Supply Chain Management Lecture 23. Semester Outline Thursday April 8Chap 14 Tuesday April 13Paul Dodge guest lecture Thursday April 15Chap 14, 15 Tuesday.

Supply Chain Management

Lecture 23

Semester Outline

• Thursday April 8 Chap 14• Tuesday April 13 Paul Dodge guest lecture• Thursday April 15 Chap 14, 15• Tuesday April 20 Chap 15• Thursday April 22 Simulation Game briefing• Tuesday April 27 Review, buffer• Thursday April 29 Simulation Game

Outline

• Today– Start with Chapter 14

• Sections 1, 2, 3, 4, 6, 7, 8, 9– Section 6 buyback and revenue sharing contracts only

• Homework 6 online tomorrow– Due Thursday April 15 before class

• Next week– Guest speaker: Paul Dodge

• SVP Supply Chain, ProBuild

Announcement

• Summer Internship at OptTek Systems, Boulder, CO– Date

• Seven consecutive weeks during summer 

– Compensation• $900/week ($6,300 Total)

– Description• This summer internship will engage the student in

research and development of the agent-based simulation model within OptForce. The student will gain practical real-world experience by analyzing actual customer data using OptForce. 

For more information, ask Career Services

Summary

• Single period inventory model– Cost of over- and understocking have a direct impact on both the

optimal cycle service level and profitability – Optimal CSL* = (p – c)/(p – s) = Cu/(Cu + Co)– Optimal order quantity O* = F-1(CSL, , )

• How to improve profitability?– Increase salvage value– Decrease margin lost from stockout– Decrease demand uncertainty

• Improved forecast• Quicker reponse• Postponement• Tailored sourcing

Drivers of Supply Chain Performance• Facilities• Inventory• Transportation• Sourcing• Pricing• Information

(Chapters 4, 5)

(Chapters 10, 11, 12)

(Chapters 4, 13)

(Chapter 14)

(Chapter 15)

(Chapters 7, 8, 9, 16)

Comparing Different Suppliers• Green Thumb, uses 1000 bearings per week for their

production of lawn mowers and snow blowers. Green Thumb is considering one of two suppliers– Supplier A charges $1.00 per bearing– Supplier B charges $0.97 per bearing

Which supplier should Green Thumb choose?

Comparing Different Suppliers• Green Thumb, uses 1000 bearings per week for their

production of lawn mowers and snow blowers. Green Thumb uses a holding cost of 25% and is considering one of two suppliers– Supplier A charges $1.00 per bearing and requires an order

size of 2000– Supplier B charges $0.97 per bearing and requires an order

size of 8000

Which supplier should Green Thumb choose?

Comparing Different Suppliers• Green Thumb, uses on average 1000 bearings per

week, with a standard deviation of 300, for their production of lawn mowers and snow blowers. It monitors inventory continuously and aims a cycle service level of 95%. Green Thumb uses a holding cost of 25% and is considering one of two suppliers– Supplier A charges $1.00 per bearing and requires an order size

of 2000. The supplier lead time is 2 weeks– Supplier B charges $0.97 per bearing and requires an order size

of 8000. The supplier lead time is 6 weeks

Which supplier should Green Thumb choose?

Comparing Different Suppliers• Green Thumb, uses on average 1000 bearings per

week, with a standard deviation of 300, for their production of lawn mowers and snow blowers. It monitors inventory continuously and aims a cycle service level of 95%. Green Thumb uses a holding cost of 25% and is considering one of two suppliers– Supplier A charges $1.00 per bearing and requires an order size

of 2000. The supplier lead time is 2 weeks, with a standard deviation of 1 week

– Supplier B charges $0.97 per bearing and requires an order size of 8000. The supplier lead time is 6 weeks, with a standard deviation of 4 weeks

Which supplier should Green Thumb choose?

Comparing Different Suppliers• Green Thumb, uses on average 1000 bearings per

week, with a standard deviation of 300, for their production of lawn mowers and snow blowers. It monitors inventory continuously and aims a cycle service level of 95%. Green Thumb uses a holding cost of 25% and is considering one of two suppliers– Supplier A charges $1.00 per bearing and requires an order size

of 2000. The supplier lead time is 2 weeks, with a standard deviation of 1 week. Quality is poor

– Supplier B charges $0.97 per bearing and requires an order size of 8000. The supplier lead time is 2 weeks, with a standard deviation of 4 weeks. Quality is good

Which supplier should Green Thumb choose?

Sourcing Decisions in a Supply Chain

According to a KPMG survey, 77% regarded cost to be as the “most important” or “second

most important” factor in all of their outsourcing decisions

The Role of Sourcing in a Supply Chain• Purchasing

– Also called procurement, is the process by which companies acquire raw materials, components, products, services, or other resources from suppliers to execute their operations

• Sourcing – Is the entire set of business processes required to purchase

goods (raw materials, components, products) and services

• Outsourcing – Results in the supply chain function being performed by a third

party

For any supply chain, the most significant decision is whether to outsource the function or perform it in-house

Outsourcing versus off-shoring• What is the difference?

A firm off-shores a supply chain function if it maintains ownership but moves the

production facility offshore

A firm outsources if the firm hires an outside firm to perform an operation rather than executing the operation within the firm

Backsourcing and nearshoring• Backsourcing

– Is the return of business activity to the original firm• Dell, Apple, Powergen (a British company) have

backsourced from Indian call centers, claiming that their costs had become too high

• Nearshoring (near source outsourcing)– Is choosing an outsource provider near the home country

• US firms are interested in nearshoring to Mexico because of its somewhat low cost labor and geographic nearness to the US

Outsourcing to China

Outsourcing to China (Walmart)• About 85% of Walmart’s merchandise is made abroad

– A whopping 10%-13% of everything China sends to the US ends up on Walmart’s shelves

• Over $15 billion worth of goods per year• Walmart has almost 600 people in China to make

purchases

– The price of portable DVD players dropped in half when Walmart found a Chinese factory to built in giant quantities

• Walmart’s success has forced other retailers and manufacturers to reevaluate their supply chains

– Walmart has led the way to product safety through its “responsible sourcing program”

• In 2009, Walmart required “an identifiable trail” from raw material to suppliers

Outsourcing in Practice

Source: The A.T. Kearney Global Outsouring Index, 2009

India and Philippines account for 50% of the world’s business process

outsourcing (BPO) market

BPO is a form of outsourcing that involves the contracting of the

operations and responsibilities of a specific business functions to a

third-party service provider

Outsourcing in Practice

Source: The A.T. Kearney Global Outsouring Index, 2009

Outsourcing in Practice

• Trends in outsourcing– North Africa and Middle

East are rising on the global sourcing index

– North America accounts for 70% of offshore outsourcing spending, but European countries are catching up as their spending has risen faster

– A move toward more outsourcing providers

– Experienced labor is key to success

Source: The A.T. Kearney Global Outsouring Index, 2009

In-House or Outsource

• The decision to outsource is based on the growth in supply chain surplus provided by the third party and the increase in risk by using a third party

How do third parties increase the supply chain surplus?• Lower cost and higher quality

– Specialized third party is further along the learning curve for some supply chain activity

• Capacity aggregation– Increase SC surplus by aggregating demand across

multiple firms and gaining economies of scale

Intel’s family of mobile PC processors gives consumers more choice by enabling PC makers to design notebooks of every shape and size

How do third parties increase the supply chain surplus?• Transportation aggregation

– Increases supply chain surplus by aggregating transportation across a variety of shippers

Transportation and Sourcing

What factors lead Wal-Mart to own its trucks although many retailers outsource their

transportation?

How do third parties increase the supply chain surplus?• Warehousing aggregation

– Increases SC surplus by aggregating warehousing needs over several customers and lowering facility cost

• Receivables aggregation– Increases SC surplus by aggregating receivables

reducing collection cost (especially when retailing is fragmented)

Safexpress provides an unrivalled range of logistics and supply chain solutions including door to door distribution and single source invoicing

How do third parties increase the supply chain surplus?• Procurement aggregation

– Increases SC surplus by aggregating procurement for many small players to facilitate economies of scale

Offering members preferred pricing and volume-based rebates on truck equipment and services through a community-driven purchasing system

How do third parties increase the supply chain surplus?• Information aggregation

– Increases SC surplus by aggregating information and reducing search cost for the (online) customer

Provides the North American Trucking Industry with the most comprehensive freight matching service

How do third parties increase the supply chain surplus?• A third party may be able to provide a sustainable growth

of the surplus by aggregating capacity, inventory, inbound or outbound transportation, warehousing, procurement, information, receivables, or relationships to a level that the firm cannot on its own

• A growth in surplus may also occur if the third party has lower costs or higher quality because of specialization or learning

How do third parties increase the supply chain surplus?• Three important factors that affect the increase in surplus

– Scale– Uncertainty– Specificity

Low HighFirm scale Low

HighDemand Low

uncertainty High

Specifity of assets involvedLow High

Firm scale Low High growth in surplusHigh No growth in surplus

Demand Lowuncertainty High

Specifity of assets involvedLow High

Firm scale Low High growth in surplusHigh No growth in surplus

Demand Low Low growth in surplusuncertainty High High growth in surplus

Specifity of assets involvedLow High

Firm scale Low High growth in surplus Low/medium growth in surplusHigh Low growth in surplus No growth in surplus

Demand Low Low/medium growth in surplus Low growth in surplusuncertainty High High growth in surplus Low/medium growth in surplus

Specifity of assets involved

A firm gains the most from outsourcing if its needs are small, highly uncertain, and shared by others

How do third parties increase risk?• Less control over the function being outsourced

– Reduced customer/supplier contact– Loss of internal capability and increase in third party’s power

• Increases complexity in coordination, and thus increases coordination cost– It is easy to underestimate the effort to coordination

• Leakage of sensitive information– In case intellectual property needs to be shared with third

parties, there is the danger of leakage

• Ineffective contracts

What are ways to mitigate these risks?

Sourcing Process

• Once a decision to outsource has been made, the sourcing process includes

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Sourcing Process

• Supplier scoring and assessment– Process used to rate suppliers

• Supplier selection– Choose the appropriate supplier(s)

• Design collaboration– Work together with supplier when designing components for the

final product

• Procurement– Process placing orders and receiving orders from supplier(s)

• Sourcing planning and analysis– Analyze spending across various suppliers, identify opportunities

for decreasing cost

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Supplier scoring and assessment• Common fundamental mistake when choosing a

supplier– Only focus on quoted price

Supplier performance should be compared on the basis of the supplier’s impact on total cost

Factors besides purchase price that influence total cost• Replenishment lead times

– Does it pay to select a more expensive supplier with a shorter lead time?

– If lead time grows, safety inventory grows proportionally to the square root of the replenishment lead time

• On-time performance– Is a more reliable supplier worth the extra pennies?– If variability of lead time grows, the required safety inventory at

the firm grows

Factors besides purchase price that influence total cost• Supply flexibility

– The less flexible a supplier is, the more lead-time variability it will display as order quantities change

• Delivery frequency/lot size– Delivery frequency affects the transportation cost, lot size affects

the cycle inventory holding cost

• Supply quality– Quality affects unit price and lead time as follow-up orders may

need to be fulfilled to replace defective products

• Inbound transportation cost– Sourcing a product overseas may have lower product cost, but

generally incurs a higher inbound transportation cost

Factors besides purchase price that influence total cost• Pricing terms

– For example, quantity discounts (and the impact it has on cycle inventory)

• Information coordination capability– Good coordination results in better planning and ultimately lower

production, safety inventory, and transportation cost

• Design collaboration capability– Can help reduce all cost, improve quality, and decrease time-

to-market

• Exchange rates, taxes, and duties– Important for global supply chains as it affects the unit price

• Supplier viability– The likelihood that the supplier will be around to fulfill the

promises it makes (uncertainty increases safety inventory)

Factors besides purchase price that influence total cost

Purchase price of

componentCycle

inventorySafety

inventoryTransporta-

tion cost

Product introduction

timeReplenishment lead time XOn-time performance XSupply flexibility XDelivery frequency X X XSupply quality X XInbound transportation cost XPricing terms X XInformation coordination X XDesign collaboration X X X X XExchange rates and taxes XSupplier viability X X

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Sourcing Planning and Analysis• A firm should periodically analyze its (1) procurement

spending and (2) supplier performance and use this analysis as an input for future sourcing decisions

• 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

Sourcing Planning and Analysis• A firm should periodically analyze its (1) procurement

spending and (2) supplier performance and use this analysis as an input for future sourcing decisions

• 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