Chopra4 PPT ch14

Chapter 14
Sourcing
Decisions in a
Supply Chain
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.
14-1
Outline
The Role of Sourcing in a Supply Chain

In-House or Outsource
Third- and Fourth-Party Logistics Providers
Supplier Scoring and Assessment
Supplier Selection Auctions and Negotiations
Contracts, risk Sharing, and Supply Chain Performance
Design Collaboration
The Procurement Process
Sourcing Planning and Analysis
The Role of IT in Sourcing
Risk Management in sourcing
Making Sourcing Decisions in Practice
Summary of Learning Objectives
14-2
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
14-3
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
14-4
Supplier Scoring and Assessment

Supplier performance should be compared on the
basis of the suppliers impact on total cost
There are several other factors besides purchase price
that influence total cost
14-5
Supplier Assessment Factors

Replenishment Lead Time
On-Time Performance
Supply Flexibility
Delivery Frequency /
Minimum Lot Size
Supply Quality
Inbound Transportation Cost
Pricing Terms
Information Coordination
Capability
Capability
Exchange Rates, Taxes,
Duties
Supplier Viability
14-6
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
14-7
Contracts and Supply Chain

Performance
Contracts for Product Availability and Supply
Chain Profits
Buyback Contracts
Revenue-Sharing Contracts
Quantity Flexibility Contracts
Contracts to Coordinate Supply Chain Costs

Contracts to Increase Agent Effort
Contracts to Induce Performance Improvement
14-8
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
Total supply chain profits might therefore be lower than if
the supply chain coordinated actions to have a common
objective of maximizing total supply chain profits
An 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 buyers demand
uncertainty
14-9
Supply Contracts
Fixed Production Cost =$100,000
Variable Production Cost=$35
Wholesale Price =$80

Selling
Price=$125
Salvage Value=$20
Manufacturer
Manufacturer DC
Retail DC
Stores
Demand Scenarios
P robability
Demand Scenarios
30%
25%
20%
15%
10%
5%
0%
Sales
Retailer Expected Profit

Expected Profit
500000
400000
300000
200000
100000
0
6000
8000
10000
12000
14000
Order Quantity
16000
18000
20000
Retailer Expected Profit

Expected Profit
500000
400000
300000
200000
100000
0
6000
8000
10000
12000
14000
Order Quantity
16000
18000
20000
Retailer orders for 12000 swimsuits
Demand
Prob
Revenue
125
Whole
Sale
Price 80
Fixed
Cost
Salvage
Value 20
Retailer
Profit
Weighted
Retail
Average
Manuf
Profit
Weighted
Average
Manuf
Profit
8000
0.11
1000000
960000
100000
80000
120000
13200
440000
48400
10000
0.11
1250000
960000
100000
40000
330000
36300
440000
48400
12000
0.275
1500000
960000
100000
540000
148500
440000
121000
14000
0.225
1500000
960000
100000
540000
121500
440000
99000
16000
0.185
1500000
960000
100000
540000
99900
440000
81400
18000
0.095
1500000
960000
100000
540000
51300
440000
41800
Total Expected Profit

Total Supply Chain Profit
470700
440000
910700
Supply Contracts (cont.)

Retailer optimal order quantity is 12,000 units
Retailer expected profit is $470,000
Manufacturer profit is $440,000
Total Supply Chain Profit is $910,000
Is there anything that the retailer and

manufacturer can do to increase the
profit of both?
Supply Contracts

Selling Price=$125
Salvage Value=$20
Manufacturer
Manufacturer DC
Retail DC
Stores
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
Downside is that buyback contract results in surplus
inventory that must be disposed of, which increases supply
chain costs
Can also increase information distortion through the
supply chain because the supply chain reacts to retail
orders, not actual customer demand
14-17
Buy back contract

Retailer proposes that unsold goods should be taken
back by the manufacturer under Buy back
arrangement for $55 per unit
Retailer orders for 12000 swimsuits with buy back arrangement
Demand
Prob
Sales
Price
Buy
Back
Wholes
le Price
Variale
cost
Fixed
cost
Profit
125
55
80
35
100000
Retailer
Manuf
Retailer
Manuf
Average Profit
8000
0.11
1000000
220000
960000
42000
0
100000
260000
220000
28600
24200
10000
0.11
1250000
110000
960000
42000
0
100000
400000
330000
44000
36300
12000
0.275
1500000
960000
42000
0
100000
540000
440000
148500
121000
14000
0.225
1500000
960000
42000
0
100000
540000
440000
121500
99000
16000
0.185
1500000
960000
42000
0
100000
540000
440000
99900
81400
18000
0.095
1500000
960000
42000
0
100000
540000
440000
51300
41800
493800
403700

TotalSupply Chain Profit
897500

Demand
Prob
Sales
Price
Buy
Back
Whole
sale
Price
Variable
cost
Fixed
cost
125
55
80
35
100000
Profit
Average Profit
Retailer
Manuf
Retailer
Manuf
8000
0.11
1000000
330000
1120000
490000
100000
210000
200000
23100
22000
10000
0.11
1250000
220000
1120000
490000
100000
350000
310000
38500
34100
12000
0.275
1500000
110000
1120000
490000
100000
490000
420000
134750
115500
14000
0.225
1750000
1120000
490000
100000
630000
530000
141750
119250
16000
0.185
1750000
1120000
490000
100000
630000
530000
116550
98050
18000
0.095
1750000
1120000
490000
100000
630000
530000
59850
50350
514500
439250

953750
Demand
Prob
Sales
Price
Buy
Back
Whole
Sale
Price
Variable
cost
Fixed
cost
125
55
80
35
100000
Profit
Retailer
Average Profit
Manuf
Retailer
Manuf
8000
0.11
1000000
440000
1280000
560000
100000
160000
180000
17600
19800
10000
0.11
1250000
330000
1280000
560000
100000
300000
290000
33000
31900
12000
0.275
1500000
220000
1280000
560000
100000
440000
400000
121000
110000
14000
0.225
1750000
110000
1280000
560000
100000
580000
510000
130500
114750
16000
0.185
2000000
1280000
560000
100000
720000
620000
133200
114700
18000
0.095
2000000
1280000
560000
100000
720000
620000
68400
58900
503700
450050
Best case Profits for both increase. With buy back

arrangement manufacturer should push for 16000 units
order.

953750
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
Supply Contracts
Wholesale Price =$??

Selling Price=$125
Salvage Value=$20
Manufacturer
Manufacturer DC
Retail DC
Stores
Revenue Sharing Contract

Manufacturer and retailer have a revenue sharing
contract
Manufacturer agrees to decrease the whole sale price
from $80 to $60
In return retailer provides 15% of the product revenue
to the manufacturer
Retailer orders for 12000 swimsuits with revenue sharing arrangement
Demand
Prob
Sales
Price
Rev
Share
Wholesale
Price
Variable
cost
Fixed
cost
125
15%
60
35
100000
Profit
Retailer
Average Profit
ManuF
Retailer
Manuf
8000
0.11
1000000
150000
720000
420000
100000
130000
350000
14300
38500
10000
0.11
1250000
187500
720000
420000
100000
342500
387500
37675
42625
12000
0.275
1500000
225000
720000
420000
100000
555000
425000
152625
116875
14000
0.225
1500000
225000
720000
420000
100000
555000
425000
124875
95625
16000
0.185
1500000
225000
720000
420000
100000
555000
425000
102675
78625
18000
0.095
1500000
225000
720000
420000
100000
555000
425000
52725
40375
484875
412625
SUM
Total SC Profit
897500
Retailer orders for 14000 swimsuits with revenue sharing

arrangement
Demand
Prob
Sales Price
Rev Share
Wholesale
Price
Variable
cost
Fixed
cost
125
15%
60
35
100000
Retailer
Profit
Average Profit
Manuf
Retailer
Manuf
8000
0.11
1000000
150000
840000
490000
100000
10000
400000
1100
44000
10000
0.11
1250000
187500
840000
490000
100000
222500
437500
24475
48125
12000
0.275
1500000
225000
840000
490000
100000
435000
475000
119625
130625
14000
0.225
1750000
262500
840000
490000
100000
647500
512500
145688
115313
16000
0.185
1750000
262500
840000
490000
100000
647500
512500
119788
94813
18000
0.095
1750000
262500
840000
490000
100000
647500
512500
61513
48688
472188
481563
Best case. Profits for both increase. Retailer should negotiate for
reduction in the wholesale price to $60 by committing to lift 14000 units.
SUM
Total SC Profit
953750
Retailer orders for 16000 swimsuits with revenue sharing arrangement
Demand
Prob
Sales Price
Rev Share
Wholesale
Price
Variable
cost
Fixed
cost
125
15%
60
35
100000
Retailer
Manuf
Profit
Average Profit
Retailer
Manuf
8000
0.11
1000000
150000
960000
560000
100000
-110000
450000
-12100
49500
10000
0.11
1250000
187500
960000
560000
100000
102500
487500
11275
53625
12000
0.275
1500000
225000
960000
560000
100000
315000
525000
86625
144375
14000
0.225
1750000
262500
960000
560000
100000
527500
562500
118688
126563
16000
0.185
2000000
300000
960000
560000
100000
740000
600000
136900
111000
18000
0.095
2000000
300000
960000
560000
100000
740000
600000
70300
57000
411688
542063
SUM
Total SC Profit
953750
Supply Contracts
Supply Contracts

Selling Price=$125
Salvage Value=$20
Manufacturer
Manufacturer DC
Retail DC
Stores
Supply Chain Profit
Supply Chain Profit
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
Production Quantity
Supply Chain Profit

Global Optimization Strategy - Marginal Profit 90 (=125-35) vs Marginal loss 15 (=35-20) Make 16000
Demand
Prob
Sales Price
Variable
Cost
Fixed cost
Salvage Value
125
35
100000
20
Over all Profit
Average
Profit
8000
0.11
1000000
560000
100000
160000
500000
55000
10000
0.11
1250000
560000
100000
120000
710000
78100
12000
0.275
1500000
560000
100000
80000
920000
253000
14000
0.225
1750000
560000
100000
40000
1130000
254250
16000
0.185
2000000
560000
100000
1340000
247900
18000
0.095
2000000
560000
100000
1340000
127300
1015550
Supply Contracts
32
Supply Contracts: Key Insights

Effective supply contracts allow supply chain partners
to replace
sequential optimization by
global optimization
Buy Back and Revenue Sharing contracts achieve this

objective through
risk sharing
Other Contracts
Quantity Flexibility Contracts
Supplier provides full refund for returned items as long as
the number of returns is no larger than a certain quantity
Sales Rebate Contracts

Supplier provides direct incentive for the retailer to increase
sales by means of a rebate paid by the supplier for any item
sold above a certain quantity
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 buyers EOQ does not take into account
the suppliers 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
14-35
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
14-36
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
Differences between direct and indirect materials listed in Table
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
14-37
Product Categorization by Value

and Criticality
Criticality
High
Critical Items
Strategic Items
General Items
Bulk Purchase
Items
Low
Low
Value/Cost
High
14-38
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
14-39
The Role of IT in Sourcing

Design collaboration
Negotiate
Buy
Supply collaboration
14-40
Risk Management in Sourcing

Supply disruption
Increased procurement costs
Intellectual property
14-41
Making Sourcing
Decisions in Practice
Use multifunction teams
Ensure appropriate coordination across regions
and business units
Always evaluate the total cost of ownership
Build long-term relationships with key suppliers
14-42
Summary of Learning Objectives

What is the role of sourcing in a supply chain?
What factors affect the decision to outsource a supply chain
function?
What dimensions of supplier performance affect total cost?
How do you structure successful auctions and negotiations?
What is the impact of risk sharing 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?
14-43

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Chapter 14

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

The Role of Sourcing in a Supply Chain

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

The Role of Sourcing

Supplier scoring and assessment

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supplier Scoring and Assessment

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supplier Assessment Factors

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supplier Selection- Auctions and

Sealed-bid first-price auctions

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Contracts and Supply Chain

Contracts to Coordinate Supply Chain Costs

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Contracts for Product Availability

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Wholesale Price =$80

Retailer Expected Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer Expected Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 12000 swimsuits

Total Expected Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supply Contracts (cont.)

Is there anything that the retailer and

Wholesale Price =$80

Contracts for Product Availability and

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Buy back contract

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 12000 swimsuits with buy back arrangement

Total Expected Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 14000 swimsuits with buy back arrangement

Total Expected Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 16000 swimsuits with buy back arrangement

Best case Profits for both increase. With buy back

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Total Expected Profit

Contracts for Product Availability and Supply

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Wholesale Price =$??

Revenue Sharing Contract

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 12000 swimsuits with revenue sharing arrangement

Retailer orders for 14000 swimsuits with revenue sharing

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Retailer orders for 16000 swimsuits with revenue sharing arrangement

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Wholesale Price =$80

Supply Chain Profit

Supply Chain Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supply Chain Profit

Over all Profit

Total Supply Chain Profit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Supply Contracts: Key Insights