Sourcing, Pricing and Procurement Process: Supply Chain Management

Supply Chain Management:
Sourcing, Pricing and

Procurement Process
Rajendran Ananda Krishnan
https://www.facebook.com/ialwaysthinkprettythings
Topics to be covered
Sourcing and Pricing
 Sourcing – In house or Outsource
 3rd and 4th PLs
 Supplier Scoring and Assessment
 Selection, Design Collaboration
 Procurement Process, Sourcing
Planning and Analysis
 Pricing and Revenue Management for
multiple customers, Perishable products,
seasonal demand, bulk and spot
contracts
https://www.facebook.com/ialwaysthink
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Sourcing – In-house or
Outsource
 The decision of a firm to perform its
activities internally or get those activities
done from an independent firm is known
as the make versus buy decision.
 Bharti Airtel, India’s number one private
telecom service provider announced its
decision to outsource key network
management activities, IT services and
call centre operations also
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Bharti Airtel : Outsourcing of Network
Operations
 Network Management to Ericsson, Nokia and
Siemens – Manage the existing network and
deploy and operate new base stations in the future.
 IT Management to IBM –IBM manages all IT
services (billing, CRM), operates data centres, help
desk for IT support and application development.
 Customer Service call centres to Hinduja, TMT,
Mphasis & IBM Daksh – Managing customer
service call centres for all customers except
corporate clients and high-value clients. Bharti itself
is maintaining customer service for these high-end
customers.
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Out sourcing Vs Off shoring
 Out sourcing - Owning the facilities
and giving them to third party and
getting manufactured .
-Off shoring
 Not owning any facilities, but making
others to acquire facility and getting
manufactured:
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Benefits from effective sourcing
decisions
 Better economies of scale can be achieved if orders
within a firm 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 the supplier and improve forecasting and planning.
Better coordination lowers inventories and improves the
matching of supply and demand.
 Appropriate supplier contracts can allow for the sharing
of risk, resulting in higher profits for both the supplier
and the buyer.
 Firms can achieve a lower purchase price by increasing
competition through the use of auctions.
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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 incurred by using
a third party. A firm should consider outsourcing
if the growth in surplus is large with a small
increase in risk.
How do Third parties increase the Supply
Chain Surplus
Third parties increase the supply chain surplus if
they either increase value for the customer or
decrease the supply chain cost relative to a firm
performing the task in-house.
Third parties can increase the supply chain
surplus effectively if they are able to aggregate
supply chain assets or flows to a higher level
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 Capacity aggregation – A third party can increase
the supply chain surplus by aggregating demand
across multiple firms and gaining production
economies of scale that no single firm can on its
own. One of the reasons that Dell outsources design
and production of the processors in its PCs to Intel is
that Intel supplies many computer manufacturers
and gains economies of scale that are not available
to Dell if it designs and produces its own processors.
 Inventory Aggregation – A third party can increase
the supply chain surplus by aggregating inventories
across a large number of customers. Aggregation
allows them to significantly lower overall uncertainty
and improve economies of scale in purchasing and
transportation. They carry significantly less safety
and cycle inventory than would be required if each
customer decided to carry inventory on its own.
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 Transportation Aggregation – UPS, FedEx
and a host of LTL carriers are examples of
transportation intermediaries that increase the
supply chain surplus by aggregating
transportation across a variety of shippers.
Each shipper wants to send less than the
capacity of the transportation mode. The
transportation intermediary aggregates
shipments across multiple shippers, thus
lowering the cost of each shipment below what
could be achieved by the shipper alone.
 Warehousing Aggregation – The growth in
surplus is achieved in terms of lower real estate
costs as well as lower processing costs within
the warehouse. Savings through warehousing
aggregation arise if a supplier’s warehousing
needs are small or if its needs fluctuate over
time. prettythings
 Procurement Aggregation – A third party
increases the supply chain surplus if it
aggregates procurement for many small
buyers and facilitates economies of scale in
production and inbound transportation.
 Lower costs and higher quality – If these
benefits come from specialization and
learning, they are likely to be sustainable
over the long term. A specialized third party
that is further along the learning curve for
some supply chain activity is likely to
maintain its advantage over the long term.
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Risks of using a Third Party
 The process is broken – The biggest
problems arise when a firm outsources
supply chain functions simply because it has
lost control of the process as it will make it
worse and harder to control.
 Underestimation of the cost of
coordination – Underestimate the effort
required to coordinate activities across
multiple entities performing supply chain
tasks. This is especially true if a firm plans to
outsource specific supply chain functions to
different third parties.
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 Reduced Customer/supplier contact – A firm
may lose customer/supplier contact by
introducing an intermediary. The loss of
customer contact is particularly significant for
firms that sell directly to consumers but decide
to use a third party to either collect incoming
orders or deliver outgoing product.
 Loss of internal capability and growth in
third party power – A firm may choose to
keep a supply chain function in-house if
outsourcing will significantly increase the third
party’s power. Companies such as HP and
Motorola have moved most of their
manufacturing to contract manufacturers but
are reluctant to move either procurement or
design even though contract manufacturers
have developed both capabilities.
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 Leakage of sensitive data and
information – Using a third party
requires a firm to share demand
information and in some cases
intellectual property. If the third party
also serves competitors, there is
always the danger of leakage.
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Third and Fourth Party Logistics
Providers
 A third party logistics provider performs one
or more of the logistics activities relating to
the flow of product, information and funds
that could be performed by the firm itself.
 Traditionally, 3 PLs focused on specific
functions such as transportation,
warehousing and information technology
within the supply chain.
 Most 3PLs started out by focusing on one of
the functions in the supply chain. For eg.
UPS started out as a small package carrier.
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 A third-party logistics provider
(abbreviated 3PL, or sometimes TPL) is a
firm that provides a one stop shop service to
its customers of outsourced (or "third party")
logistics services for part, or all of their supply
chain management functions.
 Third party logistics providers typically
specialize in integrated operation,
warehousing and transportation services that
can be scaled and customized to customer’s
needs based on market conditions and the
demands and delivery service requirements
for their products and materials.
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Types of 3PL
 Freight forwarders
 Courier companies
 Other companies integrating & offering
subcontracted logistics and transportation services
Hertz and Alfredsson describe two categories of 3PL
providers:
 Standard 3PL provider: This is the most basic form
of a 3PL provider. They would perform activities such
as, pick and pack, warehousing, and distribution
(business) – the most basic functions of logistics.
 Service developer: This type of 3PL provider will

offer their customers advanced value-added
services such as: tracking and tracing, cross-
docking, specific packaging, or providing a unique
security system.
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 A third-party logistics provider (3PL) is an
asset based company that offers logistics
and supply chain management services to
its customers. It commonly owns and
manages distribution centers and transport
modes. A fourth-party logistics provider
(4PL) integrates the resources of producers,
retailers and third-party logistics providers in
view to build a system-wide improvement in
supply chain management. They are non-
asset based meaning that they mainly
provide organizational expertise.
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4th Party Logistics Services (4PL)
 With the Increased globalization of SC ,
customers are looking for players who can
manage virtually all aspects of their supply
chain. This has led to the concept of fourth
party logistics provider.
 Anderson Consulting ( Accenture) defined 4th
PL as An integrator that assembles resources,
capabilities and technology of its own and
other Organizations, to design, build and run
comprehensive SC solutions.
 3PL – targets a function, 4PL – entire
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A Fourth-party logistics provider
(abbreviated 4PL), lead logistics
provider, or 4th Party Logistics provider,
is a consulting firm specialized in
logistics, transportation, and supply
chain management. Typical fourth-
party logistics providers are CPCS,
SCMO, BMT, Deloitte, Capgemini, 3t
Europe, Accenture and Geodis.
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4TH PL company examples
 Menlo logistics manages all aspects of the
supply chain for Home Life , national
home furnishing retail chain
◦ Integrates transportation, warehousing, home
delivery, product set-up, repair, and reverse
logistics.
Kuehne & Nagel AG - Swiss Freight forwarder,
served as 4th PL for Nortel Network for
outbound logistics to customers. Handles 35 to
40 forwarders, warehouse managers, truckers,
and other log functions.
Li & Fung- served Reebok, managing sourcing
and production across1000s of factories in 32
countries.
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The main factors behind the increasing role of 3PL and 4PL are:
 The international division of production associated with
globalization helped set a global network of manufacturing
activities, implying that producers and consumers tend to have
an acute geographical separation requiring complex
transportation services.
 An increasing focus of manufacturers and retailers on their core
business (known as core competencies) and sub-contracting
activities such as logistics where they have less expertise.
 Productivity gains in supply chain management in terms of costs
and reliability that can be derived from the managerial and
information technology expertise provided by 3/4PL.
 Better utilization of transportation assets and resulting economies
of scale. 3PLs can make better use of transportation assets by
balancing the needs of multiple client shippers across
transportation and distribution.
 3/4PLs are more prone to implement novel supply chain

management practices requiring a higher expertise on material
flows such as transloading , crossdocking and shipment
tracking.
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Key Sourcing- Related
Processes
2. Supplier
1. Suppliers 5. Sourcing
selection and 3. Design 4.
Scoring and Planning and
contract Collaboration Procurement
assessment Analysis
negotiation
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Supplier Scoring and Assessment
In addition to quoted price, the following factors must
be considered when scoring and assessing
suppliers :
 1. Replenishment Lead time
 2. On- time performance
 3. Supply Flexibility
 4. Delivery Frequency / Minimum lot size
 5. Supply Quality
 6. Inbound Transportation Cost
 7. Pricing Terms
 8. Information coordination capability
 9. Design Collaboration capability
 10. Exchange rate , Tax and Duties
 11. Supplier Viability
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When scoring and assessing suppliers , the following
factors other than quoted price must be considered:
 Replenishment Lead Time – As the replenishment
lead time from a supplier grows, the amount of
safety inventory that needs to be held by the buyer
also grows.
 On-time performance – It affects the variability of
the lead time. A reliable supplier has low variability
of lead time, whereas an unreliable supplier has
high variability. As the variability of lead time grows,
the required safety inventory at the firm grows very
rapidly.
 Supply Flexibility – Supply flexibility is the amount
of variation in order quantity that a supplier can
tolerate without letting other performance factors
deteriorate. The less flexible a supplier is, the more
lead time variability it will displayprettythings
as order quantities
 Delivery frequency/minimum lot size –
Affect the size of each replenishment lot
ordered by a firm. As the replenishment lot size
grows, the cycle inventory at the firm grows,
thus increasing the cost of holding inventory.
 Supply quality – A worsening of supply quality
increases the variability of the supply of
components available to a firm. Quality affects
the lead time taken by the supplier to complete
the replenishment order.
 Inbound transportation cost – Sourcing a
product overseas may have lower product cost
but generally incurs a higher inbound
transportation cost, which must be accounted
for when comparing suppliers.
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 Pricing terms – Include the allowable time delay
before payment has to be made and any quantity
discounts offered by the supplier. Allowable time
delays in payment to suppliers save the buyer
working capital.
 Information Coordination Capability – Affects the
ability of a firm to match supply and demand.
 Design Collaboration Capability – Good design
collaboration for manufacturability and supply chain
can also decrease required inventories and
transportation cost.
 Exchange rates, taxes and duties- Significant for a
firm with a global manufacturing and supply base.
 Supplier viability – Supplier should be around to
fulfill the promises it makes.
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Supplier Selection - Auctions and
Negotiations
A firm must decide whether to use single
sourcing or multiple suppliers. Single
sourcing guarantees the supplier sufficient
business and proper coordination is
possible if there is a single source.
Multiple sources ensures a degree of
competition and also the possibility of a
backup should a source fail to deliver.
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Selection of suppliers is done using:
1. Auctions in the supply chain
 Sealed-bid first price auction – requires each
potential supplier to submit a sealed bid for the contract
by a specified time. 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 bid is lower than the previous bid. The
supplier with the 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 to the contract at that price.
 Second Price Auctions – Each potential supplier
submits a bid. The contract is assigned to the lowest
bidder but at the price quoted by the second lowest
bidder.
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Basic Principles of Negotiation
Negotiation is likely to result in a positive
outcome only if the value the buyer places
on outsourcing the supply chain function to
this supplier is at least as large as the
value the supplier places on performing
the function for the buyer. The difference
between the values of the buyer and seller
is referred to as the bargaining surplus.
The goal of each negotiating party is to
capture as much of the bargaining surplus
as possible.
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Contracts and Supply Chain
Performance
 Buyback or Returns Contracts – Allows a
retailer to return unsold inventory upto a
specified amount, at an agreed – upon
price.
 Revenue-Sharing Contracts – The
manufacturer charges the retailer a low
wholesale price and shares a fraction of the
retailer’s revenue.
 Quantity Flexibility Contracts – The
manufacturer allows the retailer to change
the quantity ordered after observing
demand. https://www.facebook.com/ialwaysthink
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Design Collaboration (with
Suppliers)
 It is crucial for a manufacturer to collaborate with suppliers
during the design stage if product costs are to be kept low.
 Working with suppliers can speed up product development
time significantly. This is crucial in an era when product life
cycles are shrinking.
 Finally, integrating the supplier into the design phase
allows the manufacturer to focus on system integration,
resulting in a higher quality product at lower cost.
 Helps to reduce cost, improves Quality and reduce time
to market.
Eg; Ford designed the car ‘THUNDER BIRD’ through

suppliers involvement, they not only manufactured the
components, but also responsible for the design. This
allowed Ford to bring the New model to market with in 36
months of program approval..
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The Procurement Process
There are two main categories of purchased
goods : Direct and Indirect materials.
 Direct materials are components used to
make finished goods. For eg. Memory, hard
drives and CD drives are direct materials
for a PC manufacturer.
 Indirect materials are goods used to
support the operations of a firm. PCs,
stationary items are examples of indirect
materials for an automotive manufacturer.
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Difference between Direct and
Indirect Materials.
Direct Materials Indirect Materials
USE Production Maintenance. Repair
and support operations
Accounting Cost of Goods Sold Power , Fuel and other
Packing materials used
Impact on production Any delay will delay in Less direct impact

Production
Processing cost relative Low High

to value of transaction
Number of Transactions Low High
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Product Categorization by Value and Criticality
High
Critical Items (Nuts & Strategic Items

Bolts) (Electronics for
Long LT, Ensuring Auto manufacturers )
Availability is important Buyer supplier
Critical Items than Price relationship is long term.
General Items Bulk purchase Items

Indirect Materials Chemicals , Packaging
Goal is To keep the materials. Use of well
cost of acquisition or designed auctions for
transaction cost low.) procurement.
LOW
LOW High
Value / Cost
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Sourcing Planning and Analysis
 One important analysis is the aggregation of
spending across and within categories and
suppliers. Aggregation provides visibility into
what a company is purchasing and from whom
the product is being purchased. Managers can
use this information to determine economic
order quantities, volume discounts and
projected quantity discounts on future volumes.
 The second piece of analysis relates to
supplier performance. Supplier performance
should be measured against plan on all
dimensions that affect total cost, such as
responsiveness, lead times, on-time delivery,
and quality.
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Suppliers Portfolio
 Spending and supplier performance should
be used to decide on the portfolio of
suppliers to be used and the allocation of
demand among the chosen suppliers.
 Portfolio of suppliers with complementary
strengths, to be balanced
 Cheaper, but lower performing, suppliers to
be used to supply base and regular
demand.
 Higher performing but more expensive,
suppliers should be used to buffer against
variation in demand.
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Pricing and Revenue Management
(PRM)
 Revenue Management is the use of pricing
to increase the profit generated from a
limited supply of supply chain assets.
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 surplus.
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Contd.
Revenue management adjusts the pricing and available
supply of assets to maximize profits. Revenue
management has a significant impact on supply chain
profitability when one or more of the following four
conditions exist :
1. The value of the product varies in different market
segments.
2. The product is highly perishable or product wastage
occurs.
3. Demand has seasonal and other peaks.
4. The product is sold both in bulk and on the spot market.
Airline seats are a good example of a product whose value
varies by market segment. A business traveler is willing
to pay a higher fare for a flight that matches his or her
schedule. In contrast, a leisure traveler will often alter
his or her schedule to get a lower fare. An airline that
can extract a higher price from the business traveler
compared to the leisure traveler https://www.facebook.com/ialwaysthink
will always do better
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for Multiple Customer segments
1. Example of multiple customer segment:
- Business traveler, willing to pay high a higher fare to
travel a specific schedule.
- Leisure traveler, ready to shift their schedule to take
advantage of lower fares.
2. Trucking firm has 6 Trucks :
6000 Cft x $ 2.50 = $15,000………… A1 (Ordinary)
3000 Cft x $ 3.50 = $ 10500
3000 Cft x $ 2.00 = $ 6000 ……A2 ( By
PRM)
Total = $ 16500
Additional Revenue......$ 1500 https://www.facebook.com/ialwaysthink
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Allocating Capacity to a Segment
under Uncertainty
 In most instances of differential pricing, demand
from the segment paying the lower price arises
earlier in time than demand from the segment
paying the higher price. A supplier may charge
a lower price to a buyer willing to commit far in
advance and a higher price to buyers wanting to
place their orders at the last minute.
 The basic trade off to be considered by the
supplier with production capacity is between
committing to an order from a lower price buyer
or waiting for a high price buyer to arrive later
on. prettythings
Contd.
 The two risks in such a situation are spoilage and
spill.
 Spoilage occurs when the capacity reserved for
higher price buyers is wasted because demand from
the higher price segment does not materialize.
 Spill occurs if higher price buyers have to be turned
away because the capacity has already been
committed to lower price buyers.
 Another approach to differential pricing is to create
different versions of a product targeted at different
segments. Publishers introduce new books from
best-selling authors as hard-cover editions and
charge a higher price. The same books are
introduced later as paperback editions at a lower
price. https://www.facebook.com/ialwaysthink
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 Different versions can also be created by
bundling different options and services
with the same basic product. Automobile
manufacturers create a high-end, a mid-
level and a low-end version of the most
popular models based on the options
provided.
 This policy allows them to charge
differential prices to different segments for
the same core product. Many contact lens
manufacturers sell the same lens with a
one-week, one-month and six-month
warranty. prettythings
Tactics to be followed when serving
Multiple Customer segments
 1. Price based on the value assigned
by each segment
 2. Use different price for each
segment
 3. Forecast at the segment level
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For Perishable Assets
 Any Asset that loses Value over Time is called
perishable.
◦ Fruits, Vegetables, Pharmaceuticals etc,
◦ Products such as computers and cell phones that lose
value as new models are introduced.
◦ High fashion apparels
◦ All forms of production, transportation, storage
capacity, seating capacity, travelling capacity etc, that is
wasted if not fully utilized.
◦ Example of revenue management for a perishable
asset is the use of overbooking by the airline industry.
An airplane seat loses all value once the plane takes
off. Given that people often do not show up for a plane
even when they have a reservation, airlines sell more
reservations than the capacity of the plane, to maximize
expected revenue. https://www.facebook.com/ialwaysthink
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Two RM tactics used for perishable
assets
 1. Vary price dynamically over time to
maximize expected revenue ( Dynamic
Pricing)
 2. Overbook sales of assets ,to account for
cancellations (eg. In Airlines and Railways)
Dynamic Pricing is the tactic of varying
price over time, is suitable for assets such
as fashion apparel that have a clear date
beyond which they lose a lot of their value.
Apparel designed for the winter does not
have much value by April. https://www.facebook.com/ialwaysthink
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Pricing & Revenue Management For
Seasonal Demand
 Seasonal peak of demand – is a common
occurrence.
 1. For Amazon.com, Peak sales period is
‘December’. As a result of the seasonal peak, there
is a significant increase in the requirement for picking
and packing as well as transportation capacity.
Bringing in short- term capacity is expensive and
decreases Amazon’s margin.
 Off-peak discounting is followed for shifting demand
to November. Free pickup and shipping is offered to
customers in Nov, encouraging customers to shift
demand from December to November.
 2. Tactic is, to charge a higher price during the peak
period and a lower price during off-peak period .
Trade-off between ‘revenue increase due to low-price
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Marriott Corporation ( Hotel)
 Hotel industry uses ‘differential pricing’ by ‘day of
week’ and ‘time of year.’ Here goal is not to shift
demand- but to increase demand during periods of
low demand by attracting price-sensitive
customers, such as vacationing families, with a
price discount.
 For business customers, peak demand days occur
in the middle of the week.
 Lower rates during weekends to encourage
families to use the hotel.
 Charge customers a Lower rate if families stay
over a longer period that also covers low demand
days.
 This tactics increase the profit of the owner of
assets, and brings in potentially new customers
during the off-peak discount period.
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Pricing & Revenue Management for
Bulk and Spot Contracts
 Most firms face a market in which some customers
purchase in bulk at a discount and others buy single units
or small lots at a higher place.
 Warehousing capacity may be leased in bulk to a large
company or in small amounts to large companies for their
emergency needs or to small companies.
 In most instances, owners of supply chain assets prefer to
fulfill all demand that arises from bulk sales and try to
serve small customers only if any assets are left over.
 For a firm that wants to be a niche player, targeting one of
the two extremes is a sensible strategy. It allows the firm
to focus its operations on serving either only the bulk
segment or only the spot market. For other firms,
however, a hybrid strategy of serving both segments is
appropriate.
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PRM - Guidelines
1) Evaluate your market carefully – The first step in
revenue management is to identify the customer
segments being served and their needs.
2) Quantify the benefits of Revenue Management –
It is critical to quantify the expected benefits from
revenue management before starting the project.
3) Implement forecasting process – To use
overbooking with any degree of success, an airline
must be able to forecast cancellation patterns.
4) Apply optimization to obtain the revenue
management decision – The goal of optimization
is to use forecasts of customer behavior to identify a
revenue management tactic that will be most
effective.
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Contd.
5) Involve both sales and operation –
Salespeople must understand the revenue
management tactic in place so they can align
their sales pitch accordingly.
6) Understand and Inform customer –
Customers will have a negative perception of
revenue management tactics if they are simply
presented as a mechanism for extracting
maximum revenue.
7) Integrate supply planning with revenue
management – The point is not to use
revenue management in isolation, but rather to
combine it with decisions on the supply side.
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Supply Chain Management:

Sourcing, Pricing and

Rajendran Ananda Krishnan

 Service developer: This type of 3PL provider will

 3/4PLs are more prone to implement novel supply chain

Eg; Ford designed the car ‘THUNDER BIRD’ through

Impact on production Any delay will delay in Less direct impact

Processing cost relative Low High

Number of Transactions Low High

Critical Items (Nuts & Strategic Items

General Items Bulk purchase Items

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