chapters 17 and 18 business dynamics by john d. sterman

04/20/23Chapters 17 and 18 in

Sterman 1

Chapters 17 and 18Business Dynamics by John D. Sterman

Supply Chains and the Origin of Oscillations


Sterman 2

Chapter outline

What is a supply chain? Supply Chains in Business and

Beyond The Stock Management Problem The Stock Management Structure Origin of Oscillations Summary


Sterman 3

Homework:

Work the challenge questions on pages 674 and 675—questions 1 through 7


Sterman 4

§ What is a supply chain? A supply chain (SC) is the set of

structures and processes an organization uses to deliver an output to a customer

tangible or intangible product Typically, supply chains consist of

Stock and flow structures for the acquisition of the inputs to the processes, and

Management policies governing the various flows


Sterman 5

Why study SC Dynamics? SCs often exhibit persistent and costly

instability Many business and social systems are

notorious for producing counter intuitive behavior (Forrester, Sterman)

Understanding the behavior of SCs under important contexts is imperative for better management (Recall–Mental Models’ limitations- first week’s lesson)


Sterman 6

The bane of Supply Chains—Uncertainty

Uncertainty in the forecast Uncertainty in procurement details

lead time Procurement amount Procurement product quality


Sterman 7

How to deal with the Uncertainty—buffer it with INVENTORY or reduce it with IT

What is IT?

But this totally changes the dynamics of the SC System


Sterman 8

Without VISIBILITY…

Supply chains exhibit a behavior called simply the hockey-stick phenomenon


Sterman 9

Approach-some premises Stock management structure is

used to explain origin of oscillation Preconditions for oscillation are-

negative feedbacks and time delays present in the system (recall-desired inventory model)

Delays are simple enough to notice, yet are often omitted in decision making (experimental evidence supports)


Sterman 10

§ SCs in Business and Beyond

SCs extend beyond the boundaries of a firm (organization) and include the suppliers, distribution channels, and the customers (Recall-definition of a SC)

SD models need to include these players as well, to the extent the flows and rules within the firm cause feedback from these players giving rise to further dynamics in behavior of stocks

SCs are not limited to business--consider human body- supply of glucose for energy-consumption-food ingestion-digestion-storage-consumption etc forms one big supply chain


Sterman 11

SC-what to expect? SC-to provide right output at right time As requirements change, adjustments in

flow rates are initiated-and the negative feedback loop is at work! Production and inventories chronically overshoot and undershoot (17.1)

Due to time delays-SCs are prone to oscillate

Amplitude of fluctuations increases as they propagate from customer to supplier- each upstream stage lags behind its customer

Oscillation, amplification, and phase lag are pervasive in SCs


Sterman 12

SC Dynamics Understanding Process

Understand the internal dynamics and structure within the firm

Understand the dynamics and structure outside the firm


Sterman 13

§ Stock Management Problem Consider a single firm structure

Desired versus actual state-of stock Typically, outflow rate is independent Managers need to regulate inflow to

keep the stock level close to desired level

We all deal with such feedback loops- adjust temperature in shower, manage checking account balance, credit card account balance, etc


Sterman 14

The problem Two parts: Structure and Rules If there is no delay in acquisition

(instantaneous replenishments)

Stock to be controlled S is the accumulation of AR and LR S=INTEGRAL(AR-LR, Sto

) (17-1 pp 668)

Stock

acquisition rate (AR) loss rate (LR)

customer orderscurrent loss rate


Sterman 15

We have studied this structure before…

Stock SAcquisition Rate

Stock AdjustmentTime

Desired Stock


Sterman 16

This is just a Balancing Loop…

Acquisition RateAR

Stock S +

-


Sterman 17

It gave us Balancing Loop behavior that looked like this…

Stock S

1,000

750

500

250

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Stock S : stock 1

Called Exponential Goal-Seeking


Sterman 18

We can re-arrange this model ….

Without changing behavior…

Here, AS = (S* - S) / SAT and AR = AS


AR

Adjustment forStock AS Desired Stock S*

Stock AdjustmentTime SAT


Sterman 19

We still get the same exact behavior…

Stock S

1,000

750

500

250

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Stock S : stock2


Sterman 20

Now, we add a Loss Rate

Akin to a Sales Rate, a Depreciation Rate or whatever…


AR



Loss Rate

Variables XU


Sterman 21

Now we see the problem….

Stock S

1,000

750

500

250

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Stock S : stock3Stock S : stock2


Sterman 22

Let examine the Acquisition Rate…

Acquisition Rate AR

200

150

100

50

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Acquisition Rate AR : stock3Acquisition Rate AR : stock2


Sterman 23

How does the Acquisition Rate look in relation to the Loss Rate?

200

150

100

50

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Acquisition Rate AR : stock3Loss Rate : stock3


Sterman 24

The problem is Stock S….

Will never reach the Desired Stock S*, but will always differ from it by a significant amount—600 units in this case

Notice that, in steady state, the Acquisition Rate settles down to the Loss Rate


Sterman 25

Loss Rate - LR Loss Rate -outflow rate- may arise

from usage (material or wip) or decay (depreciation) and must depend on stock itself (also to prevent negative draining) LR may depend on exogenous variables

X LR may depend on endogenous variables

U

LR = ƒ (S, X, U) … (17-2 pp 668)


Sterman 26

The Loss Rate…

LR = IF THEN ELSE( Stock S > 0 , Variables XU , 0 )


Sterman 27

How can we fix the problem we just observed….

Namely, that the Stock S will always differ from the Desired Stock S* by the amount of the Loss Rate LR????

This will make inventory managers very unhappy because they cannot achieve their targeted service levels—many customers will arrive to buy but no stock will be available


Sterman 28

A way to fix the problem

Create a new variable called the DAR—Desired Acquisition Rate…

DAR = Adjustment for Stock + Loss Rate

DAR = AS + LR


Sterman 29

Here DAR = AS + LR


AR



Loss Rate

Variables XU

Desired AcquisitionRate DAR


Sterman 30

A better way…


AR



Loss Rate

Variables XU



Sterman 31

We can always…

Reconstruct the information created in a rate elsewhere without having to take information directly from a rate, as Sterman does here


Sterman 32

Now let’s look at Behavior…

Stock S

1,000

750

500

250

0

0 10 20 30 40 50 60 70 80 90 100Time (Month)

Stock S : stock4Stock S : stock3Stock S : stock2


Sterman 33

Acquisition Rate - AR Typically production requires use of

resources, hiring requires efforts-or time delays

If no such delays- refer to model (pp 669)

AR=MAX(0, DAR) (17-3 pp 668) Max function coupled with 0 ensures positive

or zero AR-prevents negative AR If excess units are returnable, that needs to

be modeled separately and not by negative AR


Sterman 34

If Desired stock changes Adjustment for stock AS needs to change Consider example STOCKMGT.MDL from

chapter 17 or 17-4 on pp 669 Desired acquisition rate formulation can

depend on several factors- this needs to be modeled based on information available to managers- typically managers use heuristic rules (falls under ‘Bounded Rationality’ domain)

DAR=EL+AS (17-4 pp 670) EL=expected loss (= LR here) AS=Desired-actual/time delay (=0 here)


Sterman 35

EL and AS formulations Actual Loss is difficult to measure-prone to

change-hence EL-avg In certain situations LR may not be directly

observable or measurable-must be estimated-introducing measurement, reporting and perception delays- think about trend in sales

Creates a negative Stock control feedback loop- simplest form-linear

AS = (S* - S)/SAT (17-5 pp 671) SAT= Stock adjustment time S* =desired stock level-(could be a CONSTANT

or variable)


Sterman 36

§ Steady State Error

Omission of EL in DAR leads to Steady State error- stock differs with desired value even in equilibrium Production=(DI-I)/IAT …(17-6 pp671) Equilibrium condition:

Production=shipments Production=(DI-I)/IAT=shipments… (17-7) I=DI-Shipments*IAT … (17-8)When in equilibrium the Inventory will be

lower than Desired Inventory


Sterman 37

Fix for Steady State Error Including the EL in the production

decision will fix this steady state error Production=AvgOR+(DI-I)/IAT…(17-6a) Equilibrium: Avg Orders= Actual Orders,

I=DI, and Orders=Shipments Avg OR- to smooth out sharp spikes- and

avoid costly changes in production Evidence suggests that managers do

include EL in production decisions


Sterman 38

Managing a Stock: Behavior

Consider example-Plant & Equipment Avg life time = 8 yrs Delays in reporting negligible EL=AL Adjustment time = 3 yrs (Senge, 1978) Desired Capital stock=exogenous; it

depends on demand for firm’s products Net Change in Capital Stock= (S*-S)/SAT

(17-9)- the first order linear negative feedback system


Sterman 39

System response to a change

Step (1, .20) produces changes in AR Amplification in AR-for a mere 20% increase

in desired stock 19.2/12.5%= 53% at peak Amplification - temporary- disequilibrium

stage If stock is to increase then AR>LR Since AR=receipts from suppliers- a 20%

increase in the operations impacts supplier more than the firm (although temporarily)

Try at least 3 tests suggested on page 674 (#4 in particular)


Sterman 40

BOT Chart of Stock

140

120

100

80

2 2

2 2 2 2 2 2 2 2 2 2 2 2 2

1 11

11

11 1 1 1 1 1 1 1 1 1

0 1 2 3 4 5 6 7 8 9 10Time (Year)

Stock S : bdscm2 Units1 1 1 1 1 1 1 1 1 1 1

"Desired Stock S*" : bdscm2 Units2 2 2 2 2 2 2 2 2


Sterman 41

BOT Chart of rates

20

16.66

13.33

10

2 22

22 2 2 2 2 2 2 2 2 2 2

1 1

11

11

1 1 1 1 1 1 1 1 1

0 1 2 3 4 5 6 7 8 9 10Time (Year)

Acquisition Rate AR : bdscm2 Units/Year1 1 1 1 1 1 1 1

Loss Rate LR : bdscm2 Units/Year2 2 2 2 2 2 2 2 2


Sterman 42

§ The Stock Mgmt Structure

Delay between order and acquisition Capital stock—construction starts/delivery time Workforce--hiring /training time

Supply Line introduced-refer model (pp 676) SL=INTEGRAL(OR-AR, SLto

)…(17-10 pp 675)

AR=L(SL, AL) …(17-11 pp 675) Most likely AR=SL/AL

AL =ƒ(SL, X, U) …(17-12 pp 675) L() denotes the material delay

Typically average acquisition lag is relatively constant until requisition rate exceeds capacity


Sterman 43

The Stock Mgmt Structure…

Typically, OR=Max(0,IO) …(17-13) Cancellations of orders need to be

modeled as distinct outflows from SL IO=DAR+ASL … (17-14) ASL=(SL*-SL)/SLAT similar to AS ..(17-15) SL*=EAL * DAR …(17-16) Managers use SL*=EAL*EL …(17-16a)

not sophisticated- instead use avg loss rate Revised DAR=MAX(0,EL+AS) …(174a)

To ensure a non negative DAR


Sterman 44

Oscillations—how do we get them?? Oscillations require delays, which

involve additional stocks (states) Negative Feedback systems

without delays will not oscillate Delays between corrective actions

and their effects create a supply line of corrections that have been initiated but not yet had their impact


Sterman 45

More on oscillations

To oscillate the time delay must be at least partially ignored

Managers must continue to initiate corrective actions in response to the perceived gap between the desired and actual state of the system, even after sufficient corrections to close the gap are in the pipeline


Sterman 46

The Beer Distribution Game Originally developed by Forrester in the

1950’s Consists of a supply chain of four entities

Retailer Wholesaler Distributor Factory

Each entity has the same exact structure


Sterman 47

The Beer Distribution Game One person assumes the role of each

entity At each stage there are order processing

and shipping delays Each player’s objective is to minimize

holding costs and stockout costs Holding costs run $.50 per case per week Stockout costs run $1.00 per case per

week


Sterman 48

The Beer Distribution Game

Incoming orders deplete inventory Players must try to maintain a

‘desired’ inventory Pattern for customer demand is:

Starting from equuilibrium, there is a small unannounced one-time increase in customer orders from 4 to 8 cases per week.


Sterman 49

Beer Distribution Game Behavior

Most players develop a backlog—meaning negative actual inventory

Eventually inventories throughout the supply chain start to rise

But then all entities inventories overshoot

See page 687


Sterman 50

Beer Distribution Game Behavior

Most players ignore the delays and order the difference between their desired inventory and their actual inventory

This creates a huge overshoot in actual inventory when it all arrives


Sterman 51

Why Do We Ignore the Supply line—the Delays??

Examples of situations where we ignore delays appear on page 695


Sterman 52

Boom and Bust in real Estate Markets Real Estate markets exhibit large

amplitude cycles of 10 to 20 years Booms are often accompanied by

periods of intense speculation involving expansion of credit and banking activity

When the bubble bursts, the resulting bad loans, defaults, and unemployment can throw an entire region into recession or even depression


Sterman 53

Recent Real Estate Boom/Bust Cycles

North American and European Property markets boomed in the 1980’s, but then crashed in the early 1990’s

Similar behavior was observed in Japan


Sterman 54

How does the cycle begin? See Figure 17-15—another adaptation of the

stock management structure Interest and mortgage rates go down to

stimulate the economy Employment goes up Vacancy rates go down as employment goes

up Rents go up as do market values Developers see an opportunity and initiate

construction This causes construction starts to increase and

go higher


Sterman 55

What happens next? High profits attract new developers and

investors Many new projects are started, swelling

the supply line of buildings under development

After a long delay—2 to 5 years—the supply of buildings rises, rents start to fall, as vacancy rates go up, dragging down market values

Meanwhile there is still a huge supply of new construction starts underway


Sterman 56

What should developers do?

They should assess the profitability of a potential new development and forecast the future vacancy rate by projecting the growth of demand and supply

In other words they should develop a structure like that in figure 17-15 and take the feedback structure of the market into account


Sterman 57

What else? Developers and bankers should consider

the supply line of buildings under development taken in relation to the growth of demand

Banks, in particular, should assume a leading role

This means using SD models to assess demand taken in relation to supply. And giving specific attention to the pipeline and construction delays


Sterman 58

What else?

Regulatory agencies should establish a regulatory environment that forces banks to behave in a more fiscally responsible way.

The HERD instinct is wrong and should be avoided at all costs


Sterman 59

Stock S

Loss RateLR

Adjustmentfor Stock

AS

ExpectedLoss Rate

EL

+

-

+

B

Stock Control

AcquisitionRate AR

DesiredAcquisitionRate DAR

++

+

StockAdjustmentTime SAT

-

AverageLife

-

DesiredStock S*+


Sterman 60

Basic Stock Management Structure


Sterman 61

Supply LineSL

Stock S

Order RateOR

AcquisitionRate AR

Loss RateLR

IndicatedOrders IO

Adjustmentfor SupplyLine ASL Desired

Supply LineSL*

Adjustmentfor Stock

AS

ExpectedLoss Rate

EL

AcquisitionLag AL

++

+

+

+

-

-

-

+

B B

Supply LineControl

Stock Control

StockAdjustmentTime SAT

Supply LineAdjustmentTime SLAT

-

-

ExpectedAcquisition

Lag EAL

+

+

DesiredAcquisitionRate DAR +

+

DesiredStock S*

<InitialDesiredStock>

<Input>+

+

+

ExogenousVariables U

EndogenousVariables X


Sterman 62

Stock Management Structure Applied to Capital Investment


Sterman 63

Stock S

Adjustment forStock AS

Desired Stock S*


Loss Rate


Supply Line SLAcquisition Rate

AROrder Rate OR

Acquisition LagAL

Expected LossRate EL

IndicatedOrders IO

Adjustment forSupply Line ASL

Desired SupplyLine SL*

Supply Line Adjustmenttime SLAT

AverageLifetime L

Expected AcquisitionLag EAL


Sterman 64


Sterman 65


Sterman 66


Sterman 67

InventoryProduction

RateShipment

Rate

DesiredProduction

ProductionAdjustment

from Inventory

DesiredInventory

ExpectedOrder Rate

Change inExp Orders

InventoryAdjustment

Time

DesiredInventoryCoverage

Time to AverageOrder Rate

OrderFulfillment

Ratio

Table forOrder

Fulfillment

Work inProcess

InventoryProductionStart Rate

ManufacturingCycle Time

Adjustmentfor WIP

Desired WIP

DesiredProductionStart Rate

WIPAdjustment

Time

CustomerOrder Rate

B

OrderFulfillment

B

Inv entoryControl

B

Ov er/UnderTime

-

-

+

+

+

+

+-

-

+

+

+

-

-+

+

+

+

-

DesiredShipment

Rate +

+

MaximumShipment

Rate

MinimumOrder

ProcessingTime

+

+-

-

+

InventoryCoverage

+ -

SafetyStock

Coverage

+

Productivity

Workweek

+

+

+

StandardProductionStart Rate

SchedulePressure

+

Effect ofSchedule

Pressure onWorkweek

Table for Effect ofSchedule

Pressure onWorkweek

<ExpectedProductivity>

StandardWorkweek

+

+

+

+

+

-

<Labor>

+

chapters 17 and 18 business dynamics by john d. sterman

Documents

supply chain sc

business dynamics

behavior of scs

big supply chainchapters

human body supply

study sc dynamics

sc systemchapters

time delaysscs