Supply Chain Management

1
Supply Chain Management

• Lecture 22

2
Outline

• Homework 6
• Today
• Start with Chapter 14
• Sections 1, 2, 3, 4, 6, 7, 8, 9
• Next week
• Guest lecture
• Paul Dodge, SVP Supply Chain at ProBuild
• Finish Chapter 14 and start with Chapter 15

3
Detailed Outline

• Thursday November 12 Chap 14
• Tuesday November 17 Paul Dodge guest lecture
• Thursday November 19 Chap 14, 15
• Fall break
• Thanksgiving
• Tuesday December 1 Chap 15
• Thursday December 3 Simulation Game briefing
• Tuesday December 8 Chap 15, review
• Thursday December 10 Simulation Game

4
Drivers of Supply Chain Performance

• Facilities
• Inventory
• Transportation
• Sourcing
• Pricing
• Information

(Chapters 4 and 5) (Chapters 10, 11,
12) (Chapters 4 and 13) (Chapter 14) (Chapter
15) (Chapter 16)
5
Comparing Different Suppliers

• Green Thumb, uses 1000 bearings per week for
  their production of lawn mowers and snow blowers.
  Green Thumb is considering one of two suppliers
• Supplier A charges 1.00 per bearing
• Supplier B charges 0.97 per bearing

Which supplier should Green Thumb choose?
6
Comparing Different Suppliers

• Green Thumb, uses 1000 bearings per week for
  their production of lawn mowers and snow blowers.
  Green Thumb uses a holding cost of 25 and is
  considering one of two suppliers
• Supplier A charges 1.00 per bearing and requires
  an order size of 2000
• Supplier B charges 0.97 per bearing and requires
  an order size of 8000

Which supplier should Green Thumb choose?
7
Comparing Different Suppliers

• Green Thumb, uses on average 1000 bearings per
  week, with a standard deviation of 300, for their
  production of lawn mowers and snow blowers. It
  monitors inventory continuously and aims a cycle
  service level of 95. Green Thumb uses a holding
  cost of 25 and is considering one of two
  suppliers
• Supplier A charges 1.00 per bearing and requires
  an order size of 2000. The supplier lead time is
  2 weeks
• Supplier B charges 0.97 per bearing and requires
  an order size of 8000. The supplier lead time is
  6 weeks

Which supplier should Green Thumb choose?
8
Comparing Different Suppliers

• Green Thumb, uses on average 1000 bearings per
  week, with a standard deviation of 300, for their
  production of lawn mowers and snow blowers. It
  monitors inventory continuously and aims a cycle
  service level of 95. Green Thumb uses a holding
  cost of 25 and is considering one of two
  suppliers
• Supplier A charges 1.00 per bearing and requires
  an order size of 2000. The supplier lead time is
  2 weeks, with a standard deviation of 1 week
• Supplier B charges 0.97 per bearing and requires
  an order size of 8000. The supplier lead time is
  2 weeks, with a standard deviation of 4 weeks

Which supplier should Green Thumb choose?
9
Comparing Different Suppliers

• Green Thumb, uses on average 1000 bearings per
  week, with a standard deviation of 300, for their
  production of lawn mowers and snow blowers. It
  monitors inventory continuously and aims a cycle
  service level of 95. Green Thumb uses a holding
  cost of 25 and is considering one of two
  suppliers
• Supplier A charges 1.00 per bearing and requires
  an order size of 2000. The supplier lead time is
  2 weeks, with a standard deviation of 1 week.
  Quality is poor
• Supplier B charges 0.97 per bearing and requires
  an order size of 8000. The supplier lead time is
  2 weeks, with a standard deviation of 4 weeks.
  Quality is good

Which supplier should Green Thumb choose?
10
Sourcing Decisions in a Supply Chain
According to a KPMG survey, 77 regarded cost to
be as the most important or second most
important factor in all of their outsourcing
decisions
11
The Role of Sourcing in a Supply Chain

• Sourcing is the entire set of business processes
  required to purchase goods (raw materials,
  components, products) and services

For any supply chain, the most significant
decision is whether to outsource the function or
perform it in-house
12
Outsourcing versus off-shoring

• What is the difference?

A firm off-shores a supply chain function if it
maintains ownership but moves the production
facility offshore
A firm outsources if the firm hires an outside
firm to perform an operation rather than
executing the operation within the firm
13
Outsourcing in Practice
India and Philippines account for 50 of the
worlds business process outsourcing market
Source The A.T. Kearney Global Souring Index,
2009
14
Outsourcing in Practice
Source The A.T. Kearney Global Souring Index,
2009
15
Outsourcing in Practice

• Trends in outsourcing
• North Africa and Middle East are rising on the
  global sourcing index
• North America accounts for 70 of offshore
  outsourcing spending, but European countries are
  catching up as their spending has risen faster
• A move toward more outsourcing providers
• Experienced labor is key to success

Source The A.T. Kearney Global Souring Index,
2009
16
In-House or Outsource

• The decision to outsource is based on the growth
  in supply chain surplus provided by the third
  party and the increase in risk by using a third
  party

17
How do third parties increase the supply chain
surplus?

• Lower cost and higher quality
• Specialized third party is further along the
  learning curve for some supply chain activity
• Capacity aggregation
• Increase SC surplus by aggregating demand across
  multiple firms and gaining economies of scale

Intels family of mobile PC processors gives
consumers more choice by enabling PC makers to
design notebooks of every shape and size
18
How do third parties increase the supply chain
surplus?

• Transportation aggregation
• Increases supply chain surplus by aggregating
  transportation across a variety of shippers

19
How do third parties increase the supply chain
surplus?

• Warehousing aggregation
• Increases SC surplus by aggregating warehousing
  needs over several customers and lowering
  facility cost
• Receivables aggregation
• Increases SC surplus by aggregating receivables
  reducing collection cost (especially when
  retailing is fragmented)

Safexpress provides an unrivalled range of
logistics and supply chain solutions including
door to door distribution and single source
invoicing
20
How do third parties increase the supply chain
surplus?

• Procurement aggregation
• Increases SC surplus by aggregating procurement
  for many small players to facilitate economies of
  scale

Offering members preferred pricing and
volume-based rebates on truck equipment and
services through a community-driven purchasing
system
21
How do third parties increase the supply chain
surplus?

• Information aggregation
• Increases SC surplus by aggregating information
  and reducing search cost for the (online) customer

Provides the North American Trucking Industry
with the most comprehensive freight matching
service
22
How do third parties increase the supply chain
surplus?

• A third party may be able to provide a
  sustainable growth of the surplus by aggregating
  capacity, inventory, inbound or outbound
  transportation, warehousing, procurement,
  information, receivables, or relationships to a
  level that the firm cannot on its own
• A growth in surplus may also occur if the third
  party has lower costs or higher quality because
  of specialization or learning

23
How do third parties increase the supply chain
surplus?

• Three important factors that affect the increase
  in surplus
• Scale
• Uncertainty
• Specificity

A firm gains the most from outsourcing if its
needs are small, highly uncertain, and shared by
others
24
Transportation and Sourcing
What factors lead Wal-Mart to own its trucks
although many retailers outsource their
transportation?
25
How do third parties increase risk?

• Less control over the function being outsourced
• Reduced customer/supplier contact
• Loss of internal capability and increase in third
  partys power
• Increases complexity in coordination, and thus
  increases coordination cost
• It is easy to underestimate the effort to
  coordination
• Leakage of sensitive information
• In case intellectual property needs to be shared
  with third parties, there is the danger of leakage

What are ways to mitigate these risks?
26
Sourcing Process

• Once a decision to outsource has been made, the
  sourcing process includes

Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
27
Sourcing Process

• Supplier scoring and assessment
• Process used to rate suppliers
• Supplier selection
• Choose the appropriate supplier(s)
• Design collaboration
• Work together with supplier when designing
  components for the final product
• Procurement
• Process placing orders and receiving orders from
  supplier(s)
• Sourcing planning and analysis
• Analyze spending across various suppliers,
  identify opportunities for decreasing cost

Supplier scoring and assessment
Supplier selection and contract negotiation
Designcollaboration
Procurement
Sourcing planning and analysis
28
Sourcing Process
Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
29
Supplier scoring and assessment

• Common fundamental mistake when choosing a
  supplier
• Only focus on quoted price

Supplier performance should be compared on the
basis of the suppliers impact on total cost
30
Factors besides purchase price that influence
total cost

• Replenishment lead times
• Does it pay to select a more expensive supplier
  with a shorter lead time?
• If lead time grows, safety inventory grows
  proportionally to the square root of the
  replenishment lead time
• On-time performance
• Is a more reliable supplier worth the extra
  pennies?
• If variability of lead time grows, the required
  safety inventory at the firm grows

31
Factors besides purchase price that influence
total cost

• Supply flexibility
• The less flexible a supplier is, the more
  lead-time variability it will display as order
  quantities change
• Delivery frequency/lot size
• Delivery frequency affects the transportation
  cost, lot size affects the cycle inventory
  holding cost
• Supply quality
• Quality affects unit price and lead time as
  follow-up orders may need to be fulfilled to
  replace defective products
• Inbound transportation cost
• Sourcing a product overseas may have lower
  product cost, but generally incurs a higher
  inbound transportation cost

32
Factors besides purchase price that influence
total cost

• Pricing terms
• For example, quantity discounts (and the impact
  it has on cycle inventory)
• Information coordination capability
• Good coordination results in better planning and
  ultimately lower production, safety inventory,
  and transportation cost
• Design collaboration capability
• Can help reduce all cost, improve quality, and
  decrease time-to-market
• Exchange rates, taxes, and duties
• Important for global supply chains as it affects
  the unit price
• Supplier viability
• The likelihood that the supplier will be around
  to fulfill the promises it makes (uncertainty
  increases safety inventory)

33
Factors besides purchase price that influence
total cost
34
Sourcing Process
Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
35
Sourcing Planning and Analysis

• A firm should periodically analyze its (1)
  procurement spending and (2) supplier performance
  and use this analysis as an input for future
  sourcing decisions
• Supplier performance analysis should be used to
  build a portfolio of suppliers with complementary
  strengths
• Cheaper but lower performing suppliers should be
  used to supply base demand
• Higher performing but more expensive suppliers
  should be used to buffer against variation in
  demand and supply from the other source

36
Sourcing Process
Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
37
Supplier Selection and Contract Negotiation

• Before selecting suppliers, a firm must decide
  whether to use single sourcing or multiple
  suppliers
• What are benefits of having one supplier?
• Single sourcing guarantees the supplier
  sufficient business
• What are benefits of having more than one
  supplier?
• Having multiple sources ensures a degree of
  competition and also the possibility of a backup
  should a source fail to deliver

38
Contracts and Supply Chain Performance

• A contract should be structured to increase the
  firms profits and supply chain profits

Many shortcomings in supply chain performance
occur because the buyer and suppliers are two
different entities, each trying to optimize its
own profits
39
Contracts and Supply Chain Performance

• Example
• Consider a music store that sells compact discs.
  The supplier buys/manufactures compact discs at
  1 per unit and sells them to the music store at
  5 per unit. The retailer sells each disc to the
  end customer at 10. At this price demand is
  normally distributed, with a mean of 1,000 and a
  standard deviation of 300. The retailer has a
  margin of 5 per disc and can potentially lose 5
  for each unsold disc

Manufacturer
Distributor
Retailer
Customer
10
5
1
40
Contracts and Supply Chain Performance
10
5
5
1
0
(p-c)/(p-s) 0.5
F-1(CSL,?,?) 1,000
(see 12.3) 3,803
1,0004 4,000
Total profit 3,803 4,000 7,803
Manufacturer
Distributor
Retailer
Customer
10
5
1
41
Contracts and Supply Chain Performance
10
1
0
(p-c)/(p-s) 0.9
F-1(CSL,?,?) 1,384
versus 7,803
(see 12.3) 8,474
Manufacturer
Distributor
Retailer
Customer
10
1
42
Contracts and Supply Chain Performance
Manufacturer
Distributor
Retailer
Customer
10
5
1
Double marginalization results in suboptimal
order quantity and lower supply chain profits
43
Netflix

• Blockbuster owns its DVDs
• Netflix has established revenue sharing contracts
  with most studios
• DVDs are purchased at cost
• Netflix pays on average 1.40 to the studios each
  time their title is rent
• At end of contract Netflix acquires some
  percentages of the units for retention or sale,
  the remaining DVDs are destroyed or returned to
  the original studio

44
Sourcing Process
Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
45
Design Collaboration

• 50-70 percent of spending at a manufacturer is
  through procurement
• 80 percent of the cost of a purchased part is
  fixed in the design phase
• Design collaboration with suppliers can result in
  reduced cost, improved quality, and decreased
  time to market

46
Design Collaboration

• Design for logistics
• Attempts to reduce transportation, handling, and
  inventory cost
• Coors redesigned glass bottle reduced
  transportation cost
• Design for manufacturability
• Attempts to design products for ease of
  manufacture (part commonality, designing
  symmetrical parts, designing parts to provide
  access for catalog parts)
• Manufacturers must become effective design
  coordinators throughout the supply chain
• Ford designs with its suppliers (some subsystems
  are entirely designed and manufactured by their
  suppliers)

47
Sourcing Process
Supplier scoring and assessment
Designcollaboration
Supplier selection and contract negotiation
Procurement
Sourcing planning and analysis
48
Procurement

• Procurement transactions begin with the buyer
  placing the order and end with the buyer
  receiving and paying for the order
• Goal is to enable orders to be placed and
  delivered on schedule at the lowest possible
  overall cost
• Two main categories of purchased goods
• Direct materials components used to make
  finished goods
• Memory, hard drives, and CD drives are direct
  materials for a PC
• Indirect materials goods used to support the
  operations of a firm
• PCs are indirect materials for a car manufacturer

49
Product Categorization by Value and Criticality
High
Critical items(i.e. components with long lead
times) Ensure availability
Strategic items(i.e. subsystems, electronics
for an auto manufacturer) Ensure long term
relationship
Criticality
General items(mostly indirect materials) Ensure
low cost
Bulk purchase items(small parts,
packaging) Ensure low cost
Low
Low
High
Value/Cost
50
Product Categorization by Value and Criticality
An auto manufacturer sources both office
supplies and subsystems such as seats. What, if
any, difference in sourcing strategy would you
recommend for the two types of products?
51
Outsourcing Logistics

• A third-party 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

52
Services Provided by 3PLs
How has globalization impacted sourcing decisions?
53
Outsourcing Logistics

• A fourth-party logistics (4PL) provider manages
  other 3PLs. Whereas a 3PL targets a function, a
  4PL targets management of an entire process

54
Best Practice 4PL

• Li Fung
• The firm aggregates demand across hundreds of
  customers, capacity across thousands of
  suppliers, and uses detailed information to match
  supply and demand in the most cost effective
  manner
• By sourcing appropriately Li Fung gets around
  regional trade umbrellas such as the EU and NAFTA

55
How do 4PLs Add Value?

• How do 4PLs add value to a firm managing its own
  logistics providers?

The fundamental advantage that 4PLs may provide
comes from greater visibility and coordination
over a firms supply chain and improved handoffs
between logistics providers