ch14 Sourcing Rev1

Chapter 14
Sourcing Decisions in a Supply Chain
Mainly Taken from:

- Chopra/Meindl, Supply Chain Management (3rd ed)
- Heizer/Render, Principles of Operations Management (7th ed)
© 2007 Pearson Education

Outline
 The Role of Sourcing in a Supply Chain
 Supplier Scoring and Assessment
 Sourcing Planning and Analysis
 Making Sourcing Decisions in Practice
 Summary of Learning Objectives
© 2007 Pearson Education 13-2

The Role of Sourcing
in a Supply Chain
 Sourcing is the set of business processes required
to purchase goods and services
 Critical decision: to outsource or in house
 Sourcing processes include:
– Supplier scoring and assessment
– Supplier selection and contract negotiation
– Design collaboration
– Procurement
– Sourcing planning and analysis

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

What is Outsourcing?
 Outsourcing -
– “the strategic use of outside resources to perform activities
traditionally handled by internal staff and resources” Dave
Griffiths
 Why Outsource?
– Provide services that are scalable, secure, and efficient,
while improving overall service and reducing costs
 Off sourcing?

Subcontracting
 Subcontracting occurs when primary contractors

contract part of their work to other contractors
– ie. Construction, aerospace
 Beneficial when orders take a long period of time, are

extremely costly, or when work is difficult to define

Outsourcing
 An “easy way” to increase profits
 Nike, Cisco, Apple outsource most of their
manufacturing
– Each could focus on research, marketing
– Each has gotten into trouble
» 2001 – Nike reported unexpected profit shortfalls due to inventory
problems
» 2000 – Cisco had to write down billions in obsolete inventory
» 1999 – Apple was unable to meet customer demand for new
products
 Dell, off sourcing its manufacturing

Examples of Outsourcing
 Call centers in French Angola, Bangalore

India
 Legal and finance service in the Philippines
 EDS handling information
technology for Nextel
 IBM providing travel and
payroll for P&G
 Solectron producing
IBM computers

Reasons for Outsourcing
 Traditional role - reaction to problem
– Reduction and control of costs
– Avoid large capital investment costs
– Insufficient resources available
 Modern role – business strategy
– Allows company to focus on their core competencies
– Keeping up with cutting-edge technology
– Creating value for the organization and its customers
– Building partnerships

Strategic Rationale
 Focus on core competencies
– Activities that are not core competencies are often not cost
effective to perform
» Why do something yourself if someone else can do it better and
cheaper?
» If starting over, would you do the activity yourself?
» Would someone else pay you to do the activity for them?
10
Strategic Rationale
 Outsourcing frees resources to be used in more
profitable ways
– Resources are allocated to the areas where the company has
a competitive advantage
 Reduces complexity
– Number of activities performed is reduced
11
Strategic Rationale
 Eliminates the need for expensive capital investment
– Facilities are owned by the supplier
 Increased flexibility
– Can focus on the internal activities
– External activities are shifted to the supplier
12
Outsourcing Benefits
– Economies of scale reduce manufacturing costs
– Risk pooling – demand uncertainties are
transferred
– Reduced capital investment
– Focus on core competencies
– Increased flexibility

Problems (Challenges)
With Outsourcing
 Loss of Control
 Increased cash outflow
 Confidentiality and security:
leakage of sensitive data and info
 Selection of supplier
 Too dependent on service provider
 Loss of staff or moral problems
 Time consuming
 Provider may not understand
business environment
 Provider slow to react to changes
in strategy

Types of Outsourcing
 Common processes outsourced are

 Purchasing  Finance/accounting
 Logistics  Customer relations
 R&D  Sales/marketing
 Operations  Training
 Service management  Legal processes
 Human resources
 Outsourcing implies a legally binding

contract
Theory of Comparative
Advantage
If an external outsourcing provider can

perform activities more productively than
the client firm, the outsourcing provider
should do the work
r d l e ss o f the
s a ppl i e s rega
Thi c a l l o c a t io n
geograph i

Outsourcing Trends and
Political Repercussions
According to a survey of 53 major
corporations, the most important
reasons for outsourcing are:
Cost savings 77%

Gaining outside expertise 70%
Improving services 61%
Focusing on core competencies 59%
Gaining access to technology 56%

 Outsourcing includes specific business
functions (computer help desks) and entire
departments (accounting, marketing, finance,
etc.)
 35% of businesses said they would continue
or expand outsourcing
 40% said they would continue outsourcing
but revise their arrangements
 Some said they would reduce outsourcing

 Outsourcing includes specific business
functions (computer help desks) and entire
departments ts (accounting,
o u rc in g e x p eri en c es
marketing, are finance,
 N o t all ou
etc.)
satisfactory
 35% of businesses
s t il l a lo t said
to le athey
rn a b o u t
would continue
 T h ere is p ro v e
or expandrcoutsourcing as a m e th o d to i m
outsou ing
 40%prsaid
oducti they
vity would continue outsourcing
but revise their arrangements
 Some said they would reduce outsourcing

 Political backlash can occur when jobs are
outsourced to foreign countries
 In the U.S. state and federal laws have been
enacted to limit or prevent outsourcing
activities
 Recent data suggests more foreigners
outsource jobs to the U.S. than American
companies outsource offshore
 Backsourcing describes the process of
returning work to the original firm when
outsourcing fails
Risks in Outsourcing
 Outsourcing can be risky

 As many as half of all outsourcing
agreements fail because of inappropriate
planning and analysis
 Erratic power grids, government difficulties,
inexperienced managers, and unmotivated
labor can create problems
 Failure to achieve unrealistic goals
sometimes create the impression of failure

Outsourcing Examples of
Process Possible Risks
Identify non-core Can be incorrectly identified as a
competencies non-core competency
Identify non-core Just because the activity is not a
activities that should be core competence for your firm
outsourced does not mean an outsource
provider is more competent and
efficient
Identify impact on May fail to understand the

existing facilities, change in resources and talents
capacity, and logistics needed internally
Table S11.1
Establish goals and Goals can be set so high that
draft outsourcing failure is certain
agreement
specifications
Identify and select Can select the wrong outsource
outsource provider provider
Negotiate goals and Can misinterpret measures and

measures of goals, how they are measured,
outsourcing and what they mean
performance
Table S11.1
Monitor and control May be unable to control
current outsourcing product development,
program schedules, and quality
Evaluate and give May have non-responsive

feedback to outsource provider (i.e., one that ignores
provider feedback)
Evaluate international County’s currency may be

political and currency unstable, a country may be
risks politically unstable, or cultural
and language differences may
inhibit successful operations
Table S11.1
Evaluate coordination May not understand the timing
needed for shipping and necessary to manage flows to
distribution different facilities and markets
Table S11.1
Outsourcing brings other issues:
 Employment
 Changes in facilities and processes
needed to receive components in a
different state of assembly
 Vastly expanded logistics issues

Supplier Selection Process
Steps in Supplier Selection Process
– Evaluating Needs and Defining Objectives

– Gathering a Limited Pool of Vendors
– Interviewing with Vendors
– Selecting and Applying the Method

1. Evaluating Needs and Defining
Objectives
 What need you are looking to satisfy?
– Increase product quality
 Which evaluation categories you will use?
 What are your business, technical and usability requirements?
 What are the must requirements?
– Max price, min performance, etc
 How will you score the requirements?
OUTCOME: list of requirements, objective and criterias to

evaluate the vendors and the way to score different criterias

Supplier Assessment Factors
 Replenishment Lead Time  Pricing Terms
 On-Time Performance  Information Coordination
 Supply Flexibility Capability
 Delivery Frequency /  Design Collaboration
Minimum Lot Size Capability
 Supply Quality  Exchange Rates, Taxes,
 Inbound Transportation Cost Duties
 Supplier Viability

2. Gathering a Limited Pool of Vendors
 Evaluating all potential vendors takes much time
 Basic screening and elimination due to lack of must
requirements
OUTCOME: vendors pool

3. Interviewing with Vendors
 One by one interview with vendors
 Gap analysis between your requirements, objectives
and vendor properties
 Scoring each criteria
OUTCOME: criteria-score list for each vendor

4. Selecting and Applying the Method
 Select one among various methods
– AHP, fuzzy logic method, etc
 Calculate overall vendor score using selected method
 Select the vendor with best score

Supplier Evaluation Criterias
 The evaluation criterias are fundamental to choose the best

supplier. They are specific to each firm, because they vary
according to the needs.
 The criteria exposed in the following slides are the most

common ones.*
 Six categories of criteria selected
(*) We have analysed almost 30 texts in order to select the most common
criterias
Supplier Evaluation Criterias
The six classes for the suppliers’evaluation
measurement:
– FINANCIAL HEALTH
– EXPERTISE
– OPERATIONAL PERFORMANCE METRICS
– BUSINESS PROCESSES & PRACTICES
– ENABLING BEHAVIORS OR CULTURAL FACTORS
– RISK FACTORS

Financial Health
In order to evaluate if a potential supplier is in good
financial position, a buyer can use indicators such as:
– Sales
– Profitability
– Liquidity
– ROI
– Debt ratio
– Transparency of finances

Expertise
The purchasing department of the firm should choose
its suppliers according to its capabilities:
– Network capabilities
– Quality and production capabilities (dedicated level?)
– Technical level compared to sector average
– Spread of technical creation
– Investment in R&D

Operational Performance
There are a large number of criteria in this category, such
as:
– On-time delivery
– Lead time
– Responsiveness
– Inventory management and control: reorder management, forecasting
capabilities…
– Order acceptance, processing & fulfillement
– Customer service
– Preventive maintenance
– Hours of operators training in Total Quality Control (TQC) or JIT

Business Processes and Practices
How does supplier provide a product or service at the
best value, on time and exactly as required from the
buyers?
 Best practice and quality based information.

 This evaluation business can help get at the root causes of supplier
problems.
For example: is the quality standard of the products met by the production
process (preventing defection) or by inspecting the quality of the
products after production?

Behaviors and Cultural factors
The evaluation criteria of such a category focus on the
long term sustainability of potential suppliers:
– What is the improvement culture of the supplier? Are his

information capabilities always up-to-date?
– What is his intention of coordination?

Risk Factors
 A supplier’s risks are risks for the buyer. Indeed, if a
supplier takes too much risk, it can have a great
impact on his customer.
 Risk factors can be uncovered in the previous criteria
exposed, but also in criteria such as: trade relations,
currency exchange, insurance, legislations.

Criteria Selection
 In reality, these mesures of supplier performance are difficult to
obtain (financial publications, questionnaires, surveys, site
visits).
 Whichever criteria chosen, the assessment system must be
optimal for good decision making.
 Markov chain concept: the decision environment is dynamic,
i.e. there must be interaction between the cooperation patterns
and the supplier evaluation criteria.

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

Selection Methods
 AHP
 Mathematical Models
 Qualitative Methods

Analytic Hierarchy Process
 For Complex Decisions rather than Correct Decision
 Mathematics and Human Psychology
 Government, Business, Industry, Healthcare, and Education.
 Decomposition of a problem into a hierarchy
 Evaluation of various elements comparing them to one another
in pairs
 A numerical weight or priority is derived for each element of
the hierarchy
 Thomas L. Saaty

Ex. Complex Decision Situations
 Deciding how best to reduce the impact of global climate

change
 Quantifying the overall quality of software systems (Microsoft
Corporation)
 Deciding where to locate offshore manufacturing
plants(University of Cambridge)
 Assessing risk in operating cross-country petroleum pipelines
(American Society of Civil Engineers)
 Deciding how best to manage U.S. Watersheds (U.S.
Department of Agriculture)
 Etc...

AHP Process
 State the Objectives
 Define the Criteria
 Pick the Alternatives
 Establish Hierarchy
 Pairwise Comparison
 Synthesize Judgments
 Check Consistency Index
 Comparison between Criteria and Alternatives
 Calculate Final Rankings

AHP Process
 Objective is to open an ice cream shop for young children and families.
 Establish Criteria
– Neighborhood
– Visibility
– Competition
– Price
 Identify Alternatives
– Suburban Shopping Center
– Main Business District
– Suburban Mall Location
Example based on Decision By Objectives (How to convince others that you are
right)
By: Ernest Forman, DSc., George Washington University & Mary Ann Selly, Expert
Choice Inc.

AHP Process
 Hierarchical Arrangement

AHP Process
 Hierarchical Arrangement

AHP Process
 Pairwise Comparison Matrix

1- Equally preferred
2 - Equally to moderately preferred
3 - Moderately preferred
4 - Moderately to strongly preferred
5 - Strongly preferred
6 - Strongly to very strongly preferred
7 - Very Strongly preferred
9 - Extremely preferred
8 - Very Strongly to extremely preferred

AHP Process
– Synthesize Judgments
– Check Consistency Index

AHP Process
 Comparison between
Criteria and Alternatives

AHP Process
 Recall Ranking for the Criteria
 Calculate Final Rankings
First choice: Shopping Center (59%)
Second choice: The Mall (32%)
Third choice: Main Street (9%)

AHP Major Benefits
 Precise assessment of values through hierarchical structuring
and pair-wise comparison.
 Programmable on a computer.
 Value assessment, forecasting, alternative selection and
resource allocation.
 Widely accepted and applied by major business corporations
and government agencies world wide.

AHP Major Pitfalls
 Human perception can distort pair-wise comparison.
 Hierarchy is one directional and it is difficult to accommodate
feedback.
 Values are highly aggregated and difficult to reflect the degree
of uncertainty.

Other Analytic Vendor Selection Methods

Pre-emptive Goal Programming
 Wang, Huang, and Dismukes (2004) developed an
integrated AHP and pre-emptive goal programming (PGP)
methodology to take into account both qualitative and
quantitative factors in supplier selection. While the AHP
process matched product characteristics with supplier
characteristics in order to qualitatively determine supply
chain strategy, PGP mathematically determined the
optimal order quantity from the chosen suppliers.

Multi Objective Programming
 Weber, Current,and Desai (2000) combined a multi-

objective programming (MOP) and DEA method to
provide buyers with a tool for negotiating with
vendors that were not selected right away, as well as
to evaluate potential suppliers.

Linear Programming
 Manufacturing supply chain design and evaluation GeWang · Samuel H. Huang · John P. Dismukes
 Ghodsypour and O’Brien (1998) proposed an

integration of an AHP and linear programming to
consider both tangible and intangible factors in
choosing the best suppliers and giving them optimal
order quantities so that the total purchasing value is
maximized.

Fuzzy Set Theory
 Morlacchi (1999) developed a model that combines

the use of a fuzzy set with an AHP and implemented it
in order to evaluate small suppliers in the engineering
and machinery sectors.

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
Ethical Issues in Outsourcing
Ethics Principle Outsourcing Linkage

Seek to do no harm to Don’t use outsourcing in a
indigenous cultures way that violates religious
holidays
Seek to do no harm to the Don’t use outsourcing to

ecological systems of the move pollution from one
world country to another
Seek to uphold universal Don’t use outsourcing to take

labor standards advantage of cheap child
labor that leads to child abuse

Ethical Issues in Outsourcing
Ethics Principle Outsourcing Linkage

Seek to uphold basic human Don’t accept outsourcing that
rights violates basic human rights
Seek to pursue long-term Don’t use outsourcing as a
involvement in foreign short-term arrangement to
countries reduce costs; view it as a
long-term partnership
Seek to share knowledge Don’t think an outsourcing
and technology with foreign agreement will prevent loss of
countries technology, but use the
inevitable sharing to build a
good relationship

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Chapter 14

Sourcing Decisions in a Supply Chain

Mainly Taken from:

© 2007 Pearson Education

© 2007 Pearson Education 13-2

© 2007 Pearson Education 13-3

© 2007 Pearson Education 13-4

© 2007 Pearson Education

 Subcontracting occurs when primary contractors

 Beneficial when orders take a long period of time, are

© 2007 Pearson Education

© 2007 Pearson Education

 Call centers in French Angola, Bangalore

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

 Common processes outsourced are

 Outsourcing implies a legally binding

If an external outsourcing provider can

© 2007 Pearson Education

Cost savings 77%

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

 Outsourcing can be risky

© 2007 Pearson Education

Identify impact on May fail to understand the

Negotiate goals and Can misinterpret measures and

Evaluate and give May have non-responsive

Evaluate international County’s currency may be

© 2007 Pearson Education

– Evaluating Needs and Defining Objectives

© 2007 Pearson Education

OUTCOME: list of requirements, objective and criterias to

© 2007 Pearson Education

© 2007 Pearson Education 13-29

OUTCOME: vendors pool

© 2007 Pearson Education

OUTCOME: criteria-score list for each vendor

© 2007 Pearson Education

© 2007 Pearson Education

 The evaluation criterias are fundamental to choose the best

 The criteria exposed in the following slides are the most

 Six categories of criteria selected

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

 Best practice and quality based information.

© 2007 Pearson Education

– What is the improvement culture of the supplier? Are his

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education 13-42

© 2007 Pearson Education

© 2007 Pearson Education

 Deciding how best to reduce the impact of global climate

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education

© 2007 Pearson Education