in which their model has included uncertainty in customer demand and factory lead time, which followed specified probability distributions. Effects of a step wise change in customer demand were simulated. In a supply chain, there are many aspects and operations that are susceptible to uncertainty. Supply chain uncertainty can be defined as factors that cannot be controlled or eliminated in the operation of a supply chain. This uncertainty cannot be measured or forecasted with accuracy but can yield positive results. However, due to globalization of customers, companies need to be flexible and more adaptive enough to satisfy more demanding customers as well as provide a high service level for customers (Swafford et al., 2004). The concept of uncertainty has been defined in various ways by several studies (Duncan, 1972). Decision theorists define uncertainty as the situation where the probability of the outcome of

an event is unknown, as opposed to a risk situation where each outcome has a calculated probability (Luce and Raiffa, 1957). Lawrence and Lorsch (1967) and Duncan (1972) viewed uncertainty as consisting of three components: (1) a lack of information regarding the environmental factors associated with a given decision-making situation; (2) not knowing the outcome of a specific decision in terms of how much the organization would lose if the decision were incorrect; and (3) inability to assign any degree of confidence, as to how environmental factors are going to affect the success or failure of a decision unit in performing its function. Applying these definitions to the contexts of a supply chain, the uncertainty occurs when information becomes unreliable for effective decision-making or prediction of the outcome of a decision. This uncertainty also occurs when there are unpredictable changes in the system. Uncertainties in parameters in supply chain management and control problems have been treated as stochastic processes and described by probability distributions. A probability distribution is usually derived from evidence recorded in the past. This requires a valid hypothesis that evidence collected is complete and unbiased, and that the stochastic mechanism generating the recorded data continues in force on an unchanged basis. However, there are situations where not all these requirements are satisfied, and therefore, the conventional probabilistic reasoning methods are not appropriate. For example, there may be a lack of evidence available or lack of confidence in evidence, or simply evidence may not exist, as in the case of launching a new product. In these situations, uncertainties in parameters can be specified based on managerial experience and subjective judgement. It has long been theorized that there is a relationship between variability and performance (Bhatnagar and Chandra, 1994). Deming (1986) went so far as to propose that the key aim of management is to control variability in order to ultimately lower costs. Moreover, Dellino et al. (2010) suggested that an effective way to optimize simulated systems involves using Taguchi's worldview to separate decision variables that are to be optimized, and uncertain environmental variables that affect the optimum. The general operations management theory of swift, even low argues that reduced variance in materials flow and operational activities contribute to improved performance (Schmenner and Swink, 1998). The more consistent the flow of materials, the more productive processes should be, and this implies improved financial performance (Germain et al., 2001). The importance of financial decision in supply chain management has been highlighted by many researchers (Shapiro, 2004; Hammami et al., 2008; Papageorgiou, 2009) especially as a crucial part of global supply chain, being significant to its configuration (Melo et al., 2009). Treating uncertainty is an important issue in supply chain modelling and analysis of supply chain behaviour and performance (Petrovic, 2001). According to Van der Vorst and Beulens (2002), supply chain uncertainty refers to a decision making situation in the supply chain in which the decision maker does not know definitely what to decide, as he is unclear about the objectives: lack of information about its environment or the supply chain, lack information processing capacity, is unable to accurately predict the impact of possible control actions on supply chain behavior, or lacks effective control actions. Different sources of uncertainty in a supply chain can exist, encompassing suppliers, production/manufacturing processes and customers. Davis (1993) also identified three distinct sources of uncertainty in supply chains: supply uncertainty, process uncertainty, and demand uncertainty. Supply uncertainty is caused by the variability of supplier performance due to late or defective deliveries. Process uncertainty results from the unreliability of the

production process due to machine breakdowns. Finally, demand uncertainty, which according to Davis (1993) is the most serious of the three, arises from volatile demand or inaccurate forecasts. In fact, these uncertainties may be different in nature, caused by random events, imprecision in judgment, lack of evidence available, or lack of certainty in evidence. However, speaking of different types of demand uncertainty, the double probabilistic setting should be taken into account. De Rocquigny et al. (2008) has proposed that there are two components of the double probabilistic setting: epistemic and aleatory uncertainty. The epistemic uncertainty refers to sampling the mean of uncertainty, but the aleatory uncertainty is instead sampling the demand for an appropriate mean. Helton (2009) proposed that the aleatory uncertainty arises from an inherent randomness in the properties or behaviour of the system under study while the epistemic uncertainty derives from a lack of knowledge about the appropriate value to use for a quantity that is assumed to have a fixed value in the context of a particular analysis. Supply chain inventory management decisions also depend on inventory data gathered from automated or manual control systems. As a result of advances in information technologies, companies started to automate their inventory management processes and use inventory management software (Lee and Ozer, 2005). Although the use of Information Technology (IT) has made collecting and storing data about the flow of items through a supply chain easier and less expensive, the tracking of inventory remains prone to error. The data collected may not be accurate due to various reasons: incorrect product identification, transaction errors, inaccessibility of items due to improper usage of the depot, misplacement of items, shrinkage, etc. These may result in two problems: unplanned inventory depletion, and addition. If the inventory records do not agree with the actual physical stock, either an order may not be placed in time or excessive inventory is held. Kang and Gershwin (2005) reported inventory accuracies of a global retailers stores. It is seen that the inventory accuracy is only 51% on average for 500 stores. In other words, the stores have accurate records for only about a half of the SKUs (Stock Keeping Units). The best performing store in the study knows its actual inventory with only 75-80% accuracy. Raman et al. (2001) reported similar findings for a leading retailer. Almost 370,000 SKUs were investigated for the retailer. It was concluded that more than 65% of the inventory records do not match with the physical inventory. 3. Simulation Optimization In this study, the simulation and optimization procedure are completed by using ARENA commercial software and the OptQuest tool. Like all practical simulation optimization methods, the OptQuest is also an iterative heuristic (Kleijnen, 2008). It can be used to utilize a combination of three meta-heuristics: Scatter Search (SS), Tabu Search (TS), and Neural Networks (NN) (Glover et al., 1999; Keskin 2010). An example of successful application of scatter search within OptQuest is reported by Bulut (2001) to solve a multiscenario optimization problem based on a large-scale linear programming model. The OptQuest package can also be used to combine with other simulation software systems (Kleijnen, 2008). It requires the specifications of lower and upper values for the input variables that are to be optimized. Moreover, it requires the selection of the (random) simulation output that is the goal or objective variable to be maximized. In our problem, we select the maximization of the whole chains profit as an objective. The OptQuest also allows the user to explicitly define integer and linear constraints on the deterministic simulation inputs. In joining a chain, it should be guaranteed that all members are better off by creating a

win-win situation for all members. As a result, the non-negativity constraints to guarantee that all members must at least gain profit (profit of each member 0) were also set in the study. The interest in simulation optimization is to find which of a large number of sets of model specifications have led to the optimal output performance (Vaghe et al., 2009). For analyzing complex systems, such as our case, the objective functions are not expressed as explicit functions of the input parameters; rather they normally involve some performance measures of the system whose accurate values can be found only by running the simulation model. Simulation optimization is defined as the process of finding the values for the input variables, such that an expected system performance from stochastic simulation is optimized (Kleijnen, 1987, 2008; Swisher et al., 2000; Fu, 2002; Law 2007). 4. Basic Model Assumptions An illustrative case of having uncertainty in a retail supply chain, consisting of three retailers and a manufacturer, is studied. This is to gain a better understanding of the retail supply chain dynamic behaviour and performance in the presence of various sources and types of uncertainty. Assumptions concerning the system operations are as follows: - Retailers are differentiated by different standard deviations of the customers inter-arrival times under the same value of mean (2 hours). A normal distribution with a mean of 2 hours and 25%, 50%, and 75% of its mean set to be the standard deviation is used for Retailer 1, Retailer 2, and Retailer 3, respectively. This is considered to be the aleatory uncertainty, which is inherent randomness in the retailers demand. - The inventory in each retail shop is controlled based on a periodic review policy. The maximum target stock level of each retailer (TSL) is set up periodically to a certain level, which is optimized by the OptQuest. - End customer demand is fulfilled from the shops inventory. When demand exceeds the available stock, unmet demand is considered to be shortages, and penalty costs are incurred. - The manufacturer is assumed to know the retailers demand in the base case for eight weeks in advance, in which the manufacturer uses this information to update its ordering and production plan for the finished products using the Wagner-Within algorithm with an 8 weeks rolling planning horizon. The plan will be updated each time before producing a new batch of production. A built-in Visual Basic sub-model was written and interfaced with the main ARENA simulation model to generate the rolling production plans of the manufacturer. At this point, the uncertainty in customer demand has no effect on changing the pattern of the calculated plans. - Replenishment quantities for each inventory are received within a given, planned lead time. The lead time includes the time necessary for order processing, production, and transportation. 5. System Configuration Figure 1 shows the scope of the simulated retail supply chain. The whole chain consists of three retailers and one manufacturer, whereas the supplier of the manufacturer is not included in the study. Three retailers place orders to the manufacturer at the end of each week, to refill their stock up to individual maximum stock keeping levels or target stock level (TSL). After a constant delivery lead time of 2 days, the ordered units will arrive at the retailers. At this

point, we are setting different levels of variation in demand, supply, and process to study their effects that may occur in the supply chain system.

Customer Demand (Inter-arrival time of customers)

Figure 1: Overview of the studied retail supply chain 5.1. Epistemic Uncertainty in the system There are three types of epistemic uncertainty in the system which are: demand, supply, and process uncertainties. The demand uncertainty is represented by the uncertainty of the rate of customer arrival at the shop. This represents inaccuracy caused by the accuracy of demand forecasting. The supply uncertainty is represented by the uncertainty of the product delivery lead time. This inaccuracy is caused by an uncertainty in logistics operations. Finally, the process uncertainty is represented by the uncertainty of the delivering product quantity to the shops which is called a missed quantity. This missed quantity may be caused by the lack of coordination among a supply chains members. It encompasses the inconsistency in product flows into, and out of, the shop, as well as internal variability, such as misplaced items or even theft during the delivery. In all three types of uncertainty, there are two levels of effects, low and high, that will be investigated. At the low level, the mean can be varied within a range of 25% (swinging on both sides with an equal chance from the base cases mean), and in the high level, the mean can vary in the range of 50%. For example, in the case of a low level of the demand uncertainty, the variation on the mean is introduced by the expression of the uniform (2*0.75, 2*1.25) = uniform (1.5, 2.5) as can be seen from Figure 2. At the low level of demand uncertainty for Retailer 1, the mean inter-arrival time of customers will follow the uniform distribution varying from 1.5 to 2.5. As the variation of the customers demand follows the normal distribution, the inter-arrival times of the customers at Retailer 1, Retailer 2, and Retailer 3 are normally distributed with the mean stated above and 25%, 50%, and 75% of the mean being set for its standard deviation.

Figure 2: Epistemic uncertainties in demand, supply and process 5.2. Objective Function and Financial Performance Measures In this section, the objective function, financial performance measures and their notations will be introduced. Notations Sm Sr Om Or Cm Cr ns(m) = Selling price of manufacturer ($/unit) = Selling price of retailers ($/unit) = Ordering cost of manufacturer ($/order) = Ordering cost of retailers ($/order) = Production cost of manufacturer ($/unit) = Operating cost of retailers ($/unit per unit time) = Sales volume of manufacturer (units)

ns( rm

= Sales volume of retailer i (units) = Number of orders of manufacturer (orders) = Number of orders of retailer i (orders) RMm = Raw material cost of manufacturer ($/unit) RMr = Raw material cost of retailers ($/unit) hm = Holding cost of parts per unit time at manufacturer ($/unit per unit time) hr = Holding cost of parts per unit time at retailers ($/unit per unit time) Pm = Penalty cost of manufacturer ($/unit) Pr = Penalty cost of retailers ($/unit) n RM(m) = Number of raw materials purchased by manufacturer (units) = Number of raw materials purchased by retailer i (units) tm = Average holding time of parts at manufacturer (unit time) = Average holding time of parts at retailer i (unit time) = Operating time duration of retailer i (unit time) n(m)miss = Number of lost sales at manufacturer (units) n ( )miss = Number of lost sales at retailer i (units) ai = Average number of units in the shop of retailer i (units)
)

5.2.1. Objective Function and Constraints Maximize Profit of the whole chain = Manufacturer profit + (Retailer 1s profit + Retailer 2s profit + Retailer 3s profit) where Manufacturer Profit = Sales Total Costs = Sales (RM Cost + Ordering Cost + Production Cost + Holding Cost + Transportation Cost + Penalty Cost)

where Sales is calculated from a selling price per unit (Sm) multiplied with the sales volume (ns(m)). Sm x ns(m) (1). RM Cost is calculated from a raw material cost per unit (RMm) multiplied with the number of purchased raw material (n RM(m)). RMm x n RM(m) (2). Ordering Cost is the cost incurred when the manufacturer places an order for raw materials. It is calculated from the ordering cost (Om) multiplied with the total number of orders (rm) made by the manufacturer. In some instances, the manufacturer may take responsibility to deliver the ordered product itself and the transportation is also charged per order. So, the transportation cost is included in the ordering cost in this study. Om x rm (3). Production Cost is calculated from a conversion cost per unit (Cm) multiplied with the number of purchased raw material (nRM(m)). Cm x nRM(m) (4).

Holding Cost is calculated from the holding cost of a unit per unit time at the manufacturer (hm) multiplied with the number of purchased raw material (nRM(m)), and multiplied by the average holding time of parts at manufacturer (tm). hm x nRM(m) x tm (5). Penalty Cost is the cost incurred when the manufacturer fails to satisfy the retailer demand. It is calculated from the penalty cost per unit (Pm) multiplied with the number of lost sales
(n(m)miss). Pm x n(m)miss

(6). (7).

Hence, Manufacturer Profit is calculated by:

Sm x ns(m) - (RMm x n RM(m) + Om x rm + Cm x nRM(m) + hm x nRM(m) x tm + Pm x n(m)miss)

And for:

Retailers Profit = Retailer 1s profit + Retailer 2s profit + Retailer 3s profit = Sales Total Costs = (Sales) (RM Cost+ Ordering Cost + Operating Cost + Holding Cost + Penalty Cost)

where Sales is calculated from a selling price per unit (Sr) multiplied with the sales volume for each retailer ( ) 3 Sr ( ) (8).
i 1

RM Cost is a raw material cost per unit (RMr) multiplied with the number of purchased raw materials from the manufacturer for each retailer ( ) 3 RMr i 1 (9).

Ordering Cost is the cost incurred when the retailer places an order. It is calculated from the total number of ordering cost ( ) multiplied with the number of orders for each retailer ( ). Similar to the manufacturer case, the retailers take a responsibility to deliver the products themselves. As a result, the ordering cost also includes the transportation cost.

r
i 1

(10).

Holding Cost is the cost of holding products in the shop. It is calculated from the holding cost of a unit per unit time for each retailer (hr) multiplied with the number of units held ( ) and multiplied by the average holding time of parts at each retailer (t ).
3

hr
i 1

x t

(11).

Operating Cost is the cost of operating the retailer shop. It is calculated from the operating cost of a unit per unit time (Cr) multiplied with the average number of units held in the shop (ai) and multiplied with the operating time duration of each retailer ( ).

i 1

(12).

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Penalty Cost is the cost incurred when the retailer fails to satisfy the demand. It is calculated from the penalty cost per unit (Pr) multiplied with the number of lost sales at each retailer (n ( )miss). Pr n (
i 1 3

)miss

(13). x t + Cr ai
i 1 3

Hence, Retailer Profit is calculated by: 3 3 3 3 Sr n3 + r + hr s( ) - (RMr i 1 i 1 i 1 i 1 + Pr n ( )miss)

i 1

(14).

Non-negativity constraints: Manufacturers profit Retailer 1s profit Retailer 2s profit Retailer 3s profit 5.3 Decision Variables There are three decision variables in the model, which are the target stock levels at Retailer 1, Retailer 2 and Retailer 3. These variables will be searched for their optimal setting by the OptQuest. The lower and upper bounds of the searching boundary in each variable are guaranteed to be large enough to ensure that the optimal setting falls inside the boundary. 5.4 Parameter Values (costs, prices, etc.) The following cost structure is used throughout our experiment. It is in line with the cost structure of day to day convenience goods sold in general convenience stores in practice. Even though, this cost structure can affect the findings, the sensitivity analysis of some cost parameters, as they are usually not reported, is another area where further study is needed. In fact, a spread sheet file in MS Excel was built in this study as a means to input the cost structure. When a new cost structure is proposed, a new finding can easily be presented. Manufacturer Selling price RM cost Holding cost Penalty cost Production cost Ordering cost Retailer Selling price Holding cost Penalty cost Operating cost Ordering cost = $20/unit = $5/unit = $0.16/unit per week ( 40% of selling price per year) = $20/unit = $5/unit = $ 250/order 0 0 0 0

= $50/unit = $0.40/unit per week ( 40% of selling price per year) = $50/unit = $2/unit per week = $250/order

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5.5. Steady-state Conditions Ten replications were simulated with 360 days per replication after an initial warm-up period of 180 days. Based on 10 replications, a 95% confidence interval for the throughput has a width less than 1.5% of its mean. The warm-up run of 180 days proved sufficient to generate stable estimates of the steady-state results. 6. Results Table 1 shows the list of abbreviations of the models under the study. The Tukey comparison test is used to compare the means of cost among the interested models, that is, it applies simultaneously to the set of all pairwise comparisons and identifies where the difference between two means is greater than the standard error would be expected to allow. The results can be presented as follows: Table 1: Model abbreviations Model LD HD LL HL LM HM Meaning Model with LOW level of DEMAND uncertainty Model with HIGH level of DEMAND uncertainty Model with LOW level of LEAD TIME uncertainty Model with HIGH level of LEAD TIME uncertainty Model with LOW level of MISSED QUANTITY uncertainty Model with HIGH level of MISSED QUANTITY uncertainty

6.1. Effect of Aleatory Uncertainty The retailers are differentiated by the different variations of the customers inter-arrival time while keeping the same mean (2 hours) at each retailer. In summary, the aleatory uncertainty was presented by setting the distribution of the customer inter-arrival time of Retailer 1, Retailer 2 and Retailer 3 following the normal distribution with the mean equal to 2 minutes while the standard deviation is 0.5, 1, and 1.5 minutes, respectively. After, optimizing the base model without epistemic uncertainty by the OptQuest, the result of the optimized target stock levels are shown in Table 2 where Retailer 3, who has the largest demand variation, shows to have the highest target stock level as expected. Please note that the base case is referred to the case without epistemic uncertainty, but there is aleatory uncertainty from setting different inherent randomness in Retailer 1, Retailer 2, and Retailer 3. Table 2: Optimized Target Stock Level from OptQuest Retailer 1 (units) Retailer 2 (units) Retailer 3 (units) Base Case 114 117 120

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Table 3 shows financial performance measures of the retailers under the base case. The presented numbers are the averaged costs per replication (from 10 replications). It was found that Retailer 3, who has the largest demand variation, has the worst financial performance. The reason for the lower profitability of Retailer 3 in relation to Retailer 1 and Retailer 2 is due to a reduction of revenue as well as an increase in operating, holding and penalty costs. It can be seen that the variation in demand has an inverse effect on the profitability. This basically stemmed from the normal distribution created demand (inter-arrival time) of customers of Retailer 3, which has the largest variance as compared to those of Retailer 1 and Retailer 2. Table 3: Financial performance measures of the retailers under the base case
Retailer (i) Retailer 1 (R1) Retailer 2 (R2) Retailer 3 (R3) Revenue ($) 216,035.00 215,115.00 210,230.00 Profit ($) 111,008.05 109,987.56 106,558.26 Holding cost ($) Operating cost Reorder Cost RM Cost ($) ($) ($) 986.09 4,795.86 12,850.00 86,370.00 1,055.01 5,131.43 12,850.00 85,996.00 1,144.88 5,568.86 12,850.00 84,018.00 Penalty Cost ($) 25.00 95.00 90.00

6.2. Effect of Epistemic Uncertainties The profits of all members and the whole chain were investigated to find which epistemic uncertainty may cause a greater impact on the profits. The obtained optimized target stock levels of each scenario from the OptQuest can be seen in Table 4. Table 4: Optimized Target Stock Levels of each scenario from OptQuest
Scenario Base Case LD LL LM HD HL HM Retailer 1 (units) Retailer 2 (units) Retailer 3 (units) 114 118 117 104 142 121 105 117 123 120 105 122 123 104 120 124 121 108 118 124 100

It was found that when there is demand and supply uncertainty, the retailers have tried to protect the effect of uncertainty by keeping higher inventories through setting a higher target stock level, as compared to the base case. But a lower target stock level (keeping less inventories) was suggested when there is process uncertainty. This is since there is a chance that extra stock could be delivered in the future, and those exceeding inventories may not be sold. In addition, the trend of optimal target stock level of the base case and the models with a low level of uncertainty in demand, supply, and process keeps increasing as the variation of the customer demand of Retailer 1, Retailer 2, and Retailer 3 increases. This is to prevent possible lost sales when there is more uncertainty in the system.

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When the uncertainty is set to the high level except for the case of high supply uncertainty (in which the uncertainty in lead time shows the least significant effect), the trend of the target stock levels of Retailer 1, Retailer 2, and Retailer 3 shows a decrease due to the fact that the variation of the customers demand for Retailer 1, Retailer 2, and Retailer 3 increases. From a detail analysis where we managed to swing the uncertainties in the demand and process half way (either swing up or swing down), it was found that, there are two possible outcomes. The first outcome results in having less inventory, as the demand and process uncertainties only set to swing down (- 25% or -50%). With this case, the trend of the optimal target stock levels of Retailer 1, Retailer 2, and Retailer 3 shows an increase similar to the base case, due to a higher inherent aleatory uncertainty of each retailer. On the contrary, with the case of having more inventories as the demand and process uncertainties only set to swing up (+25% or +50%), the retailer is advised to keep less inventory (setting lower target stock level) as the uncertainty increases. This is because there is a high chance that the kept inventory may not be sold. Therefore, it is more profitable to keep less inventories in the shop. Table 5: Profits in the retail supply chain

The profits of the whole chain and each member under different scenarios of uncertainty are presented in Table 5. Having applied various uncertainties in the models to investigate their effects under the optimal setting conditions of the interested parameters (target stock level of the retailers), it was found that the uncertainties cause a negative impact on the whole chains profit, and a higher level of uncertainty can cause more or less even more severe negative impact. For example, as shown in Table 5, for the model with a low level of demand uncertainty (LD), the profit of the whole chain is reduced by 2.53% in relation to the base cases profit, while for the model with a high level of demand uncertainty (HD), the profit is reduced up to 12.41%.

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Demand Uncertainty
500,000.00 450,000.00 400,000.00 350,000.00 300,000.00 250,000.00 200,000.00 150,000.00 100,000.00 50,000.00 Base Case LD HD

Profit ($)

Manufacturer's Profit ($) Retailers' Profit ($) Whole Chain's Profit ($)

Supply Uncertainty
500,000.00 450,000.00 400,000.00 350,000.00 300,000.00 250,000.00 200,000.00 150,000.00 100,000.00 50,000.00 Base Case LL HL

Profit ($)

Manufacturer's Profit ($) Retailers' Profit ($) Whole Chain's Profit ($)

Process Uncertainty
500,000.00 450,000.00 400,000.00 350,000.00 300,000.00 250,000.00 200,000.00 150,000.00 100,000.00 50,000.00 Base Case LM HM

Profit ($)

Manufacturer's Profit ($) Retailers' Profit ($) Whole Chain's Profit ($)

Figure 3 : Profits of each retailer and the whole chain under each type of uncertainty From Figure 3, it can also be noticed that the demand and process uncertainties (missed quantity) show negative effects on the supply chain profitability. The demand uncertainty demonstrates a significant effect on the whole chain and particularly on the retailers profit, but no significant change in the manufacturers profit. This is due to the fact that the manufacturer always sets its production 8 weeks in advance due to a retailers demand

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without epistemic uncertainty. As a result, when there is the demand uncertainty, it does not show any effect on the manufacturers production plan. In fact, as the uncertainty in demand swings both up and down, it does not show much effect on the manufacturers profit. However, in the case of process uncertainty, there is a negative effect for all members and the whole chain. This is due to the difference between the number of units ordered and actual units delivered from the manufacturer. When the process uncertainty swings up, more excessive units are delivered from the manufacturer but when the process uncertainty swings down, some delivered units are presumably lost during the delivery. The supply uncertainty (lead time) fails to show a significant change in retailers, manufacturer, or the whole supply chain profits under each optimal target stock level condition providing that it is varied up to 50% from the normal level. A Tukey comparison test of each members profit is also shown in Figure 4. This is to rank the profits under uncertain conditions from maximum to minimum as compared to the base case where there is no epistemic uncertainty. Please note again that underlined models denote models that cannot distinguish their profits under a 95% C.I. The Tukey comparison test results also confirm that there is no significant impact of lead time uncertainty on profits as compared to other uncertainties. 1) Result from Tukey 95% C.I. comparison of the Manufacturers Profit
Demand uncertainty LD Base HD Supply uncertainty LL Base HL Process uncertainty Base LM HM

2) Result from Tukey 95% C.I. comparison of the Retailers Profit

Demand uncertainty Base LD HD Supply uncertainty Base LL HL Process uncertainty Base LM HM

3) Result from Tukey 95% C.I. comparison of the Whole Chains Profit
Demand uncertainty Base LD HD Supply uncertainty Base LL HL Process uncertainty Base LM HM

Note: Profits are ranked from maximum to minimum Figure 4: Tukey 95% C.I. comparison test of the profits under the uncertainty 6.2.1. Effect of Epistemic Uncertainties on the Manufacturer According to the Tukey comparison tests results on the manufacturers profit presented in Figure 4, the demand and lead time uncertainties show insignificant effect on the manufactures profit. As for the process uncertainty, the profit of the manufacturer is proven to be lower by the comparison test when the level of uncertainty increases. This is mainly due to a decrease in the revenue of the manufacturer, which is reduced according to this uncertainty, as shown in Table 6. When the process uncertainty occurs, the manufacturer still produces the same production level as in the base case. Hence, the raw material, ordering and

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production costs are nearly the same as those of the base cases scenario. If the process uncertainty swings up (+25% or +50%), the number of delivered units to the retailers will be higher than it should have been. As a result, more products will be taken out from the manufacturers inventory. This can lead to a lower holding cost. On the other hand, if the process uncertainty swings down (-25% or -50%), some delivered units will presumably disappear from the system during the delivery. Since products are lost from the system, the penalty cost from lost sales will increase while the manufacturers revenue is reduced. Table 6: Performance measure of the manufacturer under process uncertainty

6.2.2. Effect of Epistemic Uncertainties on the Retailers Supply uncertainty (lead time) with both levels show no significant effect on the retailers, while the demand and process uncertainties demonstrate some effects. Table 7 also shows the revenues, profits, and all related costs of all retailers under demand and process uncertainties. Investigating each retailer reveals that there are some variations in the results. Table 7: Financial performance measures of the retailers under demand and process uncertainty
Revenue ($) Retailer 1 Base Case Retailer 2 Retailer 3 Retailer 1 LD Retailer 2 Retailer 3 Retailer 1 HD Retailer 2 Retailer 3 LM Retailer 1 Retailer 2 Retailer 3 Retailer 1 Retailer 2 Retailer 3 216,035.00 215,115.00 210,230.00 213,560.00 217,225.00 211,670.00 222,085.00 214,630.00 205,770.00 202,715.00 202,815.00 200,945.00 191,250.00 190,105.00 184,420.00 Profit ($) 111,008.05 109,987.56 106,558.26 102,981.54 106,837.68 105,453.31 100,362.04 86,688.53 87,862.60 90,317.17 91,288.83 92,726.97 71,779.55 71,006.46 66,828.97 Holding Operating Cost ($) Cost ($) 986.09 4,795.86 1,055.01 5,131.43 1,144.88 5,568.86 1,084.78 5,276.68 1,165.95 5,670.37 1,220.03 5,934.65 1,507.13 7,336.83 1,170.43 5,692.04 1,126.71 5,480.69 885.70 903.37 948.94 926.48 898.02 862.77 4,307.13 4,393.80 4,665.83 4,505.97 4,369.51 4,143.45 Penalty Cost ($) 25.00 95.00 90.00 6,005.00 3,905.00 1,650.00 11,265.00 22,525.00 16,290.00 13,345.00 12,395.00 9,375.00 24,810.00 25,105.00 25,900.00 RM Cost ($) 86,370.00 85,996.00 84,018.00 85,362.00 86,796.00 84,562.00 88,764.00 85,704.00 82,160.00 81,010.00 80,984.00 80,368.00 76,378.00 75,876.00 73,782.00

HM

17

This variation has been proven by the statistical analysis as shown in Table 8 (Tukey comparison test) as well as in the plot between the profit and conditions under the demand uncertainty shown in Figure 5. The demand uncertainty has a negative impact on all retailers profit, despite the fact that the revenue of Retailer 1 is increased, while revenues drop for the case of Retailer 2 and Retailer 3 when the level of uncertainty is changing from a low level to a high level (as also shown in Table 7). This is corresponding to the higher target stock level of Retailer 1 under the high uncertainty level as mentioned earlier. The penalty cost is shown to increase as the level of uncertainty increases while the holding, operating, and raw material costs seem to follow the same pattern. Retailer 1 pays the highest amount among retailers as more products are kept in the shop. Table 8: Tukey comparison test of demand uncertainty on the performance measures of the retailers Demand Uncertainty Retailer 1 Retailer 2 Retailer 3 Revenues H B L L B H L B H Profit H B L L B H L B H Holding Cost B L H B L H B L H Operating Cost H L B H L B L B H H L B Penalty Cost H L B L B H RM Cost H L B L B H H L B Ranking: All measures are ranked from maximum to minimum. Note: B = Base case L = Low level of demand uncertainty H = High level of demand uncertainty

18

Revenue
225,000 222,500 220,000 217,500 215,000 212,500 210,000 207,500 205,000 202,500 Base case LD HD 115,000

Profit
110,000 105,000
Profit ($)
Retailer 1 Retailer 2

Revenue ($)

100,000 95,000 90,000 85,000

80,000 Base case LD HD

Retailer 1 Retailer 2

Retailer 3

Retailer 3

Holding Cost
1,600 1,500 7,500

Operating Cost
7,000 6,500
Cost ($)
Retailer 1 Retailer 2 6,000 Retailer 1 Retailer 2

1,400
Cost ($)
1,300 1,200

5,500
5,000

1,100
1,000 900 Base case LD HD

Retailer 3

4,500
4,000 Base case LD HD

Retailer 3

Penalty Cost
22,500 20,000 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0
Base case LD HD 90,000 88,000 Retailer 1 Retailer 2

RM Cost

Cost ($)

Cost($)

86,000 84,000
82,000 80,000 Base case LD HD

Retailer 1 Retailer 2

Retailer 3

Retailer 3

Figure 5: Retailers financial performance measures with the demand uncertainty

Table 9: Tukey comparison test of process uncertainty on the performance measures of retailers Process Uncertainty Retailer 1 Retailer 2 Retailer 3 Revenues B L H B L H B L H Profit B L H B L H B L H Holding Cost B H L B L H B L H L Operating Cost B H L B H B L H Penalty Cost H L B H L B H L B RM Cost B L H B L H B L H Ranking: All measures are ranked from maximum to minimum. Note: B= Base case L= Low level of process uncertainty H= High level of process uncertainty Table 9 and Figure 6 show the Tukey comparison test and the plot of all measures under the process uncertainty. It was found that the process uncertainty also has a negative impact on the revenues and profits of all retailers. When this uncertainty increases, revenues and profits drop as their penalty costs rise up sharply. Even though the raw material cost shows a

19

decrease due to the fact that the target stock levels become lower in relation to the base case, the holding and operating costs, which are charged to the number of units held in the shops, seem to be quite stable when the process uncertainty has changed from a low level to a high level. This is since the order quantity can be missed in both directions (either exceed or shortage). As a result, the inventories in the shops are not much different.

Revenue
220,000 215,000 210,000 205,000 200,000 195,000 190,000 185,000 180,000
Base case LM HM

Profit
120,000 110,000

Revenue ($)

Profit ($)

100,000 90,000 Retailer 1

Retailer 1
Retailer 2

80,000 70,000
60,000 Base case LM HM

Retailer 2
Retailer 3

Retailer 3

Holding Cost
1,200 1,150 1,100 1,050 1,000 950 900 850 800
Base case LM HM

Operating Cost
6,000
5,500 Retailer 1

Cost ($)

Cost ($)

5,000 4,500

Retailer 1

Retailer 2
Retailer 3

Retailer 2
Retailer 3

4,000
Base case LM HM

Penalty Cost
30,000 25,000 90,000
86,000

RM Cost

Cost ($)

Cost ($)

20,000
15,000 10,000 Retailer 1

82,000 78,000

Retailer 1

Retailer 2
Retailer 3

Retailer 2
Retailer 3

5,000 0
Base case LM HM

74,000 70,000
Base case LM HM

Figure 6: Retailers financial performance measures with the process uncertainty

6.3 Analysis of the effect of epistemic uncertainties with interaction effects Full factorial design with 8 scenarios ( ) has been performed. All models under the epistemic uncertainty have also been optimized by The OptQuest in order to find the optimal target stock levels. Table 10 summaries the financial results when there are interaction effects from the interested uncertainties and Figure 7 shows ANOVA of total profit from the experiment.

20

Table 10: Financial performance measures under the interaction effects

Revenue ($) Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 Manufacturer Retailer 1 Retailer 2 Retailer 3 246,508.00 177,140.00 185,605.00 208,900.00 252,128.00 198,625.00 202,545.00 203,230.00 248,540.00 187,650.00 202,235.00 188,715.00 251,368.00 201,680.00 213,315.00 191,070.00 248,026.00 183,435.00 196,825.00 195,470.00 252,290.00 199,550.00 205,530.00 200,170.00 249,884.00 191,130.00 204,500.00 179,525.00 252,112.00 204,700.00 207,615.00 194,695.00 Profit ($) 96,521.18 37,933.82 53,729.18 90,622.40 101,373.13 67,991.88 74,087.92 86,319.39 98,073.20 50,615.17 70,872.45 58,463.18 100,696.84 70,495.91 93,171.65 68,497.78 100,132.61 57,352.61 76,476.57 78,775.73 105,581.81 82,008.33 93,795.87 89,938.04 102,200.56 68,833.69 88,604.00 56,240.01 105,041.79 89,281.21 94,765.07 80,480.96 Holding Cost ($) 3,979.82 797.05 979.34 1,441.05 3,943.87 1,056.62 1,055.12 1,205.86 3,589.80 943.16 1,116.05 954.01 3,764.16 1,058.40 1,354.23 922.79 3,878.39 827.60 1,030.24 1,064.52 4,363.20 910.87 1,066.54 1,032.39 3,902.44 911.80 1,203.77 819.76 4,013.21 989.65 1,076.01 895.92 Operating Cost ($) 63,877.50 3,874.13 4,760.48 7,004.55 63,877.50 5,138.50 5,067.73 5,867.76 63,877.50 4,581.67 5,428.51 4,640.81 63,877.50 5,147.69 6,591.73 4,489.43 63,877.50 4,022.79 5,013.19 5,174.75 63,877.50 4,429.80 5,185.59 5,031.31 63,877.50 4,434.52 5,861.23 3,984.23 63,877.50 4,812.14 5,233.92 4,356.12 Penalty RM Cost ($) Cost ($) 5,402.00 63,877.50 50,945.00 70,740.00 39,010.00 74,276.00 13,400.00 83,582.00 6,206.00 63,877.50 32,220.00 79,368.00 28,715.00 80,974.00 15,675.00 81,312.00 6,272.00 63,877.50 43,600.00 75,060.00 30,590.00 80,522.00 36,425.00 75,382.00 6,302.00 63,877.50 31,515.00 80,708.00 15,050.00 85,182.00 27,850.00 76,460.00 3,410.00 63,877.50 35,070.00 73,312.00 22,815.00 78,640.00 19,235.00 77,970.00 1,740.00 63,877.50 20,240.00 79,756.00 10,490.00 82,142.00 11,375.00 80,028.00 3,176.00 63,877.50 27,500.00 76,600.00 14,355.00 81,626.00 33,855.00 71,776.00 2,452.00 63,877.50 14,520.00 81,902.00 10,680.00 83,010.00 18,260.00 77,852.00

1. HD + HL + HM

2. HD + HL + LM

3. HD + LL +HM

4. HD + LL + LM

5. LD + HL + HM

6. LD + HL + LM

7. LD + LL + HM

8. LD + LL + LM

21 General Linear Model: Whole chains Profit versus DEMAND, SUPPLY, PROCESS UNCERTAINTY
Factor DEMAND SUPPLY PROCESS Type fixed fixed fixed Levels 2 2 2 Values 1, 2 1, 2 1, 2

Analysis of Variance for Total Profit, using Adjusted SS for Tests Source DEMAND SUPPLY PROCESS DEMAND*SUPPLY DEMAND*PROCESS SUPPLY*PROCESS DEMAND*SUPPLY*PROCESS Error Total S = 13029.2 DF 1 1 1 1 1 1 1 72 79 Seq SS 10299263437 55088762 24746527058 6441125 34932531 2453501 1789216 12222686155 47369181786 Adj SS 10299263437 55088762 24746527058 6441125 34932531 2453501 1789216 12222686155 Adj MS 10299263437 55088762 24746527058 6441125 34932531 2453501 1789216 169759530 F 60.67 0.32 145.77 0.04 0.21 0.01 0.01 P 0.000 0.571 0.000 0.846 0.651 0.905 0.919

R-Sq = 74.20%

R-Sq(adj) = 71.69%

Figure 7: ANOVA of the whole chains profit versus demand, supply, and process uncertainty ANOVA results presented in Figure 7 show that, with 95% confidence level, the demand and process uncertainties have an effect on the total profit of the supply chain. If we look closely at the results from ANOVA, we can see that the process uncertainty (missed quantity) has the highest effect to the chain profit, followed by the demand uncertainty. However, the supply uncertainty and all interactions have shown no effect on the whole chains profits. As can be seen from Figure 8 (the main effect plot of the demand and process uncertainties), the graph shows that the level of uncertainty of both demand and process has a negative effect to the whole chains profit. When the level of uncertainty changes from a low level to a high level, the total profits of the whole chain reduce accordingly. Since, there is no interaction among the main effects; the profits of the chain are mainly reduced as the change of conditions from the main effects, which are the demand and process uncertainties.

22

Main Effects Plot (fitted means) for Total Profit

DEMAND 300000 PROCESS

Mean of Total Profit

290000

280000

270000

260000 2 LOW 3 HIGH 2 LOW 3 HIGH

Figure 8: Main effect plots of demand and process uncertainties 7. Conclusion In most supply chain production/inventory models that involve uncertainties in the environment, the attention has been focused on the probabilistic modelling of the customer demand side. Therefore, up until recent years, the uncertainties in the supply side have not received the amount of treatment that they deserve. We have studied how demand, supply and process uncertainties affect inventory inaccuracy, the out-of stock level, and the cost related to inventory inaccuracy. Our results indicate that eliminating inventory inaccuracy caused by uncertainty can reduce supply chain costs as well as increase profit. These results are achieved in a supply chain in which information on customer demand is already exchanged. There are three main causes of uncertainty in the retail supply chain under study demand, supply, and process uncertainties. The impact of the uncertainty on supply chain performance varies by the factor that causes it. Inaccuracy caused by the process uncertainty, such as missed quantity and theft, appears to have the biggest impact on supply chain performance, compared to inaccuracy caused by inaccurate demand forecast and shipment lateness. In our study, inventory inaccuracy caused by supply uncertainty (lead time uncertainty) does not have a significant impact on supply chain performance. This can mainly be attributed to the fact that the level of its impact on the supply chain profitability is not as significant, and can be managed by setting a higher target stock level in the shop. While this study makes a contribution to the academic literature and provides the potential to positively influence managerial practice, there are nonetheless limitations that provide opportunities for further research. First, the accuracy of a companys cost structure plays an important role in obtaining good results. In fact, it is quite difficult for a company to commit to some numbers in its cost structure since they probably have never been recorded or, in

23

many instances, managers are hesitant to estimate them. Moreover, the cost structure varies from one company (industry) to the other. As poor inputs lead to poor results, without a reliable cost structure, the obtained results could be misleading and could lead to misinterpretation. Sensitivity analysis could also be conducted with respect to some cost parameters to check their influence on the results. Also various structures of supply chains are needed to further investigate in order to understand the circumstances under which it is worthwhile to address the problem of inventory inaccuracy. Our study is limited to a oneproduct supply chain configuration with specific parameter estimates (e.g., for demand, lead time, and incorrect delivery variability) and default values for the factors that cause inventory inaccuracy. An extension to cover a wider range of the above-mentioned factors could possibly lead to other in-depth results. Our current results suggest that it can be useful for companies that face a high level of inventory inaccuracy to examine procedures or technologies to eliminate them. To give some guidelines, the results of our model indicate that an elimination of inventory inaccuracy can increase the chain profit up to 30%. A larger saving comes from the retailers than the manufacturer since most of the members in the retail supply chain are retailers. With the current setting, the manufacture does not show to be affected much by the uncertainty. In fact, only the process uncertainty can affect the manufacturers profit. However, the retailers are somewhat more sensitive and should be well aware of these unforeseeable uncertainties. In practice, there are different approaches that can help to improve inventory accuracy. Some researchers advocate the use of benchmarking, awareness building, and process improvements. Additionally, automatic identification technologies such as RFID offer the potential to increase accuracy. Recent developments indicate that RFID is going to be, and in some cases, has been, adopted in a number of retail supply chains to replace the old bar code systems. As a result, case studies based on real data should be conducted to study the impact of these uncertainties in relation to total supply chain costs. In these case studies, one may also compare the benefits of eliminating the uncertainty with associated cost of process changes or the introduction of new technologies.

Acknowledgements

This work was supported by the National Research University Project of Thailand Office of Higher Education Commission. We are also grateful to the reviewers for their constructive and helpful comments on an earlier version of this paper.

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