Supply Chain Management

Lecture 23

Semester Outline
Thursday April 8 Tuesday April 13 Thursday April 15 Tuesday April 20 Thursday April 22 Tuesday April 27 Thursday April 29 Chap 14 Paul Dodge guest lecture Chap 14, 15 Chap 15 Simulation Game briefing Review, buffer 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 Walmarts merchandise is made abroad
A whopping 10%-13% of everything China sends to the US ends up on Walmarts 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
Walmarts 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
India and Philippines account for 50% of the worlds 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

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

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
Intels 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
Specifity of assets involved Low High High growth in surplus Low/medium growth in surplus Low growth in surplus No growth in surplus Low/medium growth in surplus Low growth in surplus High growth in surplus Low/medium growth in surplus

Firm scale Demand uncertainty

Low High Low High

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 partys 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 selection and contract negotiation

Supplier scoring and assessment

Design collaboration

Procurement

Sourcing planning and analysis

Sourcing Process
Supplier scoring and assessment
Process used to rate suppliers
Supplier scoring and assessment Supplier selection and contract negotiation

Supplier selection
Choose the appropriate supplier(s)

Design collaboration
Work together with supplier when designing components for the final product

Design collaboration

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

Sourcing planning and analysis

Analyze spending across various suppliers, identify opportunities for decreasing cost

Sourcing planning and analysis

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

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 suppliers 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 timeto-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 component Replenishment lead time On-time performance Supply flexibility Delivery frequency Supply quality Inbound transportation cost Pricing terms Information coordination Design collaboration Exchange rates and taxes Supplier viability Cycle inventory Safety inventory X X X X X Product Transporta- introduction tion cost time

X X X X X X X

X X

X X X

X X

X X

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

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