Chapter 7: Strategic Sourcing
Strategic Sourcing
 Strategic Sourcing is the development and
management of supplier relationships to
acquire goods and services in a way that aids
in achieving the immediate needs of the
business
Ford Manufacturing Supply Chain
http://www.covisint.com/
What is the bullwhip effect?
 Demand variability increases as you move up the supply chain
from customers towards supply
Equipment Tier 1 Supplier
Factory
Distributor
First noticed regarding Pampers
Retailer
Customer
Bullwhip effect in the US PC supply chain
Changes in
demand
80%
60%
Semiconductor
Equipment
40%
20%
PC
0%
-20%
Semiconductor
-40%
1995
1996
1997
1998
1999
2000
2001
Annual percentage changes in demand (in $s) at three levels of the semiconductor
supply chain: personal computers, semiconductors and semiconductor manufacturing
equipment.
Consequences of the bullwhip effect
 Inefficient production or excessive inventory.
 Low utilization of the distribution channel.
 Necessity to have capacity far exceeding average
demand.
 High transportation costs.
 Poor customer service due to stockouts.
Causes of the bullwhip effect
 Order synchronization
 Order batching
 Trade promotions and forward buying
 Reactive and over-reactive ordering
 Shortage gaming
Order synchronization
70
 Customers order on the same
order cycle, e.g., first of the
month, every Monday, etc.
50
40
Units
 The graph shows simulated
daily consumer demand (solid
line) and supplier demand
(squares) when retailers order
weekly: 9 retailers order on
Monday, 5 on Tuesday, 1 on
Wednesday, 2 or Thursday
and 3 on Friday.
60
30
20
10
0
T im e (e a c h p e rio d e q u a ls o n e d a y )
Order batching
70
 The graph shows simulated
daily consumer demand (solid
line) and supplier demand
(squares) when retailers order
in batches of 15 units, i.e.,
every 15th demand a retailer
orders one batch from the
supplier that contains 15
units.
60
50
Units
 Retailers may be required to
order in integer multiples of
some batch size, e.g., case
quantities, pallet quantities,
full truck load, etc.
40
30
20
10
0
T im e (e a c h p e rio d e q u a ls o n e d a y )
Trade promotions and forward buying
 Supplier gives retailer a temporary discount, called a trade promotion.
 Retailer purchases enough to satisfy demand until the next trade promotion.
 Example: Campbell’s Chicken Noodle Soup over a one year period:
Total shipments and consumption
One retailer’s buy
7000
6000
S hipm e nts
Cases
Cases
5000
4000
3000
C ons um ption
2000
1000
Nov
Oct
Sep
Aug
Jul
Jun
Apr
Mar
Feb
May
T im e (w e e ks )
Jan
Dec
0
Reactive and over-reactive ordering
 Each location forecasts demand to determine shifts in the demand process.
 How should a firm respond to a “high” demand observation?
ä Is this a signal of higher future demand or just random variation in current
demand?
ä Hedge by assuming this signals higher future demand, i.e. order more than
usual.
 Rational reactions at one level propagate up the supply chain.
 Unfortunately, it is human to over react, thereby further increasing the
bullwhip effect.
Shortage gaming
 Setting:
ä Retailers submit orders for delivery in a future period.
ä Supplier produces.
ä If supplier production is less than orders, orders are rationed, i.e., retailers
are “put on allocation”.
 … to secure a better allocation, the retailers inflate their orders, i.e., order
more than they need…
 … So retailer orders do not convey good information about true demand …
 This can be a big problem for the supplier, especially if retailers are later able
to cancel a portion of the order:
ä Orders that have been submitted that are likely be canceled are called
phantom orders.
Strategies to combat the bullwhip effect
 Information sharing:
ä Collaborative Planning, Forecasting and Replenishment (CPFR)
 Smooth the flow of products
ä Coordinate with retailers to spread deliveries evenly.
ä Reduce minimum batch sizes.
ä Smaller and more frequent replenishments (EDI).
 Eliminate pathological incentives
ä Every day low price
ä Restrict returns and order cancellations
ä Order allocation based on past sales in case of shortages
 Vendor Managed Inventory (VMI): delegation of stocking decisions
ä Used by Barilla, P&G/Wal-Mart and others.
Supply Chain Design Strategy
Based on concepts developed by
Marshall Fischer at Wharton (Penn)
 Functional Products
ä Staples that people buy at retail outlets
ä Predictable demand and long life cycles
ä Physical costs
ä Strategy: Minimize physical costs
 Innovative Products
ä Life cycle is just a few months (e.g. fashion
clothes & computers)
ä Demand is unpredictable
ä Market mediation costs (inventory &
stockouts)
ä Strategy: Maximize responsiveness &
flexibility
Hau Lee’s Concepts of Supply Chain Management
 Hau Lee’s approach to supply chain (SC) is one of aligning SC’s
with the uncertainties revolving around the supply process side
of the SC
 A stable supply process has mature technologies and an
evolving supply process has rapidly changing technologies
 Types of SC’s
ä Efficient SC’s
ä Risk-Hedging SC’s
ä Responsive SC’s
ä Agile SC’s
Hau Lee’s SC Uncertainty Framework
Demand Uncertainty
Supply
Uncertainty
Low
(Stable
Process)
High
(Evolving
Process)
Low (Functional
products)
High (Innovative
products)
Efficient SC
Responsive SC
Ex.: Grocery
Ex.: Computers
Risk-Hedging SC
Agile SC
Ex.: Hydro-electric
power
Ex.: Telecom
Outsourcing
Outsourcing is defined as the
act of moving a firm’s internal
activities and decision
responsibility to outside
providers
 Reasons to Outsource
ä Organizationally-driven
ä Improvement-driven
ä Financially-driven
ABC News Report on Outsourcing Part 2
Inventory Turnover
 Obtaining data
ä Look up inventory value on the
balance sheet
ä Look up cost of goods sold
(COGS) from earnings statement
– not sales!!
 Common benchmark is inventory turns
ä Inventory Turns = COGS/
Inventory Value
 A manufacturing company producing
medical devices reported $60 million
in sales last year. At the end of the
year, they had $20 million worth of
inventory in ready-to ship devices.
Assuming that units are valued at
$1000 per unit and sold at $2000
per unit, what is the turnover rate?
Sales = $60,000,000 per year / $2000
per unit = 30,000 units sold per year
@ $1000 COGS per unit
Inventory = $20,000,000 / $1000 per
unit = 20,000 units in inventory
Turns = COGS/Inventory =
$30,000,000/$20,000,000 = 1.5
turns
Inventory Turnover Statistics
Industries with higher gross margins tend to have lower inventory turns
Wholesale
Retail
Hardware stores: 3.5
Retail Nurseries & Garden Supply: 3.3
General Merchandise Stores: 4.7
Groceries & related: 17.8
Vehicles & automotive: 6.9
Furniture & fixtures: 5.5
Sporting goods: 4.8
Grocery Stores: 12.7
Drug store items: 8.5
New & Used Car Dealers: 6.8
Apparel & related: 5.5
Gas stations & mini-marts: 39.3
Petroleum & related: 42.4
Apparel &
Alcoholic beverages: 8.5
Accessories: 3.5
Furniture & home furnishings: 4.1
Drug Stores: 5.3
Liquor Stores: 6.6
Other Retail Stores: 4.3
Source: Bizstats.com
Value Density
 Value density is defined as the value of an item
per pound of weight
ä It is used as an important measure when
deciding where items should be stocked
geographically and how they should be shipped
Mass Customization
 Mass customization is a term used to describe the
ability of a company to deliver highly customized
products and services to different customers
ä The key to mass customization is effectively postponing
the tasks of differentiating a product for a specific
customer until the latest possible point in the supplychain network