Sourcing Decisions
Chapter Objectives
Be able to:
 Discuss the various strategic issues surrounding
sourcing decisions and identify some of the key factors
favoring one approach over the other.
 Perform a simple total cost analysis.
 Explain what a sourcing strategy is, and show how
portfolio analysis can be used to identify the appropriate
sourcing strategy for a particular good or service.
 Show how multicriteria decision models can be used to
evaluate suppliers, and interpret the results.
 Discuss some of the longer-term trends in supply
management and why they are important.
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 2
Introduction
• The sourcing decision
• Sourcing strategies
• Supplier evaluation
• Trends in supply management
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 3
Focus
Sourcing decisions and purchasing activities serve to
link a company with its supply chain partners
• Sourcing decisions –
High level, often strategic decisions regarding which products or
services will be provided internally and which will be provided by
external supply-chain partners
• Purchasing – discussed in Chapter 11
The activities associated with identifying needs, locating and
selecting suppliers, negotiating terms, and following up to ensure
supplier performance
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 4
The Sourcing Decision
Sourcing decisions are high-level, often
strategic decisions that address:
What will use resources within the firm
What will be provided by supply chain partners
• Insourcing –
The use of resources within the firm
to provide products or services
• Outsourcing –
Make-or-Buy
Decision
The use of supply chain partners
to provide products or services
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 5
Advantages and
Disadvantages of Insourcing
Advantages
Disadvantages
• High degree of control • Required strategic
flexibility
• Ability to oversee the
entire program
• Required high
investment
• Economies of scale
and/or scope
• Loss of access to
superior products and
services offered by
potential suppliers
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 6
Advantages and
Disadvantages of Outsourcing
Advantages
Disadvantages
•
•
•
•
• Possibility of choosing a
bad supplier
• Loss of control over the
process and core
technologies
• Communication and
coordination challenges
• “Hollowing out” of the
corporation
High strategic flexibility
Low investment risk
Improved cash flow
Access to state-of-the-art
products and services
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 7
Factors Affecting the Decision to
Insource or Outsource
Factor
Favors
Insourcing
Favors
Outsourcing
Environmental uncertainty
low
high
Competition in the supplier market
low
high
Ability to monitor supplier performance
low
high
Relationship of product/service to
buying firm’s core competencies
high
low
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 8
Total Cost Analysis
A process by which a firm seeks to
identify and quantify all of the major costs
associated with various sourcing options
• Direct costs –
Costs that are tied directly to the level of
operations or supply chain activities
• Indirect costs –
Costs that are not tied directly to the level of
operations or supply chain activity
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 9
Insourcing and Outsourcing
Costs
Insourcing
Direct
costs
Indirect
costs
Outsourcing
•Direct material
•Direct labor
•Freight costs
•Variable overhead
•Price (from invoice)
•Freight costs
•Supervision
•Administrative support
•Supplies
•Maintenance costs
•Equipment depreciation
•Utilities
•Building lease
•Fixed overhead
•Purchasing
•Receiving
•Quality control
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 10
Portfolio Analysis
High
Complexity
or Risk
Impact
Bottleneck
Critical
Routine
Leverage
Low
Low
High
Value Potential
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 11
Critical Quadrant
• Critical to profitability and
operations
• Few qualified sources of
supply
• Large expenditures
• Design and quality critical
• Complex and/or rigid
specification
• Strategy
– Form partnerships with
suppliers
• Tactics
– Increase role of selected
suppliers
• Actions
– Heavy negotiation
– Supplier process
management
– Prepare contingency plans
– Analyze
market/competitions
– Use functional
specifications
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 12
Bottleneck Quadrant
• Complex specifications
requiring complex
manufacturing or service
process
• Few alternate
productions/sources of
supply
• Big impact on
operations/maintenance
• New technology or
untested processes
• Strategy
– Ensure supply continuity
• Tactics
– Decrease uniqueness of
suppliers
– Manage supply
• Actions
–
–
–
–
–
Widen specification
Increase competition
Develop new suppliers
Medium-term contracts
Attempt competitive
bidding
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 13
Leverage Quadrant
• High expenditures,
commodity items
• Large marketplace
capacity, ample
inventories
• Many alternate products
and services
• Many qualified sources of
supply
• Market/price sensitive
• Strategy
– Maximize commercial
advantage
• Tactics
– Concentrate business
– Maintain competition
• Actions
– Promote competitive
bidding
– Exploit market cycles/trends
– Procurement coordination
– Use industry standards
– Active sourcing
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 14
Routine Quadrant
• Many alternative
• Strategy
– Simplify acquisition
products and services
process
• Many sources of
• Tactics
supply
– Increase role of systems
• Low value, small
– Reduce buying effort
individual transactions • Actions
• Everyday use,
– Rationalize supplier base
– Automate requisitioning,
unspecified items
e.g., EDI, credit cards
• Anyone could buy it
– Stockless procurement
– Minimize administration
costs
– Little negotiating
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 15
Sourcing Strategies
• Single sourcing –
The buying firm depends on a single company for all or nearly all
of an item or service
• Multiple sourcing –
The buying firm shares its business across multiple suppliers
• Cross sourcing –
Using a single supplier for a certain part or service and another
supplier with the same capabilities for a similar part
• Dual sourcing –
Using two suppliers for the same purchased product or service
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 16
Multicriteria Decision Models in
Sourcing and Purchasing
How do we evaluate alternatives when criteria
include both quantitative measures (such as costs
and on-time delivery performance) and qualitative
factors (such as management stability and
trustworthiness)?
Weighted-Point Evaluation
System - I
Purpose:
• Evaluating potential suppliers
• Tracking suppliers’ performance over time
• Ranking current suppliers
The Process:
• Assign weights to performance dimensions
• Rate the performance of each supplier with
regard to each dimension
• Calculate the total score
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 18
Weighted-Point Evaluation
System - II
Summary Data for Alternative Suppliers
Performance
Dimension
Price
Quality
Delivery
reliability
Aardvark
Electronics
Beverly
Hills Inc.
Conan the
Electrician
$4/unit
$5/unit
$2/unit
5% defects
1% defects
10% defects
95% on time
80% on time
60% on time
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 19
Weighted-Point Evaluation
System - III
n
Score X   Performance XY  WY
Y 1
Criteria Weights
WPrice
= 0.3
Scoring Scheme
5 = excellent
4 = good
WQuality = 0.4
3 = average
2 = fair
WDelivery = 0.3
1 = poor
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 20
Weighted-Point Evaluation
System - IV
Performance Values for Alternative Suppliers
Performance
Dimension
Aardvark
Electronics
Beverly
Hills Inc.
Conan the
Electrician
4
3
5
Quality
3
5
1
Delivery
reliability
4
2
1
Price
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 21
Weighted-Point Evaluation
System - V
Total Scores for Alternative Suppliers
Score Aardvark = (4 x 0.3) + (3 x 0.4) + (4 x 0.3) = 3.6
Score Beverly = (3 x 0.3) + (5 x 0.4) + (2 x 0.3) = 3.5
Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2
Aardvark should improve their quality
Beverly Hills should improve their delivery and price
Conan is out of the running as a potential supplier
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 22
Trends in Supply Management
• Sustainable Supply*
• Supply Base Reduction
• Global Sourcing
– Supply Chain Disruptions
– Supply Chain Capacity
– Transportation Costs
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 10, Slide 23
Case Study in Sourcing
Decisions
Pagoda.Com