Sourcing Decisions in

Supply Chain
Chapter 15
 What we will learn in
Chapter 15

 Understand the role of sourcing in supply

chain
 Factors that affect the decision to outsource
a supply chain function
 Identify dimensions of supplier performance
that affect total cost
 Structure successful auctions and
negotiations
 Describe the impact of different contracts on
supplier performance and information
distortion
Role of Sourcing in a supply chain
 Purchasing also called procurement, is a process by
which companies acquire raw material, components,
products, services, or other resources from suppliers to
execute their operations.
 Sourcing is the entire set of business processes required
to purchase goods and services.
 For companies an important decision is either to
execute operations IN-HOUSE or OUTSOURCE.
 Outsourcing can be a good option for one company but
can be a disaster for another one. Example of DELL and
P&G.
Role of Sourcing in a supply chain

 Important question to ask

before going for outsourcing: Outsourci
ng In House
 1. Will the 3rd party increase
supply chain surplus relative
to performing the activity in
house?
 2. To what extent do risks
Suppl Chai
grow upon outsourcing?
y n
 SC Surplus is the total share
all the participant get to
share.
Surplus
Sourcing Process

Once a decision to outsource has been made, and organization has to

go through the sourcing process

Cost of Goods sold comprise of over 50% of the sales for major
manufacturers.

Effective sourcing can improve the profits for a company and total SC
surplus can improve in a variety of ways
Benefits of effective sourcing

 Better Economies of Scale if order within a firm can be aggregated

 Efficient procurement transactions can reduce overall purchasing

cost
 Design collaboration can result in products that are easier to
manufacture and distribute.
 Good procurement process can facilitate coordination with the
suppliers and improve forecasting and planning
 Appropriate supplier contracts can allow for the sharing of risk ,
resulting in higher profits
 Firms can achieve lower purchase price by increasing competition
through use of auctions
INHOUSE or OUTSOURCE

 A Firm will choose either of the options where the growth in

surplus is large with small increase in risk. How a 3rd party
increase the SC surplus?

1. Capacity Aggregation: 3rd party can increase SC Surplus by

aggregating demand across multiple firms
2. Inventory Aggregation: 3rd party can increase the supply chain
surplus by aggregating inventories across a large number of customers
3. Transportation aggregation by intermediaries: 3rd party increase
surplus by aggregating the transportation function and merge routes
4. Transportation aggregation by storage intermediaries: 3rd party that
stores inventory can also increase the supply chain surplus by
aggregating inbound and outbound transportation
5. Warehousing aggregation: 3rd party may increase the SC surplus by
aggregating inventories of multiple buyers
INHOUSE or OUTSOURCE (Contd.)

6. Procurement aggregation: 3rd party increases the SC surplus if it

aggregates procurement for many small players and facilitates economies
of scale
7. Information aggregation: 3rd party increase SC surplus by aggregating
information to higher level than can be achieved by a firm performing in-
house
8. Receivable aggregation: 3rd party increase SC surplus if it aggregate
the receivable risk to a higher level than a firm.
9. Relationship Aggregation: An intermediary can increase the SC surplus
by decreasing the number of relationships required between multiple
buyers and sellers
10. Lower cost and higher quality: 3rd party can increase the supply chain
surplus if it provides lower cost or higher quality relative to firm.

3 important factors will however affect surplus:

1. Scale
2. Uncertainty
3. Specificity of asset
Risk of using a 3rd party

 Below risk have to be analyzed before proceeding to a 3rd

party:
 The process is broken
 Underestimation of the cost of coordination
 Reduced customer/supplier contact
 Loss of internal capability and growth in 3 rd party power
 Leakage of sensitive data and information
 Ineffective contracts
Supplier Scoring and Assessment

 When comparing suppliers below points can assist a firm in building a

scorecard:
 Replenishment lead time
 On-time performance
 Supply flexibility
 Delivery frequency/minimum lot size
 Supply quality
 Inbound transportation cost
 Pricing terms
 Information coordination capability
 Design collaboration capability
 Exchange rates, taxes and duties
 Supplier viability
Supplier Selection-Auctions and Negotiations

 Before Selection, a firm must decide whether to use single

sourcing or multiple suppliers
 1. Auction:
 Sealed Bid first-price auctions
 English Auctions
 Dutch Auctions
 Second-price (vickrey) auctions

 2. Negotiation
 Is Bargaining to reach win-win situation
Contracts and Supply Chain Performance

 A Supply Contract specifies parameters governing the

buyer-supplier relationship.
 Contracts for product availability and supply chain profits
 Buyback contracts

 Revenue sharing contracts

 Quantity flexible contracts

 Contracts to coordinate supply chain costs

 Contracts to increase agent effort
 Contracts to induce performance improvement
Design Collaboration
 Working with suppliers can speed up the product development time
significantly.
 It is generally accepted that about 80% of the cost of purchased
part is fixed during the design stage.
 To reduce inventory costs, the primary approach is to design the
product for postponement and mass customization.
 Customization:
 Modular customization
 Adjustable customization
 Design for manufacturability
The Procurement Process
 After the selection, contracts, product design, now the buyer
and seller are ready to engage in procurement transaction.
 The designing of procurement process requires the
classification of goods that the process will be used to
purchase:
 Direct Material
 In-direct Material
The Procurement Process (Contd.)
 General items: Indirect material
 Bulk Purchase: Mostly Direct Material
 Critical Items: Goods with long lead time & Specialty
Chemicals
 Strategic Items: Electronics for Auto Manufacturer
Sourcing planning and analysis
 Each firm must analyze its procurement spending and
supplier performance and use this as input for future sourcing
decision
 Decision to aggregate visibility into what a company is
purchasing and from whom is been purchased
 Supplier performance should be measured against total cost,
responsiveness, lead time, on time deliveries, quality and
delivery accuracy.