Chapter 13
Sourcing Decisions in a
Supply Chain
( remaining ….)
Supplier Selection and Contracts
• Contracts for Product Availability and
Supply Chain Profits
[Link] Contracts
[Link]-Sharing Contracts
[Link] Flexibility Contracts
• Contracts to Coordinate Supply Chain
Costs
• Contracts to Increase Agent Effort
• Contracts to Induce Performance
Improvement
Contracts for Product Availability
and Supply Chain Profits
• Many shortcomings in supply chain performance
occur because the buyer and supplier are
separate organizations and each tries to
optimize its own profit
• However supply chain coordinated actions
maximize total supply chain profits if they have
common objective
• Another approach to dealing with this problem is
to design a contract that encourages a buyer to
purchase more and increase the level of product
availability
• The supplier must share in some of the buyer’s
demand uncertainty
Contracts for Product Availability
and Supply Chain Profits: Buyback
Contracts
• Allows a retailer to return unsold inventory up
to a specified amount at an agreed upon price
• Increases the optimal order quantity for the
retailer, resulting in higher product availability
and higher profits for both the retailer and the
supplier
• Most effective for products with low variable
cost, such as music, software, books,
magazines, and newspapers
• Downsides
[Link] that buyback contract results in surplus
inventory that must be disposed of, which
increases supply chain costs
[Link] also increase information distortion
through the supply chain because the
supply chain reacts to retail orders, not
Contracts for Product Availability
and Supply Chain Profits: Revenue
Sharing Contracts
• The buyer pays a minimal amount for each unit
purchased from the supplier but shares a
fraction of the revenue for each unit sold
• Decreases the cost per unit charged to the
retailer, which effectively decreases the cost of
overstocking
Can result in supply chain information
distortion, however, just as in the
case of buyback contracts
Contracts for Product Availability
and Supply Chain Profits: Quantity
Flexibility Contracts
• Allows the buyer to modify the order (within
limits) as demand visibility increases closer to
the point of sale
• 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
Contracts to Coordinate Supply
Chain Costs
• Differences in costs at the buyer and supplier
can lead to decisions that increase total supply
chain costs
• Example: Replenishment order size placed by the
buyer. The buyer’s EOQ does not take into
account the supplier’s costs.
• A quantity discount contract
– May encourage the buyer to purchase a
larger quantity (which would be lower
costs for the supplier), which would result
in lower total supply chain costs
– Quantity discounts lead to information
distortion because of order batching –
retailer order less frequently!! –
supplier receives information less
Contracts to Increase Agent Effort
• There are many instances in a supply chain where
an agent acts on the behalf of a principal and
the agent’s actions affect the reward for
the principal
• Example: A car dealer who sells the cars of a
manufacturer, as well as those of other
manufacturers
• Examples of contracts to increase agent effort
include two-part tariffs (Franchise fee + on
cost selling & profit on sale proceed) and
threshold contracts
• Threshold contracts increase information
distortion!!!
Contracts to Induce Performance
Improvement
• A buyer may want performance improvement
from a supplier who otherwise would have little
incentive to do so
– Brunt to reduce lead time – SUPPLIER
– Benefit to reduce lead time – BUYER
• A shared savings contract provides the supplier
with
a fraction of the savings that result from the
performance improvement
• Particularly effective where the benefit from
improvement accrues primarily to the buyer,
but where the effort for the improvement comes
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
• Important to employ design for logistics, design
for manufacturability
• Manufacturers must become effective design
coordinators throughout the supply chain
The Procurement Process
• The process in which the supplier sends product in
response to orders placed by the buyer
• 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
– Indirect materials: goods used to support the
operations of a firm
• Focus for direct materials should be on improving
coordination and visibility with supplier
• Focus for indirect materials should be on
decreasing the transaction cost for each order
• Procurement for both should consolidate orders
where possible to take advantage of economies
of scale and quantity discounts
Product Categorization by Value
and Criticality
High
Critical Items Strategic Items
Criticali
ty
General Items Bulk Purchase Items
Low
Low High
Value/Cost
Product Categorization by Value
and Criticality
High
Critical Items Strategic Items
Criticali
ty
Indirect
General Items Bulk Purchase Items
Low
Low High
Value/Cost
Product Categorization by Value
and Criticality
High Direct
Critical Items Strategic Items
Criticali
ty
General Items Bulk Purchase Items
Low
Low High
Value/Cost
Sourcing Planning and Analysis
• A firm should periodically analyze its procurement
spending and supplier performance and use this
analysis as an input for future sourcing
decisions
• Procurement spending should be analyzed by part
and supplier to ensure appropriate economies
of scale
• 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
Making Sourcing Decisions in
Practice
• Use multifunction/cross functional teams
• Ensure appropriate coordination across
regions and business units
• Always evaluate the total cost of ownership
• Build long-term relationships with key
suppliers
