SWAMINATHAN AND TAYUR Models for Supply Chains in E-Business included how the Internet operation should differ es th he product. We will discuss several mod priced across these two channels; whether all prod- their effect on supply chain performance In ss hs and from traditional practice; how the products should be capture the trade-offs in these operatio ucts should be offered on both channels: and what kind of autonomy should be provided to Internet 1.3.5. Enterprise Software and Decision Support operations. Technologies. Last, the Internet has had a great The ability to dynamically change prices in the impact on development of decision technologies that marketplace is yet another aspect of distribution that use the available data across the supply chain. In the e-business has greatly impacted. In traditional sup- past, although the models were available, their imple- ply chain operations, price changes were allowed mentation in real time was almost infeasible. As a but would occur only at regular or planned inter- result, they were mainly used for planning purposes vals. However, the Internet enables firms to more However the Internet has facilitated real-time acce dynamically adjust prices with little additional effort. to information across the supply chain, making it now This poses interesting issues related to how often possible to use decision models durin execution. A prices should be changed and how one can effectively related phenomenon is the development of intelligent couple dynamic pricing with production or capacity supply chain software agents that could take appro- decisions priate actions in real time, thus, streamlining supply of distribution that relates to risk pooling. Because sion technologies in greater detl some of these deci- The Internet has compounded one of the benefits chain operations. In s6, we discuss products may be stored at fewer physical loca tions, the benefits of risk pooling will lead to lower inventory requirements. Having a separate inven- 2. Procurement and Supplier tory depot for Internet operations provides the abil- Selection ity to adjust inventory allocations between the retailer One of the major effects of the Internet on supply and the inventory depot. This raises several impor- chain practices is in the area of procurement. Firms tant research issues. How much inventory should be now use the Internet, not only to diversify the supply stored at the various locations? How can firms cre- base and hedge risk, but also to obtain lower costs ate incentives so that the brick-and-mortar retailers through auctions. This has raised important issues an collaborate with each other? We discuss pertinent related to supply chain management. At the strategi research related to distribution and pricing in $4 level, firms need to decide whether they should have 1.3.4. Customization and Postponement. The In- long-term contracts with a few fixed ternet has increased the expectation of customers for auctions and a dynamic supplier base to reduce their complete customization at a nominal charge. Even costs. In particular, firms need to understand under before the advent of e-business, firms faced the chal- what circumstances is it beneficial to have(1)long es relate ed to mass customization and high prod- term relationships; (2)auction-based, short-term rela uct variety, but this has increased immensely over the tionships; or(3)a combination of(1)and(2).Another last few years. Part of the reason is the Internet pro- important decision is whether a firm should have one vides an easy and convenient wa ay for customers to supplier or multiple suppliers and how that choice express their preferences, and sometimes even v: may depend on repetition in purchase Elmaghraby the product as it is customized. Firms are finding(2000) presents an extensive survey of economics that it is important not to completely rely on tradi- oriented models that deals with supplier selection and ional manufacturing paradigms of inventory build- sourcing strategies in traditional settings. Our focus ing(make to stock). They are fine tuning their produc- will be on supplier selection and procurement models tion process so that they can store inventory of raw under uncertainty in demand or supply that incorpo- materials or semifinished inventory and more rapidly rate the ability of the firm to use the Internet to make respond to customer demand after the customer has the process more efficient MANAGEMENT SCIENCE/Vol. 49, No 10, October 2003
SWAMINATHAN AND TAYUR Models for Supply Chains in E-Business included how the Internet operation should differ from traditional practice; how the products should be priced across these two channels; whether all products should be offered on both channels; and what kind of autonomy should be provided to Internet operations. The ability to dynamically change prices in the marketplace is yet another aspect of distribution that e-business has greatly impacted. In traditional supply chain operations, price changes were allowed but would occur only at regular or planned intervals. However, the Internet enables firms to more dynamically adjust prices with little additional effort. This poses interesting issues related to how often prices should be changed and how one can effectively couple dynamic pricing with production or capacity decisions. The Internet has compounded one of the benefits of distribution that relates to risk pooling. Because products may be stored at fewer physical locations, the benefits of risk pooling will lead to lower inventory requirements. Having a separate inventory depot for Internet operations provides the ability to adjust inventory allocations between the retailer and the inventory depot. This raises several important research issues. How much inventory should be stored at the various locations? How can firms create incentives so that the brick-and-mortar retailers can collaborate with each other? We discuss pertinent research related to distribution and pricing in §4. 1.3.4. Customization and Postponement. The Internet has increased the expectation of customers for complete customization at a nominal charge. Even before the advent of e-business, firms faced the challenges related to mass customization and high product variety, but this has increased immensely over the last few years. Part of the reason is the Internet provides an easy and convenient way for customers to express their preferences, and sometimes even view the product as it is customized. Firms are finding that it is important not to completely rely on traditional manufacturing paradigms of inventory building (make to stock). They are fine tuning their production process so that they can store inventory of raw materials or semifinished inventory and more rapidly respond to customer demand after the customer has ordered the product. We will discuss several models that capture the trade-offs in these operations and their effect on supply chain performance in §5. 1.3.5. Enterprise Software and Decision Support Technologies. Last, the Internet has had a great impact on development of decision technologies that use the available data across the supply chain. In the past, although the models were available, their implementation in real time was almost infeasible. As a result, they were mainly used for planning purposes. However, the Internet has facilitated real-time access to information across the supply chain, making it now possible to use decision models during execution. A related phenomenon is the development of intelligent supply chain software agents that could take appropriate actions in real time, thus, streamlining supply chain operations. In §6, we discuss some of these decision technologies in greater detail. 2. Procurement and Supplier Selection One of the major effects of the Internet on supply chain practices is in the area of procurement. Firms now use the Internet, not only to diversify the supply base and hedge risk, but also to obtain lower costs through auctions. This has raised important issues related to supply chain management. At the strategic level, firms need to decide whether they should have long-term contracts with a few fixed suppliers or use auctions and a dynamic supplier base to reduce their costs. In particular, firms need to understand under what circumstances is it beneficial to have (1) longterm relationships; (2) auction-based, short-term relationships; or (3) a combination of (1) and (2). Another important decision is whether a firm should have one supplier or multiple suppliers and how that choice may depend on repetition in purchase. Elmaghraby (2000) presents an extensive survey of economicsoriented models that deals with supplier selection and sourcing strategies in traditional settings. Our focus will be on supplier selection and procurement models under uncertainty in demand or supply that incorporate the ability of the firm to use the Internet to make the process more efficient. 1392 Management Science/Vol. 49, No. 10, October 2003
SWAMINATHAN AND TAYUR Models for Supply Chains in E-Business Peleg et al.(2002)develop a model that considers two states. This uncertainty is resolved in the second the potential discounts that an exclusive long-term period where demand becomes deterministic In con- supplier may be able to offer based on learning and trast to standard two-period models, they assume that compare that to the savings that might be gener- demand only occurs in the second period. The first ated through an auction, in a two-period setting with period is only for capacity reservation and demand uncertain demand. The strategic partner guarantees resolution. Under this setting, they demonstrate the a price of p per unit in the first period and p(1-A) existence of a unique subgame perfect Nash equi in the second period, where 0 <A<1. This model librium under the various models. They show that attributes it to the long-term learning effects of an the supplier, manufacturer, and the supply chain as a exclusive supplier. In an auction-based setting, the whole are aided by this additional negotiation period firm still pays a per unit price p in the first period, but where demand is actually not realized, but demand conducts an auction in the second period. The firm resolution occurs and capacity is reserved.Under only knows the distribution of the minimum price uncertain demand and limited capacity at the sup- (which is assumed to be independent of the quan tity bought)that could be obtained as a result of the plier, they show that the additional period is bene- ficial, but the impact on profits(and its sharing) is auction. In the combined strategy, the firm decides more involved and depends on the level of capacity to use the exclusive supplier for the most part(by availabl having a contract to order a minimum amount in As more and more firms begin to use auctions for the second period)and orders any remaining amount conducting business transactions, it is important that from the auction. Under random demand assump- models be developed that capture the buyer bidder tions, Peleg et al.(2002)derive the optimal ordering interactions and tie them to supply chain decisions quantities for the firm. They show that there exists a A beyond which it is optimal for the buyer to prefer a and constraints. Motivated by FreeMarkets,Gallien and Wein(2000) study the design of smart markets strategic long-term partnership, as opposed to using for industrial procurement. They study a multi-item an auction in the second period. Further, depending on the distribution of price obtained from the auction, Procurement auction mechanism for supply environ- the combined strategy may be superior or inferior to ments with capacity constraints. This enables them to a pure auction strategy. Finally, the authors explore model rational behavior of suppliers in terms of their the effect of increasing the supplier base(in the auc- responses when they have limited capacity. In partic- tion)by modeling the benefits obtained (due to poten- ular, they consider an auction with n suppliers and tial lower prices)in the distribution of price from the m components, each having a fixed order size. The Jective of the manufacturing firm is to minimize the In the automotive supply chain, a tier-1 manu- total cost of procurement across all the components, facturer such as Ingersoll-Rand often has to reserve taking into account the capacities of the various sup- capacityfromitssupplierworldwidepm.com,whichpliersIneachroundsuppliersgiveapricebidfor is a coalition of small powder metal technology man- each of the components. The assumption is that the ufacturers.Because the coalition is a powerful entity, price bids decrease as the rounds progress. Further, at the manufacturer may need to develop contracting the end of each round, the auctioneer provides each mechanisms such as capacity reservation(which is of the suppliers information about allocations and the similar in spirit to the minimum order assumptions best bids for the next round that would maximize the of Peleg et al. 2002). Motivated by the above setting, supplier's profits, assuming all other suppliers hold Erhun et al. (2001)study the strategic interaction and on to their old bid. The auction stops when the new questions of participation(from the suppliers), profit set of bids from all the suppliers is identical to the sharing, and impact on end customers. They ana- previous round. Under these conditions, the authors lyze a two-period model where the downward slop- show that such an auction does converge, and they ing demand in the second period could be in one of provide a bound for the profits of the manufacturer MANAGEMENT SCIENCE/VoL 49, No. 10, October 2003 1393
SWAMINATHAN AND TAYUR Models for Supply Chains in E-Business Peleg et al. (2002) develop a model that considers the potential discounts that an exclusive long-term supplier may be able to offer based on learning and compare that to the savings that might be generated through an auction, in a two-period setting with uncertain demand. The strategic partner guarantees a price of p per unit in the first period and p1 − in the second period, where 0 << 1. This model attributes it to the long-term learning effects of an exclusive supplier. In an auction-based setting, the firm still pays a per unit price p in the first period, but conducts an auction in the second period. The firm only knows the distribution of the minimum price (which is assumed to be independent of the quantity bought) that could be obtained as a result of the auction. In the combined strategy, the firm decides to use the exclusive supplier for the most part (by having a contract to order a minimum amount in the second period) and orders any remaining amount from the auction. Under random demand assumptions, Peleg et al. (2002) derive the optimal ordering quantities for the firm. They show that there exists a beyond which it is optimal for the buyer to prefer a strategic long-term partnership, as opposed to using an auction in the second period. Further, depending on the distribution of price obtained from the auction, the combined strategy may be superior or inferior to a pure auction strategy. Finally, the authors explore the effect of increasing the supplier base (in the auction) by modeling the benefits obtained (due to potential lower prices) in the distribution of price from the auction. In the automotive supply chain, a tier-1 manufacturer such as Ingersoll-Rand often has to reserve capacity from its supplier, worldwidepm.com, which is a coalition of small powder metal technology manufacturers. Because the coalition is a powerful entity, the manufacturer may need to develop contracting mechanisms such as capacity reservation (which is similar in spirit to the minimum order assumptions of Peleg et al. 2002). Motivated by the above setting, Erhun et al. (2001) study the strategic interaction and questions of participation (from the suppliers), profit sharing, and impact on end customers. They analyze a two-period model where the downward sloping demand in the second period could be in one of two states. This uncertainty is resolved in the second period where demand becomes deterministic. In contrast to standard two-period models, they assume that demand only occurs in the second period. The first period is only for capacity reservation and demand resolution. Under this setting, they demonstrate the existence of a unique subgame perfect Nash equilibrium under the various models. They show that the supplier, manufacturer, and the supply chain as a whole are aided by this additional negotiation period where demand is actually not realized, but demand resolution occurs and capacity is reserved. Under uncertain demand and limited capacity at the supplier, they show that the additional period is bene- ficial, but the impact on profits (and its sharing) is more involved and depends on the level of capacity available. As more and more firms begin to use auctions for conducting business transactions, it is important that models be developed that capture the buyer bidder interactions and tie them to supply chain decisions and constraints. Motivated by FreeMarkets, Gallien and Wein (2000) study the design of smart markets for industrial procurement. They study a multi-item procurement auction mechanism for supply environments with capacity constraints. This enables them to model rational behavior of suppliers in terms of their responses when they have limited capacity. In particular, they consider an auction with n suppliers and m components, each having a fixed order size. The objective of the manufacturing firm is to minimize the total cost of procurement across all the components, taking into account the capacities of the various suppliers. In each round, suppliers give a price bid for each of the components. The assumption is that the price bids decrease as the rounds progress. Further, at the end of each round, the auctioneer provides each of the suppliers information about allocations and the best bids for the next round that would maximize the supplier’s profits, assuming all other suppliers hold on to their old bid. The auction stops when the new set of bids from all the suppliers is identical to the previous round. Under these conditions, the authors show that such an auction does converge, and they provide a bound for the profits of the manufacturer. Management Science/Vol. 49, No. 10, October 2003 1393