Chapter 7: Strategic Sourcing

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Chapter 7 Strategic Sourcing
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Strategic Sourcing

• Strategic Sourcing is the development and
  management of supplier relationships to acquire
  goods and services in a way that aids in
  achieving the immediate needs of the business

Ford Manufacturing Supply Chain
http//www.covisint.com/
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What is the bullwhip effect?

• Demand variability increases as you move up the
  supply chain from customers towards supply

Customer
Retailer
Distributor
Factory
Tier 1 Supplier
Equipment
First noticed regarding Pampers
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Bullwhip effect in the US PC supply chain
Annual percentage changes in demand (in s) at
three levels of the semiconductor supply chain
personal computers, semiconductors and
semiconductor manufacturing equipment.
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Consequences of the bullwhip effect

• Inefficient production or excessive inventory.
• Low utilization of the distribution channel.
• Necessity to have capacity far exceeding average
  demand.
• High transportation costs.
• Poor customer service due to stockouts.

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Causes of the bullwhip effect

• Order synchronization
• Order batching
• Trade promotions and forward buying
• Reactive and over-reactive ordering
• Shortage gaming

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Order synchronization

• Customers order on the same order cycle, e.g.,
  first of the month, every Monday, etc.
• The graph shows simulated daily consumer demand
  (solid line) and supplier demand (squares) when
  retailers order weekly 9 retailers order on
  Monday, 5 on Tuesday, 1 on Wednesday, 2 or
  Thursday and 3 on Friday.

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Order batching

• Retailers may be required to order in integer
  multiples of some batch size, e.g., case
  quantities, pallet quantities, full truck load,
  etc.
• The graph shows simulated daily consumer demand
  (solid line) and supplier demand (squares) when
  retailers order in batches of 15 units, i.e.,
  every 15th demand a retailer orders one batch
  from the supplier that contains 15 units.

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Trade promotions and forward buying

• Supplier gives retailer a temporary discount,
  called a trade promotion.
• Retailer purchases enough to satisfy demand until
  the next trade promotion.
• Example Campbells Chicken Noodle Soup over a
  one year period

One retailers buy
Total shipments and consumption
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Reactive and over-reactive ordering

• Each location forecasts demand to determine
  shifts in the demand process.
• How should a firm respond to a high demand
  observation?
• Is this a signal of higher future demand or just
  random variation in current demand?
• Hedge by assuming this signals higher future
  demand, i.e. order more than usual.
• Rational reactions at one level propagate up the
  supply chain.
• Unfortunately, it is human to over react, thereby
  further increasing the bullwhip effect.

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Shortage gaming

• Setting
• Retailers submit orders for delivery in a future
  period.
• Supplier produces.
• If supplier production is less than orders,
  orders are rationed, i.e., retailers are put on
  allocation.
• to secure a better allocation, the retailers
  inflate their orders, i.e., order more than they
  need
• So retailer orders do not convey good
  information about true demand
• This can be a big problem for the supplier,
  especially if retailers are later able to cancel
  a portion of the order
• Orders that have been submitted that are likely
  be canceled are called phantom orders.

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Strategies to combat the bullwhip effect

• Information sharing
• Collaborative Planning, Forecasting and
  Replenishment (CPFR)
• Smooth the flow of products
• Coordinate with retailers to spread deliveries
  evenly.
• Reduce minimum batch sizes.
• Smaller and more frequent replenishments (EDI).
• Eliminate pathological incentives
• Every day low price
• Restrict returns and order cancellations
• Order allocation based on past sales in case of
  shortages
• Vendor Managed Inventory (VMI) delegation of
  stocking decisions
• Used by Barilla, PG/Wal-Mart and others.

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Supply Chain Design Strategy
Based on concepts developed by Marshall Fischer
at Wharton (Penn)

• Functional Products
• Staples that people buy at retail outlets
• Predictable demand and long life cycles
• Physical costs
• Strategy Minimize physical costs
• Innovative Products
• Life cycle is just a few months (e.g. fashion
  clothes computers)
• Demand is unpredictable
• Market mediation costs (inventory stockouts)
• Strategy Maximize responsiveness flexibility

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Hau Lees Concepts of Supply Chain Management

• Hau Lees approach to supply chain (SC) is one of
  aligning SCs with the uncertainties revolving
  around the supply process side of the SC
• A stable supply process has mature technologies
  and an evolving supply process has rapidly
  changing technologies
• Types of SCs
• Efficient SCs
• Risk-Hedging SCs
• Responsive SCs
• Agile SCs

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Hau Lees SC Uncertainty Framework
Efficient SC Ex. Grocery
Responsive SC Ex. Computers
Risk-Hedging SC Ex. Hydro-electric power
Agile SC Ex. Telecom
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Outsourcing

• Outsourcing is defined as the act of moving a
  firms internal activities and decision
  responsibility to outside providers

• Reasons to Outsource
• Organizationally-driven
• Improvement-driven
• Financially-driven

ABC News Report on Outsourcing Part 2
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Inventory Turnover

• A manufacturing company producing medical devices
  reported 60 million in sales last year. At the
  end of the year, they had 20 million worth of
  inventory in ready-to ship devices. Assuming
  that units are valued at 1000 per unit and sold
  at 2000 per unit, what is the turnover rate?
• Sales 60,000,000 per year / 2000 per unit
  30,000 units sold per year _at_ 1000 COGS per unit
• Inventory 20,000,000 / 1000 per unit 20,000
  units in inventory
• Turns COGS/Inventory
• 30,000,000/20,000,000 1.5 turns

• Obtaining data
• Look up inventory value on the balance sheet
• Look up cost of goods sold (COGS) from earnings
  statement not sales!!
• Common benchmark is inventory turns
• Inventory Turns COGS/ Inventory Value

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Inventory Turnover Statistics
Industries with higher gross margins tend to have
lower inventory turns

• Wholesale
• Groceries related 17.8
• Vehicles automotive 6.9
• Furniture fixtures 5.5
• Sporting goods 4.8
• Drug store items 8.5
• Apparel related 5.5
• Petroleum related 42.4
• Alcoholic beverages 8.5

• Retail
• Hardware stores 3.5
• Retail Nurseries Garden Supply 3.3
• General Merchandise Stores 4.7
• Grocery Stores 12.7
• New Used Car Dealers 6.8
• Gas stations mini-marts 39.3
• Apparel Accessories 3.5
• Furniture home furnishings 4.1
• Drug Stores 5.3
• Liquor Stores 6.6
• Other Retail Stores 4.3

Source Bizstats.com
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Value Density

• Value density is defined as the value of an item
  per pound of weight
• It is used as an important measure when deciding
  where items should be stocked geographically and
  how they should be shipped

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Mass Customization

• Mass customization is a term used to describe the
  ability of a company to deliver highly customized
  products and services to different customers
• The key to mass customization is effectively
  postponing the tasks of differentiating a product
  for a specific customer until the latest possible
  point in the supply-chain network