S U P P L Y C H A I N M A N A GEM E N T

MODULE IV –SOURCING &

PRICING
Role of Sourcing……..
 Purchasing or procurement
 Is the process by which companies acquire
 Raw materials
 Components

 Products
 Services or
 Other resources

 From suppliers to execute their operations

 Entire set of processes required to purchase goods
& service
Role of Sourcing……..
 Most significant decision will be whether to
 Outsource the function or
 Perform it in-house

 Outsourcing results in activities performed a third party

 WW Grainger
 Consistently owned & managed its DC
 Outbound transport from DC outsourced

 For LTL transport, Grainger owns some truck (hybrid

model)
 Dell
 Credited with improving profit by keeping retail function
in house & selling directly to customers
Role of Sourcing……..
 P&G
 Never sold detergents directly to customer
 Motorola
 Uses a distributor to sell cell phone in Latin America
 In US doesn’t use distributor model

Outsourcing Vs Off-shoring
 Offshoring is maintains the ownership but moves the
production facility offshore
 Outsource – hiring outside firm to perform an
operations rather than executing the operations within
the firm.
Role of Sourcing……..
Two major questions that need to be addressed
 Will the third party increase the supply chain
surplus relative to performing the activity in
house?
 To what extent do risks grow upon outsourcing?
Sourcing Process
Sourcing processes include:
Supplier scoring and assessment
Supplier selection and contract
negotiation
Design collaboration
Procurement

Sourcing planning and analysis

In-house or Outsource
How do third parties increase SC surplus
 Capacity aggregation
 Aggregating demand across multiple firms
 Gaining production economy of scale
 Dell
 Outsource design & production of the processors to INTEL

 But if the volume is sufficient (large & stable) may

not outsource
 No automobile manufacturer outsource production
of its best selling cars
In-house or Outsource
How do third parties increase SC surplus
Transportation aggregation by transportation
intermediaries
 Aggregation to a higher level than any shipper
 Eg: UPS, Fed Ex
 Transport intermediaries aggregates shipment across
multiple shippers
 Especially when it is geographically distributed
 Shippers transportation flow is highly unbalanced –
coming into Vs. leaving the region
 Wall Mart – this may add least value
In-house or Outsource
How do third parties increase SC surplus
Transportation aggregation by Storage
intermediaries
 Stock products from multiple manufacturers and sell
it to many customer
 Helps in aggregating inbound and outbound
transportation
 Less effective if the demand & supply grows
 Decrease in Supermarkets using distributor as they
get full truckloads delivered
In-house or Outsource
How do third parties increase SC surplus
Warehouse aggregation
 Growth achieved in terms of
 Lower real estate cost
 Lower processing cost
 Need arises if
 Needs are small

 Needs fluctuate over time

 Required when you are entering new geography

 If need stabilises then may not be of great use
In-house or Outsource
How do third parties increase SC surplus
Procurement aggregation
 Economy of scale in production
 Inbound transportation
 If you are big manufacturing firm then marginal
impact on the entire SC cost
In-house or Outsource
How do third parties increase SC surplus
Information aggregation
 Aggregation to a higher level can be achieved
through having function in-house
 This reduces search cost for customers
 If you are buying from single supplier then
information aggregation may not help much
In-house or Outsource
How do third parties increase SC surplus
Receivables aggregation
 Will lower the collection cost
 If retailer sells product of multiple manufacturer,
collectively they can outsource receivables
 If retailing is fragmented then the SC cost may go up
–developing countries
In-house or Outsource
How do third parties increase SC surplus
Relationship aggregation
 Intermediaries to reduce the no. of relationship
between multiple buyers & sellers
 This increases the size of each transactions
 Decreased no. of transactions
 Reduction in number of transaction doesn’t mean
reduction in cost
In-house or Outsource
How do third parties increase SC surplus
Lower Costs & Higher quality
 Benefits come from specialisation & learning
 Low cost location which the firms doesn’t
 Lower labor cost & overhead cost
In-house or Outsource
Risk of using a third party
 The process is broken
 Lost control of the process
 If it is a broken SC process
 First get the process under control

 Do a cost –benefit analysis & then outsource

 Underestimation of the cost of coordination

 With multiple entities
 Coordination has to be the core strength
 Eg: Nike & i2 Technologies
In-house or Outsource
Risk of using a third party
 Loss of internal capabilities & growth in the
third party power
 Better to in-house if outsourcing will significantly increases the
third party ‘s powers
 For Eg: HP & Motorola
 Reluctant to outsource procurement & design
 Even though the contract manufacturer has capabilities

 Leakage of sensitive data & Information

 Ineffective Contracts
Third Party & Fourth Party
Logistic Providers
Third Party Logistics (3PL) Provider
 Performs one or more of the logistics activities
 Relating to the flow of
 Product
 Information
 Funds
 That could be performed by the firm itself
 Most of the 3PLs started out focusing one of the
function in SC
 UPS – small package carrier
 Schneider – truck load carrier
Third Party & Fourth Party
Logistic Providers
Third Party & Fourth Party
Logistic Providers
 Over the years basic functions have become
commoditized
 UPS started with outbound transportation, has now
expanded to include
 Warehousing
 Information technology
 The trend of outsourcing broader range of SC
services has been growing since late 1990s
 Today customers are looking for players that can
manage virtually all aspects of their SC
Third Party & Fourth Party
Logistic Providers
 This has led to the concept of a Fourth Party logistics
(4PL) provider
 4PL first defined by Andersen Consulting (now
Accenture) as
 “An integrator that assembles the
 resources, capabilities & technology
 of its own organization and other
organizations
 to design, build & run
 comprehensive SC solutions”
Third Party & Fourth Party
Logistic Providers
 Whereas 3PL target functions
 4PL targets management of the entire process
 4PL –general contractor who manages other 3PLs,
truckers, forwarders, customer brokers & others
 Initially when the idea formulated Andersen
conceived a neutral 4PL that did not own any
logistics assets itself
 The reality was different
Third Party & Fourth Party
Logistic Providers
 The fundamental advantage that 4PL provides comes
from the greater visibility & coordination
 This requires use of sophisticated information
technology
 Given the
 high cost of development or purchase of this technology
 Expertise required for implementation
 4PL can increase surplus by spreading this cost
across multiple customers
Third Party & Fourth Party
Logistic Providers
 As SC become more global, 3PLs enjoying the
advantage
 This has led to series of mergers, with large 3PLs
getting even larger
 They are even asked to take partial manufacturing
responsibilities
Key sourcing related processes

Supplier Scoring & Assessment

Supplier Selection & Contract Negotiation

Design Collaboration

procurement

Sourcing Planning & analysis

Supplier Scoring & Assessment

 Replenishment Lead Time  Pricing Terms

 On-Time Performance  Information
 Supply Flexibility Coordination Capability
 Delivery Frequency /  Design Collaboration
Minimum Lot Size Capability
 Supply Quality  Exchange Rates, Taxes,
 Inbound Transportation Duties
Cost  Supplier Viability

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Supplier Selection & Contract Negotiation

Before selecting suppliers, a firm must decide whether to

use single sourcing or multiple suppliers
The selection of suppliers is done using a variety of
mechanisms:-
 offline competitive bids
 reverse auctions, or direct negotiations
Supplier selection should be based on the total cost of
using a supplier and not just the purchase price
In many supply chain settings, a buyer looks to
outsource a supply chain function such as production or
transportation

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Supplier Selection & Contract Negotiation

Potential suppliers are first qualified and then

allowed to bid on how much they would charge to
perform the function
When conducting an auction based primarily on unit
price, it is thus important for the buyer to specify
performance expectations along all dimensions other
than price

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Supplier Selection & Contract Negotiation

Sealed-bid first-price auctions - Each potential supplier to submit a

sealed bid for the contract. These bids are then opened and the 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 last (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 (Vickrey) 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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Supplier Selection & Contract Negotiation

Buyers should structure auctions to minimize their

cost and have the lowest-cost supplier(s) win with
their bid
 Open auctions such as the English auction are
likely to achieve this outcome

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Supplier Selection & Contract Negotiation

Buyback or returns contracts

Open auctions such as the English auction are likely
to achieve this outcome
The manufacturer specifies a wholesale price along
with a buy back price at which the retailer can
return any unsold units at the end of the season

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Supplier Selection & Contract Negotiation

Revenue – sharing contracts

The manufacturer charges the retailer a low
wholesale price and shares a fraction of the
retailer’s revenue
Even if no returns are allowed, the lower wholesale
price decreases the cost to the retailer in case of an
overstock
The retailer thus increases the level of product
availability resulting in higher profits for both the
manufacturer and the retailer.
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Supplier Selection & Contract Negotiation

Quantity flexibility contracts

The manufacturer allows the retailer to change the
quantity ordered after observing demand
Increase the average amount the retailer purchases
and may increase total supply chain profits

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Supplier Selection & Contract Negotiation

Contracts to coordinate supply chain costs

Differences in costs at the buyer and supplier can lead to

decisions that increase total supply chain costs

Example: Replenishment order size placed by the buyer. The

buyer’s EOQ does not take into account the supplier’s costs

A quantity discount contract may encourage the buyer to

purchase a larger quantity (which would be lower costs for the
supplier), which would result in lower total supply chain costs

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Supplier Selection & Contract Negotiation

Contracts to increase agent effort

There are many instances in a supply chain where
an agent acts on the behalf of a principal and the
agent’s actions affect the reward for the principal

Example: A car dealer who sells the cars of a

manufacturer, as well as those of other
manufacturers

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