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Supply Chain Management

Chapter 14 Sourcing Decisions in a Supply Chain

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The Role of Sourcing in a Supply Chain

Sourcing is the set of business processes required to purchase goods and services Sourcing processes include:
Sourcing planning and analysis Supplier selection and contract negotiation Design collaboration Procurement Supplier scoring and assessment

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Benefits of Effective Sourcing Decisions

Better economies of scale by order aggregation Efficient procurement reduces overall purchasing cost Design collaboration with suppliers results in easier manufacturing and distribution and low overall costs Appropriate supplier contracts can allow for sharing of risk Firms can achieve a lower purchase price by increasing competition through the use of auctions

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In-House or Outsource
In-House is when the supply chain functions are performed by
the company. e.g. Madura Garments Outsourcing is when the supply chain functions are performed by a third party. e.g. Puma

Off-shoring is when a company maintains ownership of the

supply chain functions but moves production facility offshore.
e.g. Maduras apparel production in Bangladesh

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Third-Party Logistics (3PL) and Fourth-Party Logistics (4PL) A Third-Party (3PL) logistics firm is an external supplier that
manages one or more of a companys logistics functions. Generally 3PL manage functions like transportation, warehousing and information technology
e.g. DHL for Xerox, IBM

A Fourth-Party (4PL) logistics firm is an external supplier that

consults and/or manages complete aspects of a companys logistics functions.
e.g. Menlo Logistics for Carrefour Retail

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Sourcing Processes 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:
Replenishment Lead Time Increase in lead time means more safety stock to be stored On time Performance Impacts safety stock and downstream processes Supply Flexibility Affects safety stock and downstream processes Delivery Frequency/Minimum Lot Size Impacts Inventory holding costs

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Supplier Assessment Factors continued

Supply Quality Impacts Total Costs, WIP , FG, customers Inbound Transportation Cost Affects the final product pricing Pricing Terms Allowable payment delays save working capital for buyer (30, 60, 90 days) Information Coordination Capability Helps better planning, lower costs, improves overall visibility Design Collaboration Capability - Design collaboration with suppliers results in reduced cost, improved quality and decreased time to market Exchange Rates, Taxes, Duties Decides location of supplier, Hedging Supplier Viability Dependability, especially for very critical raw materials

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Supplier Selection- Auctions and Negotiations

Supplier selection can be performed through competitive bids, reverse auctions, and direct negotiations Auctions: Sealed-bid first-price auctions Each potential supplier submits sealed bid for contract by specified time. Contract assigned to lowest bidder. English auctions Auctioneer starts with a price and suppliers make successive open lower bids. The lowest bid gets the contract. Dutch auctions Auctioneer starts with low price and raises it slowly until one of the supplier agrees to that price. Second-price auctions Each potential bidder submits a bid. The contract is assigned to lowest bidder but at price quoted by second-lowest bidder.

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Example of Reverse Auction

V Ramachandran, deputy general manager, Corporate Buying Cell, Ashok Leyland (AL), the Chennai based manufacturer of medium and heavy commercial vehicles was surfing the Internet in his office. A closer look at the screen showed that he had logged on to an auction site. But this auction site was different. Ramachandran was looking for suppliers of some specific tyres in the global market. At a price of $350, five suppliers were interested. He then lowered the price by $5. Now three of them were willing. Ramachandran kept lowering the price, each time by $5. At $325, there was only one response. The seller asked for an hour's time to confirm. Within one hour, this Czechoslovakian company confirmed it could supply the tyres. Both parties then signed up by e-mail and the deal was struck at $325, saving Ashok Leyland Rs 14,700 per set. Known as reverse auction, this was one of the many ways AL was reducing materials cost, which accounted for nearly 70 per cent of its product cost.

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Design Collaboration
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

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The Procurement Process

Procurement is 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

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The Procurement Process continued

For direct materials, focus should be on improving coordination and visibility with supplier For indirect materials, focus should be on decreasing the transaction cost for each order

Procurement for both types should consolidate orders where possible to take advantage of economies of scale and quantity discounts

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Product Categorization by Value and Criticality

Critical Items Strategic Items


General Items

Bulk Purchase Items Take example of few product s/ raw materials/components and categorize them based on value and criticality





2007 Pearson Education

Sourcing Planning and Analysis

A firm must analyze its procurement spending and supplier performance and use this analysis as an input for future sourcing decisions Procurement spending should be analyzed parts wise and supplier wise 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 sources

2007 Pearson Education