MODULE 4

SUPPLY CHAIN CONTRACT

A.​ Learning Outcomes

Learning outcomes of supply chain contract practicum are shown in Table 3.1.
Table 3.1 Module Learning Outcomes

B.​ Grading System

The grading system of supply chain contract practicum is shown in Table 3.2.
Table 3.2 Grading Method for Each Performance Indicators

Performance Indicators Assessment Method

A3-3, B4-2 Briefing Assignment

B1-2, B1-3 Pre-practicum Assignment

A3-3, B1-1, B1-2, B1-3, B4-2 On-the-spot Assignment

A3-3, B1-1, B1-2 Pre-Test & Post-Test

C.​ Objectives
Objectives of the supply chain contract practicum are
1.​ Provide understanding of sourcing and supply chain contract
2.​ Understand the strategies in supply chain contract
3.​ Provide understanding about the concept of global optimization in supply
chain management
 4.​ Understand how the strategies in supply chain contracts can affect global
optimization

D.​ Tools and Equipment

This practicum requires a laptop/computer, Microsoft Excel, and will use the
case data of supply chain contracts provided by the laboratory assistants.

E.​ Overview
Sourcing
In today's highly competitive and interconnected business environment,
sourcing has become a critical factor in the supply chain. Sourcing is the entire set of
business processes required to acquire goods and services from suppliers to execute
their operations. The most important decision in sourcing is whether to make
(in-house) or buy (outsource), considering factors such as business model, cost,
lead-time, delivery, and geographic location. In this practicum, we will only discuss
outsourcing which involves suppliers as third parties. The benefits of effective
sourcing decisions follow:
1.​ Increase performance with lower price
2.​ Better economies of scale, due to aggregated order amount within a company
3.​ Reduce overall purchasing cost, due to more efficient procurement
transactions
4.​ Design collaboration results in lower overall cost, because products are easier
to manufacture and distribute
5.​ Lower inventories and match supply-demand because good procurement
facilitates coordination and improve forecasting & planning
6.​ Risk sharing, resulting in higher profits for both the supplier and the buyer

On the other hand, ineffective sourcing may leads to have risks as follows:
1.​ Lost control of the process
A company with a broken/fragmented supply chain process will only get
worse and hard to control. Hence, it should control the process, do cost-benefit
analysis, then decide on sourcing.
2.​ Weak coordination
 Adding a third party means adding more effort to coordinate activities
across multiple entities performing supply chain tasks. If coordination fails, the
efficiency in the supply chain can be disrupted.
3.​ Reduced customer/supplier contact
By using a third party for such functions (such as picking, delivery),
these roles have been replaced and a company isn't able to directly contact the
supplier/customer.
4.​ Loss of internal capability
Excessive dependency on third parties can hinder the company to
improve skills and perform tasks. Keeping part of sourcing in-house is also
important if a complete loss of capability significantly strengthens the third
party’s bargaining position.
5.​ Leakage of sensitive data and information
Using a third party requires a firm to share demand information and in
some cases intellectual property. This may be used to make a competitor
product in the same market.
6.​ Reduced any gains from outsourcing, if the contracts with performance
metrics distort the third party’s incentives
7.​ Loss of supply chain visibility
The involvement of third parties reduces the visibility of supply chain
operations, reducing the company’s responsiveness to actual condition of
market demand.

After deciding to outsource, the following steps that will be explained in this
module can be seen in the blue part of Figure 3.1. Selecting of suppliers can be done
using competitive bids, reverse auctions, or direct negotiations. Based on Dickson’s
(1966) study, the key selection criteria for suppliers are net price, delivery, quality, and
production facilities & capabilities. For the selected suppliers, a contract should be
negotiated with the company in order to achieve targeted performance and reduce
risks.

Fig 3.1 Key Processes of Outsourcing

 In this practicum, the supplier for PT Sciloco Indonesia will be selected by
considering the supplier's selling price per unit, buyback cost, salvage value, lead
time, and lot size as the drivers, following the type of contract offered by each
supplier.

Supply Chain Contract (SCC)

Supply chain contract is a form of contract/agreement that specifies
parameters governing the buyer-supplier relationship, impacting the behavior and
performance of all stages in a supply chain. A contract is made to optimize the
profitability of both suppliers and buyer, share risks, enhance purchasing power and
improve product availability in the market, then obtain global optimization.

Fig 3.2 Illustration of SCC Goals

Global optimization is an approach to provide information of the best and
optimal contract as a reference for decisions, in order to increase, reduce inequality,
and generate balanced profit between individuals in the supply chain. SCC is said to
be effective only if the contract is able to allocate each individual’s profit in a certain
way, hence every individual is unable to increase their own profit when they violate
the contract.

Fig 3.3 Graph of Global Optimization

 In order to achieve these, there are predetermined components agreed by both
parties follows
1.​ Selling price and discount amount
2.​ Minimum and maximum quantity of purchase
3.​ Lead time of delivery
4.​ Product/material’s quality
5.​ Terms and conditions of return

In general, there are 4 types of supply chain contract usually used in industries
follows:
1.​ Buy-back Contract
A contract where the supplier buys back the unsold products, up to a
specific amount, at an agreed-upon price or higher than the salvage value.
Hence, the buyer prefers to sell back the unsold product to the supplier, rather
than to other parties at salvage value. This condition drives the buyer to buy a
high amount of product and increase supplier’s risks of unsold products.
Supplier’s Profit = Sales revenue - Fixed cost - Variable cost + Salvage value -
Buyback cost
Buyer’s Profit = Sales revenue - Buying cost + Buyback or Salvage value +
Salesback cost - Stockout cost

2.​ Quantity Flexibility Contract

A contract where the supplier buys back the unsold products from the
distributor, with agreed-upon specific amounts, at full price. This contract is
usually combined with a buy-back contract, thus the supplier buys all unsold
products at salvage value. This contract benefits the supplier by receiving back
the products with lower price, while also benefiting the buyer by not adding up
the inventory.
Supplier’s Profit = Sales revenue - Fixed cost - Variable cost - Buyback cost* +
Salvage value*
Buyer’s Profit = Sales revenue - Buying cost + Salesback cost* - Stockout cost +
Salvage cost**
* up to specific amount of unsold (x)
** if unsold > x
 3.​ Revenue-Sharing Contract
A contract where the buyer shares some of the sales revenue to the
supplier. This contract is suitable when the supplier gives a lower price to the
buyer, which results in increased profit shared from the buyer. Hence, the
supplier’s profit tends to be directly proportional to the distributor’s profit.
Supplier’s Profit = Sales revenue - Fixed cost - Variable cost + Revenue sharing
Buyer’s Profit = Sales revenue - Revenue sharing - Buying cost + Salvage value +
Stockout cost

4.​ Sales Rebate Contract

A contract that directly gives incentive for the buyer for selling a
targeted amount of products. The incentives can be in a form of rebate/
discount for purchasement from the supplier.
Supplier’s Profit = Sales revenue - Fixed cost - Variable cost - Incentive
Buyer’s Profit = Sales revenue - Buying cost + Salvage value - Stockout cost +
Incentive

To make the profit calculation easier, below is the detailed cost component
with “white blocks” values positive and “grey blocks” values negative in cash flow.

Fig 1. Cost Component of Manufacturer as Supplier

 Fig 2. Cost Component of Distributor as Buyer

Fig 3. Cost Calculation for Supplier

Fig 4. Cost Calculation for Buyer (Manufacturer)

F.​ Practicum Procedure
1.​ Create mathematical model from the case study and implement it on Microsoft
Excel or Google Spreadsheet
2.​ Solve the case using features in Microsoft Excel or Google Spreadsheet and
calculate the total expected profit for suppliers and the firm
3.​ Calculate the difference between suppliers’ and the firm’s profit, and find the
global optimization point

G.​ Case Study

PT AgroBeverage produces bottled ready-to-drink (RTD) tea. To make one

bottle, the company requires two main components: 2 packs of tea extract &
ingredients, and 1 pcs plastic bottle. The selling price of a bottle of RTD tea is
Rp32.500 with estimated demand 1784 pcs. Below are the potential suppliers and the
offered contract.

The company must decide which supplier to choose and what contract type to
apply, so the decisions approximate the global optimum.

H.​ References
Chopra, S., & Meindl, P. (2013). Supply Chain Management: Strategy, Planning, and
Operation (5th ed.). Pearson.
Ravindran, A., Warsing, D. P., Griffin, P. M., Ravindran, A. R., & Griffin, P. M.
(2023). Supply Chain Engineering: Models and Applications. CRC Press.
10.1201/9781003283393