supply chain Ass

Chrisyanqu

chopra_scm7_inppt_15MV.pptx

Home >Business & Finance homework help >supply chain Ass

Supply Chain Management: Strategy, Planning, and Operation

Seventh Edition

Chapter 15

Sourcing Decisions in a Supply Chain

If this PowerPoint presentation contains mathematical equations, you may need to check that your computer has the following installed:

1) MathType Plugin

2) Math Player (free versions available)

3) NVDA Reader (free versions available)

Learning Objectives

15.1 Understand factors that affect the decision to outsource a supply chain function.

15.2 Identify dimensions of supplier performance that affect total cost.

15.3 Design a tailored supplier portfolio.

15.4 Describe the impact of incentives on the behavior of third-parties in a supply chain.

15.5 Discuss the benefits of sharing risk and reward in a supply chain.

The Sourcing Decision in a Supply Chain (1 of 2)

Purchasing, also procurement, is the process by which companies acquire raw materials, components, products, services, or other resources from suppliers to execute their operations

Sourcing – entire set of business processes required to purchase goods and services

Outsourcing – supply chain function being performed by a third party

The Sourcing Decision in a Supply Chain (2 of 2)

Outsourcing questions

Will the third party increase the supply chain surplus relative to performing the activity in-house?

To what extent do risks grow upon outsourcing?

Are there strategic reasons to outsource?

How Do Third Parties Increase the Supply Chain Surplus?

Decisions based on supply chain surplus and risk incurred

Third parties increase surplus through

Capacity aggregation

Inventory aggregation

Transportation aggregation by transportation intermediaries

Transportation aggregation by storage intermediaries

Warehousing aggregation

Procurement aggregation

Information aggregation

Receivables aggregation

Relationship aggregation

Lower costs and higher quality

Factors Influencing Growth of Surplus by a Third Party (1 of 2)

Scale

Large scale it is unlikely that a third party can achieve further scale economies and increase the surplus

Uncertainty

If requirements are highly variable over time, third party can increase the surplus through aggregation

Specificity of assets

If assets required are specific to a firm, a third party is unlikely to increase the surplus

Cost and quantity of available capital

Third party may have available or lower cost capital

Factors Influencing Growth of Surplus by a Third Party (2 of 2)

Table 15-1 Growth in Surplus by Third Party as a Function of Scale, Uncertainty, and Specificity

Blank	Blank	Specificity of Assets Involved in Function (Low)	Specificity of Assets Involved in Function (High)
Firm scale	Low	High growth in surplus	Low to medium growth in surplus
Blank	High	Low growth in surplus	No growth in surplus unless cost of capital is lower for third party
Demand uncertainty for firm	Low	Low to medium growth in surplus	Low growth in surplus
Blank	High	High growth in surplus	Low to medium growth in surplus

Risks of Using a Third Party

The process is broken

Underestimation of the cost of coordination

Reduced customer/supplier contact

Loss of internal capability and growth in third-party power

Leakage of sensitive data and information

Ineffective contracts

Loss of supply chain visibility

Negative reputational impact

Summary of Learning Objective 1

Good sourcing decisions aim to identify suppliers that will grow the supply chain surplus. A supply chain function should be outsourced if the third party can increase the supply chain surplus without significant risk. A third party may increase the surplus by aggregating capacity, inventory, warehousing, transportation, information, receivables, and other factors to a higher level than the firm can 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. Outsourcing generally makes sense if a firm’s needs are small and highly uncertain and can be served using resources that can serve other firms as well. Outsourcing also makes sense if the firm is short of capital or if the third party has a lower cost of capital.

Total Cost of Ownership (1 of 4)

Mistake to focus only on quoted price

Total cost of ownership (T C O)

Includes all supply chain costs of sourcing from a particular supplier

Three “buckets”

Acquisition costs

Ownership costs

Post-ownership costs

Total Cost of Ownership (2 of 4)

Table 15-2 Factors Influencing Total Cost of Ownership

Performance Category	Category Components	Quantifiable?
Acquisition Costs	Blank	Blank
Supplier price	Labor, material, and overhead	Yes
Supplier terms	Net payment terms, delivery frequency, minimum lot size, quantity discounts	Yes
Taxes and duties	All tariffs and compliance costs	Yes
Delivery costs	All transportation costs from source to destination, packaging costs	Yes
Incoming quality costs	Cost of inspection, defectives, and rework	Yes
Management costs	Cost of managing and planning the purchase	Difficult

Total Cost of Ownership (3 of 4)

Table 15-2 [Continued]

Performance Category	Category Components	Quantifiable?
Ownership Costs	Blank	Blank
Inventory costs	Supplier inventory, including raw material, in process and finished goods, in-transit inventory, finished goods inventory in supply chain	Yes
Warehousing cost	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

Total Cost of Ownership (4 of 4)

Table 15-2 [Continued]

Performance Category	Category Components	Quantifiable?
Post-Ownership Costs	Blank	Blank
Reputation	Reputation impact of quality problems	No
Warranty and product liability costs	Warranty and product liability costs associated with sourced part	Difficult
Environmental costs	Environmental costs affected by sourced part	Difficult
Supplier capabilities	Replenishment lead time, on-time performance, flexibility, information coordination capability, design coordination capability, supplier viability	To some extent

Summary of Learning Objective 2

Supplier performance should be compared based on the impact on total cost of ownership. Total cost includes the cost of acquisition, ownership, and post-ownership. In addition to the supplier price, the total cost of using a supplier is affected by the supplier terms; delivery costs; inventory costs; warehousing costs; quality costs; costs of management effort and administrative support; impact on reputation; supplier capabilities, such as replenishment lead time, on-time performance, and flexibility; and other costs, such as exchange rate trends, taxes, and duties. In many instances, a higher acquisition cost is more than compensated for by lower ownership and post-ownership costs.

Designing a Sourcing Portfolio: Tailored Sourcing (1 of 5)

Options regarding to whom and where to source from in the development of a supplier portfolio:

Produce in-house or outsource to a third party

Will the source be cost efficient or responsive

Onshoring, near-shoring, and offshoring -> where

Onshoring – producing in the market where the product is sold

Near-shoring – producing at a lower cost location near the market where it is sold

Offshoring – producing at a low csot location that may be far from the market

Designing a Sourcing Portfolio: Tailored Sourcing (2 of 5)

Under tailored sourcing, supply sources must focus on different capabilities

Cost

Responsiveness

Low-cost source – focus on efficiency; supply only the predictable portion of demand

Responsive source –supply the uncertain portion of demand

Volume-based tailored sourcing – efficient facility produces the predictable part of product’s demand; responsive facility used for unpredictable portion of demand

Product-based tailored sourcing - efficient facility produces the high-volume products with less uncertain demand; responsive facility used for low-volume products with uncertain demand

Designing a Sourcing Portfolio: Tailored Sourcing (3 of 5)

Table 15.3 Factors Favoring Selection of a Responsive or Low-Cost Source

Blank	Responsive Source	Low-Cost Source
Product life cycle	Early phase	Mature phase
Demand volatility	High	Low
Demand volume	Low	High
Product value	High	Low
Rate of product obsolescence	High	Low
Desired quality	High	Low to medium
Engineering/design support	High	Low

Designing a Sourcing Portfolio: Tailored Sourcing (4 of 5)

Table 15.4 Factors Favoring Onshoring, Near-Shoring, or Offshoring

Blank	Onshore	Near-Shore	Offshore
Rate of innovation/product variety	High	Medium to High	Low
Demand volatility	High	Medium to High	Low
Labor content	Low	Medium to High	High
Volume or weight-to-value ratio	High	High	Low
Impact of supply chain disruption	High	Medium to High	Low
Inventory costs	High	Medium to High	Low
Engineering/management support	High	High	Low

Designing a Sourcing Portfolio: Tailored Sourcing (5 of 5)

Table 15.5 Differences Between Direct and Indirect Materials

Blank	Direct Materials	Indirect Materials
Use	Production	Maintenance, repair, and support operations
Accounting	Cost of goods sold	Selling, general, and administrative expenses (S G&A)
Impact on production	Any delay will delay production	Less direct impact
Processing cost relative to value of transaction	Low	High
Number of transactions	Low	High

Product Categorization

Figure 15-1 Product Categorization by Value and Criticality

Summary of Learning Objective 3

Firms must consider a tailored sourcing strategy that couples responsive onshore or near-shore sources with low-cost offshore sources. The responsive onshore sources should focus on high-value products with high demand volatility, whereas the low-cost, offshore sources should focus on lower-value, high-volume products with high labor content. Sourcing can also be tailored based on direct and indirect materials as well as the criticality and cost of items purchased.

The Impact of Incentives on Third-Party Behavior

Misalignment of incentives often hurts supply chain performance

Alignment important

When third party actions are not fully observable

When third party has information not available to the firm

Well-designed incentives can be strong communicators of desired performance

“Threshold” incentives can distort information

Summary of Learning Objective 4

Supply chain incentives can have unintended consequences when the third party’s information and actions are hard to observe. It is important to understand and address the negative consequences of these incentives to ensure that the third-party acts in a way that grows the supply chain surplus.

Sharing Risk and Reward in the Supply Chain

Independent actions by two parties often result in lower profits than could be achieved

Stronger firms tend to push risk on to supply chain partners

Optimal Service Level Equations (1 of 2)

p: sale price; c: purchase cost; s: salvage value; µ: mean demand; σ: standard deviation of demand; C S L*: optimal cycle service level; O*: optimal order quantity

Optimal Service Level Equations (2 of 2)

Impact of Local Optimization (1 of 2)

Selling compact disks – Independent retailer

Manufacturing cost = $1

Wholesale price = $5

Retail price = $10

Mean demand = 1,000

Standard deviation = 300

Co = $5 Cu = $5

Order = N O R M I N V(0.5, 1000, 300) = 1,000 disks

Expected profits = $3,803

Manufacturer makes $4,000

Total supply chain profit = $3,803 + $4,000 = $7,803

Impact of Local Optimization (2 of 2)

Selling compact disks – Vertically integrated

Manufacturing cost = $1

Wholesale price = $5

Retail price = $10

Mean demand = 1,000

Standard deviation = 300

Co = $1 Cu = $9

Order = N O R M I N V(0.9, 1000, 300) = 1,384 disks

Total supply chain profit = $8,474

Sharing Risk to Grow Supply Chain Profits (1 of 2)

Three approaches to risk sharing increase overall supply chain profits

Buyback or returns

Revenue sharing

Quantity flexibility

Sharing Risk to Grow Supply Chain Profits (2 of 2)

Three questions

How will risk sharing affect the firm’s profits and total supply chain profits?

Will risk sharing introduce any information distortion?

How will risk sharing influence supplier performance along key performance measures?

Sharing Risks through Buybacks

Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price

Buyback contract

The manufacturer specifies a wholesale price c and a buyback price b

The manufacturer can salvage $sM for any units that the retailer returns

The manufacturer has a cost of v per unit produced and the retail price is p

Impact of Risks Sharing Through Buybacks

Selling compact disks – Buybacks

Buyback price = $3

Expected profit = $4,286

Expected overstock = 223

Total supply chain profit = $4,286 + $4,011 = $8,297

Buyback Contracts (1 of 2)

Table 15-6 Order Sizes and Profits in Music Supply Chain Under Different Buyback Contracts

Wholesale Price c	Buyback Price b	Optimal Order Size for Music Store	Expected Profit for Music Store	Expected Returns to Supplier	Expected Profit for Supplier	Expected Supply Chain Profit
$5	$0	1,000	$3,803	120	$4,000	$7,803
$5	$2	1,096	$4,090	174	$4,035	$8,125
$5	$3	1,170	$4,286	223	$4,009	$8,295
$6	$0	924	$2,841	86	$4,620	$7,461
$6	$2	1,000	$3,043	120	$4,761	$7,804
$6	$4	1,129	$3,346	195	$4,865	$8,211
$7	$0	843	$1,957	57	$5,056	$7,013
$7	$4	1,000	$2,282	120	$5,521	$7,803
$7	$6	1,202	$2,619	247	$5,732	$8,351

Buyback Contracts (2 of 2)

Holding-cost subsidies

Manufacturers pay retailers a certain amount for every unit held in inventory over a given period

Encourage retailers to order more

Price support

Manufacturers share the risk of product becoming obsolete

Guarantee that in the event they drop prices they will lower prices for all current inventories

Risk Sharing through Revenue-Sharing

Revenue-sharing, manufacturer charges the retailer a low wholesale price c and shares a fraction f of the retailer’s revenue

Allows both the manufacturer and retailer to increase their profits

Results in lower retailer effort

Requires an information infrastructure

Information distortion results in excess inventory in the supply chain and a greater mismatch of supply and demand

Revenue-Sharing Contracts (1 of 3)

Expected manufacturers profits

Expected retailer profit

Revenue-Sharing Contracts (2 of 3)

Selling compact disks – Revenue sharing

Wholesale price c = $1

Revenue share f = .45

Expected profit = $4,369

Expected overstock = 302

Manufacturer profit = $4,068

Total supply chain profit = $4,369 + $4,068 = $8,437

Revenue-Sharing Contracts (3 of 3)

Table 15-7 Order Sizes and Profits in Music Supply Chain Under Different Revenue-Sharing Contracts

Wholesale Price c	Revenue-Sharing Fraction f	Optimal Order Size for Music Store	Expected Overstock at Music Store	Expected Profit for Music Store	Expected Profit for Supplier	Expected Supply Chain Profit
$1	0.30	1,320	342	$5,526	$2,934	$8,460
$1	0.45	1,273	302	$4,064	$4,367	$8,431
$1	0.60	1,202	247	$2,619	$5,732	$8,350
$2	0.30	1,170	223	$4,286	$4,009	$8,295
$2	0.45	1,105	179	$2,881	$5,269	$8,150
$2	0.60	1,000	120	$1,521	$6,282	$7,803

Optional Topics

Risk Sharing Using Quantity Flexibility (1 of 2)

Allows the buyer to modify the order (within limits) after observing demand

Better matching of supply and demand

Increased overall supply chain profits if the supplier has flexible capacity

Lower levels of information distortion than either buyback contracts or revenue sharing contracts

Risk Sharing Using Quantity Flexibility (2 of 2)

Retailer orders O units

Manufacturer commits to

Retailer commits to

Quantity Flexibility Contracts (1 of 5)

Expected quantity purchased by retailer, QR

Expected quantity sold by retailer, DR

Quantity Flexibility Contracts (2 of 5)

Expected quantity overstock at manufacturer

Expected retailer profit

Expected manufacturer profit

Quantity Flexibility Contracts (3 of 5)

Selling compact disks – Quantity flexibility

v = $1 c = $5 p = $10

α = 0.05 β = 0.005 O = 1,017

SR = 0 SM = 0

Manufacturer commits to between

Quantity Flexibility Contracts (4 of 5)

Selling compact disks – Quantity flexibility

Expected quantity purchased by retailer,

Expected quantity sold by retailer,

Expected overstock at retailer

Expected retailer

profit

Expected manufacturer profit

Total supply chain profit = $4,038 + $4,006 = $8,044

Quantity Flexibility Contracts (5 of 5)

Table 15-8 Profits at Music Supply Chain Under Different Quantity Flexibility Contracts

α	β	Wholesale Price c	Order Size O	Expected Purchase by Retailer	Expected Sale by Retailer	Expected Profits for Retailer	Expected Profits for Supplier	Expected Supply Chain Profit
0.00	0.00	$5	1,000	1,000	880	$3,803	$4,000	$7,803
0.05	0.05	$5	1,017	1,015	911	$4,038	$4,006	$8,044
0.20	0.20	$5	1,047	1,023	967	$4,558	$3,858	$8,416
0.00	0.00	$6	924	924	838	$2,841	$4,620	$7,461
0.20	0.20	$6	1,000	1,000	955	$3,547	$4,800	$8,347
0.30	0.30	$6	1,021	1,006	979	$3,752	$4,711	$8,463
0.00	0.00	$7	843	843	786	$1,957	$5,056	$7,013
0.20	0.20	$7	947	972	936	$2,560	$5,666	$8,226
0.40	0.40	$7	1,000	1,000	987	$2,873	$5,600	$8,473

Sharing Rewards to Improve Performance

A buyer may want performance improvement from a supplier who otherwise would have little incentive to do so

A shared-savings contract provides the supplier with a fraction of the savings that result from performance improvement

Effective in aligning supplier and buyer incentives when the supplier is required to improve performance and most of the benefits of improvement accrue to the buyer

Summary of Learning Objective 5 (1 of 2)

Local optimization hurts the supply chain surplus when risk and reward are not shared in a supply chain. Suppliers are more likely to act in a firm’s interest when risk and reward are shared. In the absence of risk sharing, retailers aim for a lower level of product availability than would be required to maximize supply chain profits. The use of buyback or revenue sharing is an effective risk sharing mechanism between suppliers and retailers for products like books with low variable costs. In general, however, quantity flexibility contracts are more effective because they result in a better matching of supply and demand.

Summary of Learning Objective 5 (2 of 2)

Sharing the rewards from improvements can induce performance improvement from a supplier along dimensions, such as lead time, for which the benefit of improvement accrues primarily to the buyer but the effort for improvement comes primarily from the supplier.

458 Chapter 15 • Sourcing Decisions in a Supply Chain

often exaggerated because companies do not have one system for indirect materials. Instead, they use several processes that are not streamlined or integrated. A good online procurement process that makes search easy and automates approval and transmission of the purchase order can help reduce transaction costs. The online process should also update other interested parties such as accounts payable and receiving. Clearly this is possible only with suppliers that imple- ment online catalogs and automate all transactions with the buyer. Successful examples of online procurement implementations for indirect materials include Johnson Controls and Pfizer. Both firms built their online solutions by integrating existing software. Johnson Controls integrated a Commerce One solution with existing Oracle accounting software, whereas Pfizer integrated an Ariba system with an American Express corporate purchasing card program. Both claim to have seen significant savings as a result.

Another important requirement for the procurement process for both direct and indirect materials is the ability to aggregate orders by product and supplier. For direct materials, the consolidation of orders improves economies of scale at the supplier and during transport and allows the firm to take advantage of any quantity discounts that may be offered by the supplier. For indirect materials, the consolidation of spending with a supplier often allows the firm to negotiate better purchasing discounts.

Key Point

The procurement process for direct materials should focus on improving coordination and visibility with the supplier. The procurement process for indirect materials should focus on decreasing the transaction cost for each order. The procurement process in both cases should consolidate orders to take advantage of economies of scale and quantity discounts.

In addition to the categorization of materials into direct and indirect, all products purchased may also be categorized as shown in Figure 15-2, based on their value/cost and how critical they are.

Most indirect materials are included in general items. The goal of procurement in this case should be to lower the cost of acquisition or the transaction cost. Direct materials can be further classified into bulk purchase, critical, and strategic items. For most bulk purchase items, such as packaging materials and bulk chemicals, suppliers tend to have the same selling price. It is thus important for purchasing to make a distinction between suppliers based on the services they

High C

ri ti

ca l

Low

Value/Cost

Critical Items

Strategic Items

Bulk Purchase Items

General Items

HighLow

FIGURE 15-2 Product Categorization by Value and Criticality

M15_CHOP3952_05_SE_C15.QXD 11/14/11 11:20 AM Page 458

msms

=£===

æö

ç÷

èø

*Prob(

***

CSLO*)

psCC

OF(CSL,,)NORMINV(CSL,,)

Demand

mms

éù

êú

ëû

éù

êú

ëû

+--

()

Expected profits()

,0,1,1

()

,0,1,0

()(,,,1)

()[1(,,,1)]

psNORMDIST

OcsNORMDISTO

OpcNORMDISTO

éù

êú

ëû

éù

êú

ëû

()

Expected overstock()

,0,1,1

()

,0,1,1

ONORMDIST

NORMDIST

=--

æö

éù

ç÷

êú

ëû

èø

éù

êú

ëû

()

Expected understock()1

,0,1,1

()

,0,1,1

NORMDIST

(

)

Target service level0.5

5 5

(

)

Target service level 0.9

1 9

=---

Expected manufacturing profit *()()

pected overstock at retailer

Ocvbs

=-=

$5 $3 $2

$10 $5 $5

(

)

ç÷

èø

Target service level 0.71

2 5

Order 1,170 disks

7, 1000, 300

NORMINV

(

)

(

)

=´--´=

Manufacturer profit 1170512233 $4,011

(1)

*probability (demand *)

(1)

=£==

+--

uoR

fpc

CSLO

CCfps

= c–vO*+fpO*– expectedoverstock at retai

()(

ler

)

+´

1–fO*–expected overstock at retailer

()()

expected overstock at retailer–*

scO

== $1 $0 = $1

Ccs

(

)

---´-

=1 = 1 0.45 10 1 =

()

$4.50

Cfpc

(

)

æö

èø

4.5

Target service level * 0.818

4.5 1

4.5

Order , 1000, 300 1,273 disks

5.5

CSL

NORMINV

=(1)

(1)

êú

ëû

éù

æöæö

ç÷ç÷

êú

èøèø

ëû

éù

-m-

æöæö

ç÷ç÷

êú

èøèø

ëû

()1–()

qFqQFQ

[

]

1–()

–q–

–

æöæö

ç÷ç÷

èøèø

QFQ

(

)

=´+--´

RRRRR

DpQDsQc

(

)

=´+--´

RRM

QcQQsQv

=(1)=(10.05)1017=966 units

=(1)=(10.05)1017=1,068 units

--´

++´

βO

αO

1,015 units

911 units

=-=-=

1,015911104 units

(

)

911 10 1015 911

()

0 1015 5 $4,038

=´+--´

=´+-´-´=

RRRR

DpQDQc

(

)

1015 5 1068 1015 0 1068 1 $

()

4,006

=´+--´

=´+-´-´=

RRM

QcQQsQv