scm-7_sourcing decision in a supply chain

7/27/2019 SCM-7_Sourcing Decision in a Supply Chain

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2007 Pearson Education 13-1

Chapter 14

Sourcing Decisions in a Supply Chain

Supply Chain Management

(3rd Edition)


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Outline

The Role of Sourcing in a Supply Chain

Supplier Scoring and Assessment

Supplier Selection and Contracts

Design Collaboration

The Procurement Process

Sourcing Planning and Analysis

Making Sourcing Decisions in Practice

Summary of Learning Objectives


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2007 Pearson Education

Some Definitions

Sourcing:Finding sources of supply, guaranteeing continuity in supply,ensuring alternative sources of supply and gathering knowledge of

procurable resources.

Procurement:All activities that are required in order to get the product andservices from the supplier to its final destination

Purchasing:

All activities for which the company receives an invoice fromoutside parties

Outsourcing:

in-house performed activities are transferred to a third party

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The Role of Sourcing

in a Supply Chain

Sourcing processes include:

Supplier scoring and assessment

Supplier selection and contract negotiation Design collaboration

Procurement

Sourcing planning and analysis


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Benefits of Effective

Sourcing Decisions

Better economies of scalecan be achieved if orders areaggregated

More efficient procurement transactions can significantlyreduce the overall cost of purchasing

Design collaborationcan result in products that areeasier to manufacture and distribute, resulting in loweroverall costs

Good procurement processes can faci l i tate coordinationwith suppliers

Appropriate suppl ier contractscan allow for the sharingof r isk

Firms can achieve a lower purchase price by increasingcompetition through the use of auctions


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In-house or Outsource Decision

Make or buy materials or components is a strategic decisionthat can impact an organizations competitive position.

Buy/ Outsourcing

In-house Make

Backward Integration

Forward IntegrationVS.

Strategic Decision Drivers:

Strategic Advantage Cost


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Reasons for Making

Protect proprietary technology

No competent supplier

Better quality control

Use existing idle capacity

Control of lead-time, transportation, and

warehousing cost

Lower cost



Rationales for outsourcing

Strategicreasons for

outsourcing

1. Improve company focus

2. Gain access to world class capabilities

3. Get access to resources that are not available

internally

4. Accelerate reengineering benefits

5. Improve customer satisfaction

6. Increase flexibility

7. Sharing risks

Tactical reasons

for outsourcing

1. Reduce control costs and operating costs

2. Free up internal resources

3. Receive an important cash infusion

4. Improve performance

5. Ability to manage functions that are out of control

All these reasons underlie one overall objective: to improve the overall

performance of the outsourcing firm



Strategic decision for outsourcing

Maintain / invest (opportunistically)

Competencies are not strategic

but provide important advantages;

keep in-house as long these

advantages are (integrally) real

In-house / invest

Competencies are strategic and

world-class;

focus on investments in technology

and people; maximize scale and

stay on leading edge

Outsource

Competencies have

no competitive advantage

Collaborate / maintain control

Competencies are strategic but

insufficient to compete effectively;

explore alternatives such aspartnership, alliance, joint-venture,

licensing, etc.

High

Low

Levelofcompetit

iveness

relativetosupp

liers

Strategic importance of competenceHigh

(core)

Low

(non-core)

Savelkoul, 2008



How Do Third Parties Increase the

Supply Chain Surplus

Capacity aggregation gives economies of scale

Inventory aggregation reduces uncertainty

Transportation aggregation allows to convertLTL/LCL to TL/FCL

Consolidated deliveries reduce distance per drop

Warehouse aggregation

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How Do Third Parties Increase the

Supply Chain Surplus

Procurement aggregation gives economies of scale

Information aggregation

Receivables aggregation

Relationship aggregation

Low costs and higher quality

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Risk of Using Third Party

The process is broken

Cost of coordination

Reduction of customer/supplier contact

Loss of internal capability and growth in third-party

power

Leakage of sensitive data and information

Ineffective contracts

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3PL and 4PL

A thirdparty logistics (3PL) provider performs one or more

of the logistics activities relating to the flow of product,

information, and funds that could be performed by the firm

itself.

A fourth-party logistic is an integrator that assembles the

resources, capabilities and technology of its own organization

and other organizations to design, build and run comprehensive

supply chain solutions. Andersen Consulting (now

Accenture) A general contractor who manages other 3PLs, truckers, forwarders,

custom brokers, and others essentially taking responsibility of a

complete process for the customer

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Sources of Information

Current suppliers

Preferred suppliers

Sales representatives

Information databases

Experience

Trade journals

Trade directories

Trade shows

Second-party or indirect

information

Internal sources

Internet searches

gement, 4e 14


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Supplier Scoring and Assessment

Supplier performance should be compared on the

basis of the suppliers impact on total cost

There are several other factors besides purchase price

that influence total cost


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Supplier Assessment Factors

Replenishment Lead Time

On-Time Performance

Supply Flexibility

Delivery Frequency /Minimum Lot Size

Supply Quality

Inbound Transportation Cost

Pricing Terms

Information Coordination

Capability

Design CollaborationCapability

Exchange Rates, Taxes,

Duties

Supplier Viability



The Weighted-Criteria Evaluation

system

1. Select mutually acceptable performance dimensions

2. Assign weight based on their relative importance to the company

objectives

3. Monitor and collect performance data (0100)

4. Calculate weighted sum of the performance data

5. Classify suppliers based on their overall score:

i. Unacceptable (less than 50)

ii. Conditional (between 50 and 70)iii. Certified (between 70 and 90)

iv. Preferred (greater than 90)

6. Audit and perform ongoing certification review


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Example for the XYZ Supplier company

Performance Measure Rating X Weight = Final Value

Technology 80 0.10 8.00

Quality 90 0.25 22.50

Responsiveness 95 0.15 14.25

Delivery 90 0.15 13.50

Cost 80 0.15 12.00

Environmental 90 0.05 4.50

Business 90 0.15 13.50

Total Score 1.00 88.25


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Supplier Selection- Auctions and

Negotiations

Supplier selection can be performed through competitive

bids, reverse auctions, and direct negotiations

Supplier evaluation is based on total cost of using a

supplierAuctions:

Sealed-bid first-price auctions

English auctions

Dutch auctions

Second-price (Vickery) auctions


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Supply Contract

Supply Contract can include the following:

Pricing and volume discounts.

Minimum and maximum purchase quantities.

Delivery lead times.

Product or material quality.

Product return policies.


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Supply Contracts for Strategic

Components

1. Make to Order Supply Chain Contractsi. Sequential Supplier, Contracts?

ii. Buy Back Contracts

iii. Revenue Sharing Contracts

iv. Quantity-Flexibility Contracts

v. Sales Rebate Contract

vi. Global Optimization

2. Make to Stock Supply Chain Contractsi. Pay Back Contracts

ii. Cost Sharing Contracts


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Supply Contracts for Strategic

Components

1. Contracts with Asymmetric Information

i. Capacity Reservation Contracts

ii. Advance purchase contracts

2. Contracts for Non-Strategic Componentsi. Long-Term Contracts

ii. Flexible, or option, Contract

iii. Spot Purchase

iv. Portfolio Contract


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1. Make to Order Supply Chain

Contracts


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2-Stage Sequential Supply

Chain

A buyer and a supplier who want to optimize ownprofit.

Buyers activities:

generating a forecast determining how many units to order from the supplier

placing an order to the supplier so as to optimize his ownprofit

Purchase based on forecast of customer demand

Suppliers activities: reacting to the order placed by the buyer.

Make-To-Order (MTO) policy


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Swimsuit Example

2 Stages: a retailer who faces customer demand

a manufacturer who produces and sells swimsuits to theretailer.

Retailer Information: Summer season sale price of a swimsuit is $125 per unit.

Wholesale price paid by retailer to manufacturer is $80 perunit.

Salvage value after the summer season is $20 per unit

Manufacturer information: Fixed production cost is $100,000

Variable production cost is $35 per unit


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What Is the Optimal Order

Quantity?

Retailer marginal profit is the same as the marginal profit of themanufacturer, $45.

Retailers marginal profit for selling a unit during the season,$45, is smaller than the marginal loss, $60, associated with

each unit sold at the end of the season to discount stores.Optimal order quantity depends on marginal profit and

marginal loss but not on the fixed cost.

Retailer optimal policy is to order 12,000 units for an averageprofit of $470,700.

If the retailer places this order, the manufacturers profit is12,000(80 - 35) - 100,000 = $440,000


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Sequential Supply Chain

FIGURE 4-1: Optimized safety stock


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Risk Sharing

In the sequential supply chain: Buyer assumes all of the risk of having more inventory than

sales

Buyer limits his order quantity because of the huge financial risk.

Supplier takes no risk.

Supplier would like the buyer to order as much as possible Since the buyer limits his order quantity, there is a

significant increase in the likelihood of out of stock.

If the supplier shares some of the risk with the buyer

it may be profitable for buyer to order more reducing out of stock probability

increasing profit for both the supplier and the buyer.

Supply contracts enable this risk sharing


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Buy-Back Contract

Seller agrees to buy back unsold goods from the buyer

for some agreed-upon price.

Buyer has incentive to order more

Suppliers risk clearly increases.

Increase in buyers order quantity

Decreases the likelihood of out of stock

Compensates the supplier for the higher risk


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Buy-Back Contract

Swimsuit Example

Assume the manufacturer offers to buy unsoldswimsuits from the retailer for $55.

Retailer has an incentive to increase its order quantityto 14,000 units, for a profit of $513,800, while themanufacturers average profit increases to $471,900.

Total average profit for the two parties

= $985,700 (= $513,800 + $471,900)

Compare to sequential supply chain when total profit= $910,700 (= $470,700 + $440,000)


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Buy-Back Contract

Swimsuit Example

FIGURE 4-2: Buy-back contract


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Revenue Sharing Contract

Buyer shares some of its revenue with the supplier

in return for a discount on the wholesale price.

Buyer transfers a portion of the revenue from each

unit sold back to the supplier


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Swimsuit Example

Manufacturer agrees to decrease the wholesale pricefrom $80 to $60

In return, the retailer provides 15 percent of theproduct revenue to the manufacturer.

Retailer has an incentive to increase his order quantityto 14,000 for a profit of $504,325

This order increase leads to increased manufacturersprofit of $481,375

Supply chain total profit= $985,700 (= $504,325+$481,375).


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Swimsuit Example

FIGURE 4-3: Revenue-sharing contract


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Other Types of Contracts

Quantity-Flexibility Contracts

Supplier provides full refund for returned (unsold) items

As long as the number of returns is no larger than a certainquantity.

Sales Rebate Contracts

Provides a direct incentive to the retailer to increase sales bymeans of a rebate paid by the supplier for any item soldabove a certain quantity.


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Global Optimization Strategy

What is the best strategy for the entire supply chain?

Treat both supplier and retailer as one entity

Transfer of money between the parties is ignored


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Global Optimization

Swimsuit Example

Relevant data Selling price, $125

Salvage value, $20

Variable production costs, $35

Fixed production cost.Supply chain marginal profit, 90 = 125 - 35

Supply chain marginal loss, 15 = 3520

Supply chain will produce more than average demand.

Optimal production quantity = 16,000 unitsExpected supply chain profit = $1,014,500.


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Global Optimization

Swimsuit Example

FIGURE 4-4: Profit using global optimization strategy

Global Optimization and Supply


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Global Optimization and Supply

Contracts

Unbiased decision maker unrealistic Requires the firm to surrender decision-making power to an unbiased

decision maker

Carefully designed supply contracts can achieve as much as

global optimizationGlobal optimization does not provide a mechanism to allocate

supply chain profit between the partners. Supply contracts allocate this profit among supply chain members.

Effective supply contracts allocate profit to each partner in a

way that no partner can improve his profit by deciding todeviate from the optimal set of decisions.

I l t ti D b k f


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Implementation Drawbacks of

Supply Contracts

Buy-back contracts Require suppliers to have an effective reverse logistics system

and may increase logistics costs.

Retailers have an incentive to push the products not under thebuy back contract.

Retailers risk is much higher for the products not under the buyback contract.

Revenue sharing contracts Require suppliers to monitor the buyers revenue and thus

increases administrative cost.

Buyers have an incentive to push competing products withhigher profit margins. Similar products from competing suppliers with whom the buyer

has no revenue sharing agreement.


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2. Contracts for Make-to-Stock Supply Chains

Previous contracts examples were with Make-to-

Order supply chains

What happens when the supplier has a Make-to-Stocksituation?

Supply Chain for Fashion Products


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Supply Chain for Fashion Products

Ski-Jackets

Manufacturer produces ski-jackets prior to receivingdistributor orders

Season starts in September and ends by December.

Production starts 12 months before the selling season

Distributor places orders with the manufacturer six months later.

At that time, production is complete; distributor receives firmsorders from retailers.

The distributor sales ski-jackets to retailers for $125 per unit.

The distributor pays the manufacturer $80 per unit.

For the manufacturer, we have the following information: Fixed production cost = $100,000.

The variable production cost per unit = $55

Salvage value for any ski-jacket not purchased by the distributors= $20.


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Profit and Loss

For the manufacturer Marginal profit = $25

Marginal loss = $60.

Since marginal loss is greater than marginal profit, themanufacturer should produce less than average demand, i.e., lessthan 13, 000 units.

How much should the manufacturer produce? Manufacturer optimal policy = 12,000 units

Average profit = $160,400.

Distributor average profit = $510,300.Manufacturer assumes all the risk limiting its

production quantity

Distributor takes no risk

M k t St k


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Make-to-Stock

Ski Jackets

FIGURE 4-5: Manufacturers expected profit


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Pay-Back Contract

Buyer agrees to pay some agreed-upon price for anyunit produced by the manufacturer but not purchased.

Manufacturer incentive to produce more units

Buyers risk clearly increases.Increase in production quantities has to compensate

the distributor for the increase in risk.

P B k C t t


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Pay-Back Contract

Ski Jacket Example

Assume the distributor offers to pay $18 for each unit producedby the manufacturer but not purchased.

Manufacturer marginal loss = 55-20-18=$17

Manufacturer marginal profit = $25.

Manufacturer has an incentive to produce more than averagedemand.

Manufacturer increases production quantity to 14,000 units

Manufacturer profit = $180,280

Distributor profit increases to $525,420.

Total profit = $705,400Compare to total profit in sequential supply chain

= $670,000 (= $160,400 + $510,300)

P B k C t t


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Pay-Back Contract

Ski Jacket Example

FIGURE 4-6: Manufacturers average profit (pay-back contract)

P B k C t t


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Pay-Back Contract

Ski Jacket Example (cont)

FIGURE 4-7: Distributors average profit (pay-back contract)


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Cost-Sharing Contract

Buyer shares some of the production cost with the

manufacturer, in return for a discount on the

wholesale price.

Reduces effective production cost for themanufacturer

Incentive to produce more units

C t Sh i C t t


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Ski-Jacket Example

Manufacturer agrees to decrease the wholesale pricefrom $80 to $62

In return, distributor pays 33% of the manufacturerproduction cost

Manufacturer increases production quantity to 14,000Manufacturer profit = $182,380

Distributor profit = $523,320

The supply chain total profit = $705,700

Same as the profit under pay-back contracts

C t Sh i C t t


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Ski-Jacket Example

FIGURE 4-8: Manufacturers average profit (cost-sharing contr

C t Sh i C t t


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Ski-Jacket Example (cont)

FIGURE 4-9: Distributors average profit (cost-sharing contract


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Implementation Issues

Cost-sharing contract requires manufacturer to shareproduction cost information with distributor

Agreement between the two parties:

Distributor purchases one or more components that themanufacturer needs.

Components remain on the distributor books but are shippedto the manufacturer facility for the production of thefinished good.


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Global Optimization

FIGURE 4-10: Global optimization

3 Contracts with Asymmetric


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3. Contracts with Asymmetric

Information

Implicit assumption so far: Buyer and supplier share

the same forecast

Inflated forecasts from buyers a reality

How to design contracts such that the informationshared is credible?


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Two Possible Contracts

Capacity Reservation Contract Buyer pays to reserve a certain level of capacity at the

supplier

A menu of prices for different capacity reservationsprovided by supplier

Buyer signals true forecast by reserving a specific capacitylevel

Advance Purchase Contract Supplier charges special price before building capacity

When demand is realized, price charged is different Buyers commitment to paying the special price reveals the

buyers true forecast

4 Contracts for Non Strategic


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4. Contracts for Non-Strategic

Components

Variety of suppliers

Market conditions dictate price

Buyers need to be able to choose suppliers and change

them as neededLong-term contracts have been the tradition

Recent trend towards more flexible contracts

Offers buyers option of buying later at a different price thancurrent

Offers effective hedging strategies against shortages


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Long-Term Contracts

Also calledforward or fixed commitment contracts

Contracts specify a fixed amount of supply to be

delivered at some point in the future

Supplier and buyer agree on both price and quantityBuyer bears no financial risk

Buyer takes huge inventory risks due to:

uncertainty in demand inability to adjust order quantities.


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Flexible or Option ContractsBuyer pre-pays a relatively small fraction of the product

price up-frontSupplier commits to reserve capacity up to a certain level.

Initial payment is the reservation price orpremium.

If buyer does not exercise option, the initial payment islost.

Buyer can purchase any amount of supply up to theoption level by:paying an additional price (execution price orexercise

price)

agreed to at the time the contract is signed Total price (reservation plus execution price) typically

higher than the unit price in a long-term contract.

Fl ibl O ti C t t


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Flexible or Option Contracts

Provide buyer with flexibility to adjust order quantities

depending on realized demandReduces buyers inventory risks.

Shifts risks from buyer to supplier Supplier is now exposed to customer demand uncertainty.

Flexibility contracts Related strategy to share risks between suppliers and

buyers

A fixed amount of supply is determined when the contractis signed

Amount to be delivered (and paid for) can differ by nomore than a given percentage determined upon signing thecontract.


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Spot Purchase

Buyers look for additional supply in the open market.

May use independent e-markets or private e-markets

to select suppliers.

Focus: Using the marketplace to find new suppliers

Forcing competition to reduce product price.


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Portfolio Contracts

Portfolio approach to supply contracts

Buyer signs multiple contracts at the same time optimize expected profit

reduce risk.

Contracts

differ in price and level of flexibility

hedge against inventory, shortage and spot price risk.

Meaningful for commodity products a large pool of suppliers each with a different type of contract.


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Appropriate Mix of Contracts

How much to commit to a long-term contract? Base commitment level.

How much capacity to buy from companies selling optioncontracts? Option level.

How much supply should be left uncommitted? Additional supplies in spot market if demand is high

Hewlett-Packards (HP) strategy for electricity or memoryproducts About 50% procurement cost invested in long-term contracts

35% in option contracts Remaining is invested in the spot market.

Risk Trade-Off in Portfolio


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Contracts

If demand is much higher than anticipated Base commitment level + option level < Demand,

Firm must use spot market for additional supply.

Typically the worst time to buy in the spot market

Prices are high due to shortages.

Buyer can select a trade-off level between price risk, shortagerisk, and inventory risk by carefully selecting the level of long-term commitment and the option level. For the same option level, the higher the initial contract commitment,

the smaller the price risk but the higher the inventory risk taken by the

buyer. The smaller the level of the base commitment, the higher the price and

shortage risks due to the likelihood of using the spot market.

For the same level of base commitment, the higher the option level, thehigher the risk assumed by the supplier since the buyer may exercise

only a small fraction of the option level.



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Contracts

Low High

Option level

Base commitment level

HighInventory risk

(supplier)N/A*

LowPrice and shortage

risks (buyer)

Inventory risk (buyer)

*For a given situation, either the option level or the base commitment level may be high, but not

both.


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Design Collaboration

50-70 percent of spending at a manufacturer isthrough procurement

80 percent of the cost of a purchased part is fixed inthe design phase

Design collaboration with suppliers can result inreduced cost, improved quality, and decreased time tomarket

Important to employ design for logistics, design formanufacturability

Manufacturers must become effective designcoordinators throughout the supply chain


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DESIGNING FOR MANUFACTURING

The designers consideration of the organizations

manufacturing capabilities when designing a product

Concurrent EngineeringComputer-Aided Design (CAD)Recycling

Remanufacturing

Design for DisassemblyComponent Communality


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Concurrent Engineering To achieve a smoother transition from product design to production, and to

decrease product development time, many companies are Usingsimultaneous development, or concurrent engineering.

In its narrowest sense, it brings design and manufacturing engineering

people together early in the design phase to simultaneously develop theproduct and the processes for creating the product.

May mean to include include manufacturing personnel (e.g., materialsspecialists) and marketing and purchasing personnel in loosely integrated,cross-functional teams.


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Computer-Aided Design (CAD)Computer-aided design (CAD) , Product design using

computer graphics.


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RecyclingRecovering materials for future use.

Cost savings., Environment concerns. Environmental regulations

An interesting note: Companies that want to do business

in the European Economic Com munity must show that a

specified proportion of their products are recyclable.


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Design for Recycling

Design for Recycling (DFR), referring to productdesign that takes into account the ability to

disassemble a used product to recover the recyclableparts.


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RemanufacturingRemanufacturing refers to refurbishing used products by

replacing worn-out or defective components, and

reselling the products.

This can be done by the original manufacturer, or anothercompany.

Among the products that have remanufactured components are

automobiles, printers, copiers, cameras, computers, and telephones.


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Design for Disassembly

Design for Disassembly (DFD) includes using fewerparts and less material, and using snap-fits where

possible instead of screws or nuts and bolts.


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The Purchasing Process

The process in which the supplier sends product in response toorders placed by the buyer

Goal is to enable orders to be placed and delivered on scheduleat the lowest possible overall cost

Two main categories of purchased goods: Direct materials: components used to make finished goods

Indirect materials: goods used to support the operations of a firm

Differences between direct and indirect materials listed in Table 14-7

Focus for direct materials should be on improving coordinationand visibility with supplier

Focus for indirect materials should be on decreasing thetransaction cost for each order

Procurement for both should consolidate orders where possibleto take advantage of economies of scale and quantity discounts

Manual Purchasing Process (Simplified)


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Manual Purchasing Process (Simplified)

User/Requisition

Storage/

Warehouse

Purchase

Accounting

Suppliers

Yes No

MR

PR

PO

PO

Invoice & PO

DO

Invoice

MR

MR= Material Requisition

PR = Purchase Requisition

PO = Purchase Order

DO = Delivery Order

RFQ/

RFP

& SO

RFQ= Request for Quotation

RFP = Request for Proposal

SO = Sales Order


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e-Procurement

MaterialUser

PurchasingDepartment/Buyer

Supplier

Material

Requisition

into ITsystem

Supplier

selection &

Issue PO

Bids

evaluation

Assigns

suppliers to

requisition

on B2Bsystem for

bidding

and

specificclosing

date and

other

conditions

Extracts &

merges

material

requisitiondata into

Internet

based B2B

system

Purchase

Order

Product Categorization by Value


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Product Categorization by Value

and Criticality (Figure 14.2)

Critical Items Strategic Items

General Items Bulk Purchase

Items

Low

Low

High

HighValue/Cost

Critica

lity


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Sourcing Planning and Analysis

A firm should periodically analyze its procurementspending and supplier performance and use thisanalysis as an input for future sourcing decisions

Procurement spending should be analyzed by part and

supplier to ensure appropriate economies of scaleSupplier performance analysis should be used to build

a portfolio of suppliers with complementary strengths

Cheaper but lower performing suppliers should be used tosupply base demand

Higher performing but more expensive suppliers should beused to buffer against variation in demand and supply fromthe other source

Making Sourcing


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a g Sou c g

Decisions in Practice

Use multifunction teams

Ensure appropriate coordination across regions

and business units

Always evaluate the total cost of ownershipBuild long-term relationships with key suppliers

scm-7_sourcing decision in a supply chain

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