Supply Chain Management: Sourcing Decisions - PDF

Supply Chain Management: Strategy, Planning, and Operation Seventh Edition, Global Edition Chapter 15 Sourcing Decisions in a Supply Chain Copyright © 201...

Supply Chain Management: Strategy, Planning, and Operation Seventh Edition, Global Edition Chapter 15 Sourcing Decisions in a Supply Chain Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. The Sourcing Decision in a Supply Chain (2 of 2) Outsourcing questions 1. Will the third party increase the supply chain surplus relative to performing the activity in-house? 2. To what extent do risks grow upon outsourcing? 3. Are there strategic reasons to outsource? Copyright © 2019 Pearson Education, Ltd. How Do Third Parties Increase the Supply Chain Surplus? Decisions based on supply chain surplus and risk incurred Third parties increase surplus through 1. Capacity aggregation 2. Inventory aggregation 3. Transportation aggregation by transportation intermediaries 4. Transportation aggregation by storage intermediaries 5. Warehousing aggregation 6. Procurement aggregation 7. Information aggregation 8. Receivables aggregation 9. Relationship aggregation 10.Lower costs and higher quality Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. 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 Specificity of Assets Involved in Function (Low) 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 Low Low to medium growth in Low growth in surplus uncertainty surplus for firm Blank High High growth in surplus Low to medium growth in surplus Copyright © 2019 Pearson Education, Ltd. Risks of Using a Third Party 1. The process is broken 2. Underestimation of the cost of coordination 3. Reduced customer/supplier contact 4. Loss of internal capability and growth in third-party power 5. Leakage of sensitive data and information 6. Ineffective contracts 7. Loss of supply chain visibility 8. Negative reputational impact Copyright © 2019 Pearson Education, Ltd. Strategic Factors in Sourcing 1. Support for the business strategy 2. Improve firm focus Copyright © 2019 Pearson Education, Ltd. Examples of Successful Third-Party Suppliers EMS providers UPS Li & Fung Magna Steyr Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. Total Cost of Ownership (1 of 4) Mistake to focus only on quoted price Total cost of ownership (TCO) – Includes all supply chain costs of sourcing from a particular supplier Three “buckets” – Acquisition costs – Ownership costs – Post-ownership costs Copyright © 2019 Pearson Education, Ltd. 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, Yes minimum lot size, quantity discounts Taxes and duties All tariffs and compliance costs Yes Delivery costs All transportation costs from source to Yes destination, packaging costs Incoming quality costs Cost of inspection, defectives, and rework Yes Management costs Cost of managing and planning the Difficult purchase Copyright © 2019 Pearson Education, Ltd. 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, Yes in process and finished goods, in-transit inventory, finished goods inventory in supply chain Warehousing cost Warehousing and material handling costs Yes to support additional inventory Manufacturing costs Cost of manufacturing associated with the Yes sourced part Production quality costs Impact of sourced part on finished product Difficult quality Cycle time costs Impact of sourced part on production cycle Yes time Copyright © 2019 Pearson Education, Ltd. 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 Warranty and product liability costs Difficult liability costs associated with sourced part Environmental costs Environmental costs affected by sourced Difficult part Supplier capabilities Replenishment lead time, on-time To some extent performance, flexibility, information coordination capability, design coordination capability, supplier viability Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. Designing a Sourcing Portfolio: Tailored Sourcing (1 of 5) Options with regard to whom and where to source from – Produce in-house or outsource to a third party – Will the source be cost efficient or responsive – Onshoring, near-shoring, and offshoring Tailor supplier portfolio based on a variety of product and market characteristics Copyright © 2019 Pearson Education, Ltd. Designing a Sourcing Portfolio: Tailored Sourcing (2 of 5) Sources must focus on different capabilities – Cost – Responsiveness Volume-based tailored sourcing Product-based tailored sourcing Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. 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 High Medium to High Low variety Demand volatility High Medium to High Low Labor content Low Medium to High High Volume or weight-to-value High High Low ratio Impact of supply chain High Medium to High Low disruption Inventory costs High Medium to High Low Engineering/management High High Low support Copyright © 2019 Pearson Education, Ltd. 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 (SG&A) Impact on production Any delay will delay Less direct impact production Processing cost relative Low High to value of transaction Number of transactions Low High Copyright © 2019 Pearson Education, Ltd. Product Categorization Figure 15-1 Product Categorization by Value and Criticality Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. Optimal Service Level Equations (1 of 2) p: sale price; c: purchase cost; s: salvage value; µ: mean demand; σ: standard deviation of demand; CSL*: optimal cycle service level; O*: optimal order quantity pc Cu 1 CSL*  Prob(Demand  O*)    p  s Cu  Co  Co  1    Cu  O *  F 1(CSL*,  , )  NORMINV(CSL*,  , ) Copyright © 2019 Pearson Education, Ltd. Optimal Service Level Equations (2 of 2)  (O   )  Expected profits  ( p  s ) NORMDIST     ,0,1,1   (O   )  ( p  s ) NORMDIST     ,0,1,0  O(c  s ) NORMDIST (O, , ,1) O( p  c )[1  NORMDIST (O, , ,1)]  (O   )  Expected overstock  (O   ) NORMDIST     ,0,1,1   (O   )   NORMDIST     ,0,1,1    (O   )   Expected understock  (   O )  1  NORMDIST      ,0,1,1    (O   )    NORMDIST     ,0,1,1  Copyright © 2019 Pearson Education, Ltd. Impact of Local Optimization (1 of 2) Selling compact disks – Independent retailer Manufacturing cost = $1 Mean demand = 1,000 Wholesale price = $5 Standard deviation = 300 Retail price = $10 Co = $5 Cu = $5 5 Target service level   0.5 5  5 Order = NORMINV(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 Copyright © 2019 Pearson Education, Ltd. Impact of Local Optimization (2 of 2) Selling compact disks – Vertically integrated Manufacturing cost = $1 Mean demand = 1,000 Wholesale price = $5 Standard deviation = 300 Retail price = $10 Co = $1 Cu = $9 9 Target service level   0.9 1  9  Order = NORMINV(0.9, 1000, 300) = 1,384 disks Total supply chain profit = $8,474 Copyright © 2019 Pearson Education, Ltd. Sharing Risk to Grow Supply Chain Profits (1 of 2) Three approaches to risk sharing increase overall supply chain profits 1. Buyback or returns 2. Revenue sharing 3. Quantity flexibility Copyright © 2019 Pearson Education, Ltd. Sharing Risk to Grow Supply Chain Profits (2 of 2) Three questions 1. How will risk sharing affect the firm’s profits and total supply chain profits? 2. Will risk sharing introduce any information distortion? 3. How will risk sharing influence supplier performance along key performance measures? Copyright © 2019 Pearson Education, Ltd. 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 Expected manufacturing profit  O * (c  v )  ( b  sM )  expected overstock at retailer Copyright © 2019 Pearson Education, Ltd. Impact of Risks Sharing Through Buybacks Selling compact disks – Buybacks Buyback price = $3 Co  $5  $3  $2 Cu  $10  $5  $5 5 Target service level   0.71 2  5  5  Order  NORMINV    1,170 disks  7, 1000, 300  Expected profit = $4,286 Expected overstock = 223 Manufacturer profit  1170   5  1   223  3   $4,011 Total supply chain profit = $4,286 + $4,011 = $8,297 Copyright © 2019 Pearson Education, Ltd. Buyback Contracts (1 of 2) Table 15-6 Order Sizes and Profits in Music Supply Chain Under Different Buyback Contracts Optimal Order Size Expected Expected Expected Expected Wholesale Buyback for Music Profit for Returns to Profit for Supply Chain Price c Price b Store Music Store Supplier Supplier 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 Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. Revenue-Sharing Contracts (1 of 3) Cu (1  f )p  c CSL*  probability (demand  O*)   Cu  Co (1  f )p  sR Expected manufacturers profits = (c – v)O * +fp(O * – expectedoverstock at retailer) Expected retailer profit  (1– f ) p(O * –expected overstock at retailer )  sR  expected overstock at retailer – cO * Copyright © 2019 Pearson Education, Ltd. Revenue-Sharing Contracts (2 of 3) Selling compact disks – Revenue sharing Wholesale price c = $1 sR = 0 Revenue share f =.45 Co = c  sR = $1  $0 = $1 Cu = (1  f )p  c = 1  0.45   10  1 = $4.50 4.5 Target service level CSL *   0.818  4.5  1  4.5  Order  NORMINV  , 1000, 300   1,273 disks  5.5  Expected profit = $4,369 Expected overstock = 302 Manufacturer profit = $4,068 Total supply chain profit = $4,369 + $4,068 = $8,437 Copyright © 2019 Pearson Education, Ltd. Revenue-Sharing Contracts (3 of 3) Table 15-7 Order Sizes and Profits in Music Supply Chain Under Different Revenue-Sharing Contracts Optimal Order Expected Expected Expected Revenue- Size for Overstock Profit for Expected Supply Wholesale Sharing Music at Music Music Profit for Chain Price c Fraction f Store Store Store Supplier 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 Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. Risk Sharing Using Quantity Flexibility (2 of 2) Retailer orders O units Manufacturer commits to Q = (1   )O Retailer commits to  ( 1  )O 0  ,  1 Copyright © 2019 Pearson Education, Ltd. Quantity Flexibility Contracts (1 of 5) Expected quantity purchased by retailer, QR  qF (q )  Q 1– F (Q )  Q     q      Fs    s    F        Q    q     fs    fs          Expected quantity sold by retailer, DR  Q 1– F (Q ) Q –   q–     Fs   –  fs         Copyright © 2019 Pearson Education, Ltd. Quantity Flexibility Contracts (2 of 5) Expected quantity overstock at manufacturer  QR  DR Expected retailer profit  DR  p  QR  DR  sR  QR  c Expected manufacturer profit  QR  c  Q  QR  sM  Q  v Copyright © 2019 Pearson Education, Ltd. 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 q = (1 β )O = (1 0.05)  1017 = 966 units Q = (1 α )O = (1 0.05)  1017 = 1,068 units Copyright © 2019 Pearson Education, Ltd. Quantity Flexibility Contracts (4 of 5) Selling compact disks – Quantity flexibility Expected quantity purchased by retailer, QR  1,015 units Expected quantity sold by retailer, DR  911 units Expected overstock at retailer  QR  DR  1,015  911  104 units Expected retailer  DR  p  (QR  DR )  QR  c profit  911 10  1015  911  0  1015  5  $4,038 Expected  QR  c  (Q  QR )sM  Q  v manufacturer profit  1015  5  1068  1015   0  1068  1  $4,006 Total supply chain profit = $4,038 + $4,006 = $8,044 Copyright © 2019 Pearson Education, Ltd. Quantity Flexibility Contracts (5 of 5) Table 15-8 Profits at Music Supply Chain Under Different Quantity Flexibility Contracts Expected Expected Order Purchase Expected Expected Expected Supply Wholesal Size by Sale by Profits for Profits for Chain α β e Price c O Retailer Retailer Retailer Supplier 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 Copyright © 2019 Pearson Education, Ltd. 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 Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd. 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. Copyright © 2019 Pearson Education, Ltd.