BMTS 2063 SUPPLY CHAIN

STRATEGIC SOURCING

Chapter 2
Sourcing Decisions In A
Supply Chain (1)
THE ROLE OF SOURCING IN A SUPPLY CHAIN
the set of business processes required to purchase goods and services

Supplier scoring and assessment

Supplier selection and contract negotiation

Sourcing processes Design collaboration

include:
Procurement

Sourcing planning and analysis

BENEFITS OF EFFECTIVE SOURCING DECISIONS
More efficient
The right source can result Better economies of scale procurement transactions
a higher quality and lower can be achieved if orders can significantly reduce
cost. are aggregated the overall cost of
purchasing

Design collaboration can

Good procurement
result in products that are Appropriate supplier
processes can facilitate
easier to manufacture and contracts can allow for
coordination with
distribute, resulting in the sharing of risk
suppliers
lower overall costs

Firms can achieve a lower

purchase price by
increasing competition
through the use of
auctions
 IN-HOUSE OR OUTSOURCE
The decision is based on

Growth in the
supply chain
Outsource is when;
surplus by the
third party
The growth in
surplus is large
In-house is when;
Increase in with a small
risk incurred increase in Growth in surplus is small or the increase in risk is large.
by using a risk.
third party
INCREASE SC SURPLUS BY THIRD PARTIES

decrease the SC
By increase value cost relative to flows to a higher
Able to aggregate
for the customer firm’s performing level than the
SC assets or
or the task in – firm itself can.
house.
MECHANISMS TO GROW THE SURPLUS.
Transportation aggregation
Capacity aggregation Inventory aggregation by transportation
intermediaries

Transportation aggregation
Warehousing aggregation Procurement aggregation
by storage intermediaries

Information aggregation Receivable aggregation Relationship aggregation

Lower costs and higher

quality
RISKS OF USING THIRD PARTY (OUTSOURCE)

Underestimation of the Reduced customer/

The process is broken.
cost of coordination. supplier contact.

Loss of internal
Leakage of sensitive data
capability and growth in Ineffective contracts.
and information.
third-party power.

Negative reputational
Loss of SC visibility.
impact.
STRATEGIC FACTORS IN SOURCING DECISIONS

Strategic factors

Economic
factors Support the business
strategy

Risks
Improve firm focus
SUPPLIER SCORING AND ASSESSMENT

Supplier
performance There are several
should be other factors
compared on the besides purchase
basis of the price that influence
supplier’s impact total cost
on total cost
 TOTAL COST OF OWNERSHIP (TCO)

All SC costs of sourcing a good or service from a particular supplier

Considering these THREE

‘Buckets’

Acquisition costs

Post-ownership costs Ownership costs

 Acquisition costs

• All costs associated with the purchase of material from a supplier

until it reaches the buyer and is ready to use

Costs of acquisition consists of

supplier Overhead of
terms incoming managing the
supplier taxes and delivery
affecting quality relationship
price, duties, costs,
financing costs. and planning
costs, the
purchases.
 Ownership costs

• All costs associated with purchased part, from when it arrives from
the supplier, to when the finished product is sold to the customers

includes

production production
inventory warehousing conversion
manufacturing, quality cycle time
cost, cost, costs,
costs, costs
Post-ownership costs

• All costs incurred by the firm after the

finished product has reached the end
customers warranty
reputational costs,
costs

product environmental
liability costs, costs,
 FACTORS INFLUENCING TCO
Performance Category Category Components Quantifiable?
Acquisition costs
Supplier price Labor, material, and overhead Yes
Supplier terms Net payment terms, delivery frequency, minimum lot size, quantity discount Yes
Taxes and duties All tarifs and compliance costs Yes
Delivery costs All transportation costs from source to destinatio, packaging costs Yes
Incoming quality costs Cost of inspection, defectives and rework Yes
Management costs Cost of managing and planning the purchase Difficult
Ownership costs
Inventory costs Supplier inventory, including raw material, in process and finished goods inventory in sc Yes
Warehousing costs Warehousing and material handling costs to support additional inventory Yes
Manufacturing costs Cost of manufacturing associated with the sourced part Yes
Production quality costs Impact of sourced part on finished product quality Difficult
Cycle time costs Impact of sourced part on production cycle time Yes
Post-ownership costs
Reputation Reputation impact of quality problems No
Warranty and product liability
Warranty and product liability costs associated with sourced part Difficult
costs
Environmental costs Environmental costs affected by sourced part Difficult
Replenishment lead time, on-time performance, flexibility, information coordination To some
Supplier capabilities
capability, design coordination capability, supplier viability extent
 SUPPLIER ASSESSMENT FACTORS
Replenishment Lead
On-Time Performance Supply Flexibility
Time

Delivery Frequency / Transportation Cost

Supply Quality
Minimum Lot Size (Inbound)

Information Design Collaboration

Pricing Terms
Coordination Capability Capability

Local Inflation in
Exchange Rates, Taxes,
Supplier Viability Materials and Labor
Duties
costs
SUPPLIER SELECTION

Single Multiple
Sourcing Suppliers
How many Suppliers to Use
Single-source- a risky proposition. Current trends favours fewer sources.

Reasons Favouring a Single Reasons Favouring Multiple

Supplier Suppliers

- To establish a good - Need capacity

relationship - Spread risk of supply
- Less quality variability interruption
- Transportation economies - Create competition
- Proprietary product or - Information
process - Dealing with special kinds
- Volume too small to spilt of business
 Single SUPPLIER SELECTION
Sourcing

It is sufficient for SS
when

Supplier must make a

significant buyer- In the form of Plant and equipment to
specific investment. produce the part for the
specific buyer

The needs for material

sequencing Expertise that need to be
developed
 SUPPLIER SELECTION
Multiple
Suppliers
MS allows to

Ensure a degree of Lower the risks by having

competition backups
 SUPPLIER SELECTION

AUCTIONS
NEGOTIATIONS
 AUCTIONS
NEGOTIATIONS
competitive bids,
Supplier selection can
direct
be performed through
reverse auctions negotiations

Sealed-bid first-price auctions

English auctions

Dutch auctions

Second-price (Vickery) auctions

 Best used when
quantifiable AUCTIONS
acquisition cost is
the primary
component of
total cost
NOT when ownership and post-
ownership cost are significant

Must conduct the qualification process –

specify the performances expectations
Primarily along other dimensions than price
based on
unit price
If non-price attributes is high, auction is
not suitable

Auction’s • bidders to reveal the underlying cost

purpose : structure, and choose the lowest cost
 AUCTIONS The goal is to ideally
NEGOTIATIONS create a situation in
which the surplus
grows, and leads to
Key to Win-win outcome that increasing the size of
negotiations grows the surplus* the pie they have to
share
The Bargaining
The difference of the value of buyer and sellers
Surplus

A good negotiations should be

Have a clear idea of one’s own value Look for a fair outcome based on equally
and as good an estimate of the third or equitably dividing the bargaining
party’s value as possible. surplus or dividing it based on needs.
Part 2
CONTRACTS AND SUPPLY CHAIN PERFORMANCE
Buyback
Contracts

Contracts for Product

Quantity Contracts to Coordinate
Availability and
Flexibility Supply Chain Costs
Supply Chain Profits
Contracts

Revenue-
Sharing
Contracts
Contracts to Increase Agent Contracts to Induce
Effort Performance Improvement
 CONTRACTS, RISKS & REWARD IN SC
To improve overall profits, the supplier must share risk, in a way it will encourage the buyer to purchase more and
increase the level of product availability.

Revenue Three approaches in

sharing risk sharing efforts
through contracts
Buybacks or
returns
 BUYBACKS OR RETURNS
A clause where allows a retailer to return unsold inventory up to a specified amount,
at an agreed-upon price.

Buyback
Contract
Specifies on the wholesale price along with
buyback price, in allowing return the
unsold units at the end of the season.
 BUYBACKS OR RETURNS
benefits

Increases the optimal

Most effective for
order quantity for the
Allows a retailer to products with low
retailer, resulting in
return unsold inventory variable cost, such as
higher product
up to a specified amount music, software, books,
availability and higher
at an agreed upon price magazines, and
profits for both the
newspapers
retailer and the supplier
 BUYBACKS OR RETURNS

Drawback of buyback

Increase information distortion through the supply

Leads to surplus inventory that Leads the retailer to
chain, which leads the entire SC reacting to the
must be salvaged or disposed. exert less effort to sell
order placed by the retailer and not to actual
This return increase sc costs. the products
customer demand,
 REVENUE SHARING

The manufacturer
charges the retailer a Best suited to the
lower wholesale products that has
price but shares a low variable cost and
fraction of the a high cost of return.
retailer’s revenue.
 REVENUE SHARING CONTRACTS

Decreases the cost per

The buyer pays a minimal unit charged to the
amount for each unit purchased benefits retailer, which
from the supplier effectively decreases the
cost of overstocking

Can result in supply chain information distortion, however, just as in the case
Drawback
of buyback contracts
 QUANTITY FLEXIBILITY

The
manufacturer Its best suited to Increased
allows the manufacturer or overall
retailer to supplier that supply Common for
change the selling or supply Better matching chain components in
quantity to multiple of supply and profits if the electronics
ordered retailers with demand the and computer
(within limits) independent supplier industries.
after demand as it has flexible
observing the allows capacity
demand. uncertainties to
be aggregated
by the supplier.
 CONTRACTS TO COORDINATE
SUPPLY CHAIN COSTS
Differences in costs at the buyer and supplier can lead to decisions that increase
total supply chain costs

Replenishment order size placed by the buyer. The buyer’s EOQ

Example:
does not take into account the supplier’s costs.

A quantity discount contract may encourage the

Quantity discounts lead to
buyer to purchase a larger quantity (which would be
information distortion because of
lower costs for the supplier), which would result in
order batching
lower total supply chain costs
CONTRACTS TO INCREASE AGENT EFFORT
There are many instances in a supply chain where an agent acts on the behalf of a principal
and the agent’s actions affect the reward for the principal

A car dealer who sells the cars of a manufacturer, as well as those of other
Example:
manufacturers

Examples of contracts to increase agent

However, Threshold contracts
effort include two-part tariffs and threshold
increase information distortion
contracts
 CONTRACTS TO INDUCE
PERFORMANCE IMPROVEMENT

A buyer may want performance improvement A shared savings contract provides the
from a supplier who otherwise would have supplier with a fraction of the savings that
little incentive to do so result from the performance improvement

but where the effort

Particularly effective where the benefit
for the improvement
from improvement accrues primarily to the
comes primarily from
buyer,
the supplier