Sourcing Decisions in a Supply Chain

© 2007 Pearson Education 13-1

 Outline
 The Role of Sourcing in a Supply Chain
 Supplier Scoring and Assessment
 Supplier Selection and Contracts
 Design Collaboration
 The Procurement Process
 Sourcing Planning and Analysis
 Making Sourcing Decisions in Practice
 Summary of Learning Objectives

© 2007 Pearson Education 13-2

 The Role of Sourcing
in a Supply Chain
 Sourcing is the set of business processes required
to purchase goods and services
 Sourcing processes include:
– Supplier scoring and assessment
– Supplier selection and contract negotiation
– Design collaboration
– Procurement
– Sourcing planning and analysis

© 2007 Pearson Education 13-3

 Benefits of Effective
Sourcing Decisions
 Better economies of scale can be achieved if orders
are aggregated
 More efficient procurement transactions can
significantly reduce the overall cost of purchasing
 Design collaboration can result in products that are
easier to manufacture and distribute, resulting in
lower overall costs
 Good procurement processes can facilitate
coordination with suppliers
 Appropriate supplier contracts can allow for the
sharing of risk
 Firms can achieve a lower purchase price by
increasing competition through the use of auctions
© 2007 Pearson Education 13-4
 Supplier Scoring and Assessment
 Supplier performance should be compared on the
basis of the supplier’s impact on total cost
 There are several other factors besides purchase price
that influence total cost

© 2007 Pearson Education 13-5

 Supplier Assessment Factors
 Replenishment Lead Time  Pricing Terms
 On-Time Performance  Information Coordination
 Supply Flexibility Capability
 Delivery Frequency /  Design Collaboration
Minimum Lot Size Capability
 Supply Quality  Exchange Rates, Taxes,
 Inbound Transportation Cost Duties
 Supplier Viability

© 2007 Pearson Education 13-6

 Supplier Assessment Factors
 Replenishment Lead Time: more the lead time, more
would be safety inventory
 On-Time Performance: performance at the scheduled
time
 Supply Flexibility: the amount of variation in order
quality that a supplier can tolerate without letting other
performance factors deteriorate.
 Delivery Frequency / Minimum Lot Size: these two
affects the replenishment not ordered. As the
replenishment lot size grows, the cycle inventory grows
and thus the handling costs.
© 2007 Pearson Education 13-7
 Supplier Assessment Factors
 Supply Quality: the quality affects the lead time
because the follow up orders often need to be fulfilled
to replace defective products.
 Inbound Transportation Cost
 Pricing Terms: This includes the inbound
transportation cost of bringing material in from the
supplier.
 Information Coordination Capability: Good
information coordination results in better replenishment
planning, thus decreases inventory carried as well as the
sales lost because of lack of availability.
© 2007 Pearson Education 13-8
 Supplier Assessment Factors
 Design Collaboration Capability: As designs and
manufacture of components are outsourced, the
ability to coordinate design across many suppliers is
critical to ultimate success of the product and its
introduction.
 Exchange Rates, Taxes, Duties
 Supplier Viability: Given the impact that suppliers
have on a company’s performance, an important
factor in picking a supplier is the likelihood that it
will be around to fulfill the promises it makes.

© 2007 Pearson Education 13-9

 Supplier Selection- Auctions and
Negotiations
 Supplier selection can be performed through competitive
bids, reverse auctions, and direct negotiations
 Supplier evaluation is based on total cost of using a
supplier
 Auctions:
– Sealed-bid first-price auctions
– English auctions
– Dutch auctions
– Second-price (Vickery) auctions

© 2007 Pearson Education 13-10

 Types of Auctions
 Sealed-bid first-price auctions: It requires each potential
supplier to submit a sealed bid for the contract by a specified
time. These bids are then opened and the contract is assigned to
the lowest bidder.
 English auctions: the auctioneer starts with a price and suppliers
can make bids as long as each successive bids is lower than the
previous bid. The supplier with the last( lowest) bid receives the
contract.
 Dutch auctions: the auctioneer starts with a low price and then
raises it slowly until one of the suppliers agrees t the contract at
that price.
 Second-price (Vickery) auctions: The contract is assigned to the
lowest bidder but at the price quoted by the second-lowest bidder.

© 2007 Pearson Education 13-11

 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
© 2007 Pearson Education 13-12
 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
• In addition to the categorization of materials into
direct and indirect, all products purchased may also
be categorized as follows:
© 2007 Pearson Education 13-13
 Procurement process
 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

© 2007 Pearson Education 13-14

 Product categorization by value
and criticality

High
Critical Item Strategic items

Critical

General Items Bulk Purchase

Low Items

Low Value/Cost High

© 2007 Pearson Education 13-15

 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 other source
© 2007 Pearson Education 13-16
 Third and Fourth Party Logistics
 A third party logistics (3PL) provider performs one
or more of the logistics activities relating to the flow
of product, info, and funds that could be performed by
the firm itself.
 Traditionally focused on transportation, warehousing
and information technology within the supply chain.

© 2007 Pearson Education 13-17

 Services provided by 3PLs
Service Category Basic Services Value added Services

Transportation Inbound, outbound Mode conversion,

by any mode dispatch, freight pay
etc

Warehousing Storage, facilities Cross-docks, in-

management transit merge,
pick/pack, labeling,
home delivery of
catalog orders
IT Provide and maintain Worldwide track,
advanced info/ global visibility,
© 2007 Pearson Education
computer systems freight bill payments 13-18
 Service Category Basic services Value added services

Reverse Logistics Handle reverse Recycling, used-

flows asset disposition,
customer returns,
returnable container
management, repair.
Other 3 PL services Brokering, purchase-
order management,
loss and damage
claims, port services,
export crating,
handling hazardous
© 2007 Pearson Education
material, 13-19
 Fourth Party Logistics (4PL)
 The term 4PL is generally considered to have been
introduced by Accenture, which registered it as
a trademark in 1996. 
 Accenture described the 4PL as an "integrator that
assembles the resources, capabilities, and technology
of its own organization and other organizations to
design, supply chain solutions“
 3 PL targets on the function and 4 PL targets
management of the entire process.

© 2007 Pearson Education 13-20

 The Role of Revenue Management
in the Supply Chain
 Revenue management is the use of pricing to increase
the profit generated from a limited supply of supply
chain assets
 Supply assets exist in two forms: capacity and
inventory
 Revenue management may also be defined as the use
of differential pricing based on customer segment,
time of use, and product or capacity availability to
increase supply chain profits
 Most common example is probably in airline pricing
© 2007 Pearson Education 15-21
 The Role of Revenue Management
in the Supply Chain
 Revenue management has a significant impact on the
supply chain profitability when one or more of the
following 4 conditions are met:
 The Value of product varies in different market
segments
 The product is highly perishable or product wastage
occurs
 Demand has seasonal peaks
 The product is sold both in bulk and on the spot
market.

© 2007 Pearson Education 13-22

 Conditions Under Which Revenue
Management Has the Greatest Effect
 The value of the product varies in different market
segments (Example: airline seats)
 The product is highly perishable or product waste
occurs (Example: fashion and seasonal apparel)
 Demand has seasonal and other peaks (Example:
products ordered at [Link])
 The product is sold both in bulk and on the spot
market (Example: owner of warehouse who can
decide whether to lease the entire warehouse through
long-term contracts or save a portion of the
warehouse for use in the spot market)
© 2007 Pearson Education 15-23
 Revenue Management for
Multiple Customer Segments
 If a supplier serves multiple customer segments with
a fixed asset, the supplier can improve revenues by
setting different prices for each segment
 Prices must be set with barriers such that the segment
willing to pay more is not able to pay the lower price
 The amount of the asset reserved for the higher price
segment is such that the expected marginal revenue
from the higher priced segment equals the price of the
lower price segment

© 2007 Pearson Education 15-24

 Revenue Management
for Perishable Assets
 Any asset that loses value over time is perishable
 Examples: high-tech products such as computers and
cell phones, high fashion apparel, underutilized
capacity, fruits and vegetables
 Two basic approaches:
– Vary price over time to maximize expected revenue
– Overbook sales of the asset to account for cancellations

© 2007 Pearson Education 15-25

 Revenue Management
for Perishable Assets
 Overbooking or overselling of a supply chain asset is
valuable if order cancellations occur and the asset is
perishable
 The level of overbooking is based on the trade-off
between the cost of wasting the asset if too many
cancellations lead to unused assets and the cost of
arranging a backup if too few cancellations lead to
committed orders being larger than the available
capacity

© 2007 Pearson Education 15-26

 Revenue Management
for Seasonal Demand
 Seasonal peaks of demand are common in many supply
chains
 Examples: Most retailers achieve a large portion of
total annual demand in December ([Link])
 Off-peak discounting can shift demand from peak to
non-peak periods
 Charge higher price during peak periods and a lower
price during off-peak periods

© 2007 Pearson Education 15-27

 Revenue Management for
Bulk and Spot Customers
 Most consumers of production, warehousing, and transportation
assets in a supply chain face the problem of constructing a
portfolio of long-term bulk contracts and short-term spot market
contracts
 The basic decision is the size of the bulk contract
 The fundamental trade-off is between wasting a portion of the
low-cost bulk contract and paying more for the asset on the spot
market
 Given that both the spot market price and the purchaser’s need
for the asset are uncertain, a decision tree approach as discussed
in Chapter 6 should be used to evaluate the amount of long-term
bulk contract to sign

© 2007 Pearson Education 15-28

 Using Revenue Management
in Practice
 Evaluate your market carefully
 Quantify the benefits of revenue management
 Implement a forecasting process
 Apply optimization to obtain the revenue
management decision
 Involve both sales and operations
 Understand and inform the customer
 Integrate supply planning with revenue management

© 2007 Pearson Education 15-29

 Summary of Learning Objectives
 What is the role of sourcing in a supply chain?
 What dimensions of supplier performance affect
total cost?
 What is the effect of supply contracts on supplier
performance and information distortion?
 What are different categories of purchased
products and services? What is the desired focus
for procurement for each of these categories?

© 2007 Pearson Education 13-30