Supply Chain Management
Lecture 24
Semester Outline
•
•
•
•
•
Thursday April 15
Tuesday April 20
Thursday April 22
Tuesday April 27
Thursday April 29
Chap 14
Chap 15
Simulation Game briefing
Review, buffer
Simulation Game
Outline
• Today
– Finish with Chapter 14
• Sections 1, 2, 3, 4, 6, 7, 8, 9
– Section 6 buyback and revenue sharing contracts only
• Homework 5 due tomorrow
• Next week
– Chapter 15
• Sections 1, 2
– Simulation game briefing
Summary
• In-House or Outsource (make or buy)?
– The decision to outsource is based on the growth in supply
chain surplus provided by the third party and the increase in
risk by using a third party
Summary
• Buy if
– Supplier has cost advantage, better quality
• Supplier may have better technology and may aggregate orders
– Insufficient capacity
• Demand grows faster than anticipated
– Lack of expertise
• Supplier may hold the patent to a process or product
• Make if
– Control cost and quality
• Easier to control cost and quality
– Protect proprietary technology
• Protect competitive advantage
– Use existing idle capacity
• Short term solution
Single Versus Multiple Suppliers
• Reasons for favoring a single supplier
–
–
–
–
To establish a good relationship
Less quality variability
Lower cost (quantity discount)
Transportation economies
• Reasons for favoring multiple suppliers
–
–
–
–
Need capacity
Spread the risk of supply interruption
Create competition
Policy
Outsourcing Logistics
• A third-party logistics (3PL) provider performs
one or more of the logistics activities relating to the
flow of product, information, and funds that could
be performed by the firm itself
– First party logistics provider (1PL)
• Shipper, a firm that needs to have goods transported from A to B
– Second party logistics provider (2PL)
• Carrier, firm which actually owns the means of transportation
– Third party logistics provider (3PL) (sometimes LSP)
• Typically specialize in integrated operation, warehousing and
transportation services that can be scaled and customized to
customer’s needs
Services Provided by 3PLs
Service Category
Basic Service
Some specific value added
services
Transportation
Inbound, outbound by ship,
truck, rail, air
Track/trace, mode conversion
Warehousing
Storage, facilities
management
Cross-dock, in-transit merge,
inventory control
Information
technology
Provide and maintain
advanced information
systems
Transportation management
systems, warehousing
management
Reverse logistics
Handle reverse flows
Recycling, customer returns,
repair/refurbish
Other 3PL services
Customs brokering, hazardous
material, order taking,
consulting, port services, etc.
How has globalization impacted sourcing decisions?
Outsourcing Logistics
• A fourth-party logistics (4PL) provider
manages other 3PLs. Whereas a 3PL targets a
function, a 4PL targets management of an entire
process
– Fourth party logistics provider (4PL)
• “A 4PL is an integrator that assembles the resources,
capabilities, and technology of its own organization and other
organizations to design, build and run comprehensive supply
chain solutions” Source: Accenture
• 4PL use 2PLs and/or 3PLs to supply service to customers,
owning mostly computer systems/technology
Best Practice 4PL
• Li & Fung
– The firm aggregates demand across hundreds of
customers, capacity across thousands of suppliers,
and uses detailed information to match supply and
demand in the most cost effective manner
– By sourcing appropriately Li & Fung gets around
regional trade umbrellas such as the EU and NAFTA
How do 4PLs Add Value?
• How do 4PLs add value to a firm managing its
own logistics providers?
The fundamental advantage that 4PLs may
provide comes from greater visibility and
coordination over a firm’s supply chain and
improved handoffs between logistics
providers
Sourcing Process
• Supplier scoring and assessment
Supplier
scoring
and
assessment
– Process used to rate suppliers
• Supplier selection
Supplier
selection
and
contract
negotiation
– Choose the appropriate supplier(s)
• Design collaboration
– Work together with supplier when designing components for the
final product
Design
collaboration
• Procurement
– Process of placing orders and receiving orders from supplier(s)
Procurement
• Sourcing planning and analysis
– Analyze spending across various suppliers, identify opportunities
for decreasing cost
Sourcing
planning
and
analysis
Sourcing Process
Supplier
scoring
and
assessment
Supplier
selection
and
contract
negotiation
Design
collaboration
Procurement
Sourcing
planning
and
analysis
Supplier scoring and assessment
• Common fundamental mistake when choosing a
supplier
– Only focus on quoted price
Supplier performance should be compared on
the basis of the supplier’s impact on total cost
Factors besides purchase price
that influence total cost
• Replenishment lead times
– Does it pay to select a more expensive supplier with a
shorter lead time?
– If lead time grows, safety inventory grows proportionally to the
square root of the replenishment lead time
• On-time performance
– Is a more reliable supplier worth the extra pennies?
– If variability of lead time grows, the required safety inventory at
the firm grows
Factors besides purchase price
that influence total cost
• Supply flexibility
– The less flexible a supplier is, the more lead-time variability it will
display as order quantities change
• Delivery frequency/lot size
– Delivery frequency affects the transportation cost, lot size affects
the cycle inventory holding cost
• Supply quality
– Quality affects unit price and lead time as follow-up orders may
need to be fulfilled to replace defective products
• Inbound transportation cost
– Sourcing a product overseas may have lower product cost, but
generally incurs a higher inbound transportation cost
Factors besides purchase price
that influence total cost
• Pricing terms
– For example, quantity discounts (and the impact it has on cycle
inventory)
• Information coordination capability
– Good coordination results in better planning and ultimately lower
production, safety inventory, and transportation cost
• Exchange rates, taxes, and duties
– Important for global supply chains as it affects the unit price
• Supplier viability
– The likelihood that the supplier will be around to fulfill the
promises it makes (uncertainty increases safety inventory)
• Design collaboration capability
– Can help reduce all cost, improve quality, and decrease time-tomarket
Sourcing Process
Supplier
scoring
and
assessment
Supplier
selection
and
contract
negotiation
Design
collaboration
Procurement
Sourcing
planning
and
analysis
Design Collaboration
• 50-70% of spending at a manufacturer is
through procurement
– Compared to only about 20% several decades ago
• 80% 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
How Much Does it Cost to Make an
iPad?
Com ponent
Estim ated cost
Display Module - 9.7" Diagonal, 262K Color TFT, IPS Technology,
$65.00
1024 x 768 Pixels
Touchscreen Assembly - 9.7" Diagonal, Capacitive, ITO Glass
$30.00
on Glass, Painted
All enclosure metals, plastics, PCB substrates, connectors, $32.50
etc.
Battery - Li-Ion Polymer, 3.75V, 6600mAh
$21.00
Microprocessor A4 Microprocessor Core Integrated w ith Graphics
$19.50 Processing Unit w / PoP DRAM
2Gbit Mobile SDRAM - Package on Package (stacked on A4) $7.30
WLAN n + BT + FM Module (Featuring Broadcom)
$8.05
Touchscreeen Microcontroller
$2.30
Touchscreen Driver
$1.80
Multitouch Controller - Capacitive
$1.40
Audio Codec - Ultra Low Pow er, Stereo, w / Headphone Amplifier
$1.20
Pow er Management Integrated Circuit
$2.10
Pow er Management Integrated Circuit
$1.25
Other Electronic Components
$20.20
NAND Flash
$29.50
Box Contents
$7.50
Total Materials
$250.60
Manufacturing
$9.00
Retail Price
$499.00
Source: iSuppli
Supply Chain Top 25, 2009
Design Collaboration
• Design for logistics
– Attempts to reduce transportation, handling, and inventory cost
– Coors redesigned glass bottle reduced transportation cost
• Design for manufacturability
– Attempts to design products for ease of manufacture (part
commonality, designing symmetrical parts, designing parts to
provide access for catalog parts)
Sourcing Process
Supplier
scoring
and
assessment
Supplier
selection
and
contract
negotiation
Design
collaboration
Procurement
Sourcing
planning
and
analysis
Contracts and Supply Chain
Performance
• Many shortcomings in supply chain performance occur
because the buyer and supplier each try to optimize their
own profits
– Total supply chain profits might therefore be lower than if the
supply chain coordinated actions to have a common objective
of maximizing total supply chain profits
– Double marginalization results in suboptimal order quantity
– The supplier must share in some of the buyer’s demand
uncertainty
• A contract should be structured to increase the firm’s
profits and supply chain profits
Contracts and Supply Chain
Performance
• Example
– Consider a music store that sells compact discs. The
supplier buys/manufactures compact discs at $1 per
unit and sells them to the music store at $5 per unit.
The retailer sells each disc to the end customer at
$10. At this price demand is normally distributed, with
a mean of 1,000 and a standard deviation of 300. The
retailer has a margin of $5 per disc and can
potentially lose $5 for each unsold disc
Manufacturer
Distributor
$1
Retailer
$5
Customer
$10
Contracts and Supply Chain
Performance
Retailer
p = $10
c = $5
s = $0
Supplier
$5
$1
CSL = (p-c)/(p-s) = 0.5
O* = F-1(CSL,,) =1,000
Expected profits = (see 12.3) = $3,803
1,000*4 = $4,000
Total profit = 3,803 + 4,000 = $7,803
Manufacturer
Distributor
$1
Retailer
$5
Customer
$10
Contracts and Supply Chain
Performance
Supply Chain
p = $10
c = $1
s = $0
CSL = (p-c)/(p-s) = 0.9
O* = F-1(CSL,,) =1,384
Expected profits = (see 12.3) = $8,474
Manufacturer
Distributor
$1
versus $7,803
Retailer
Customer
$10
Supplier Selection and Contracts
• Contracts to increase product availability and supply
chain profits
– Buyback Contracts
– Revenue-Sharing Contracts
– Quantity Flexibility Contracts
• Contracts to increase agent effort
• Contracts to induce performance improvement
– Shared savings contract
Buyback Contracts
• Allows a retailer to return unsold inventory up to a
specified amount at an agreed upon price
• Increases the optimal order quantity for the retailer,
resulting in higher product availability and higher profits
for both the retailer and the supplier
Impact of Buyback Contracts on
Profitability
Wholesale Buyback Optimal Expected
Price c
Price b Order Size Returns
$5
$0
1,000
120
$5
$2
1,096
174
$5
$3
1,170
223
$6
$0
924
86
$6
$2
1,000
120
$6
$4
1,129
195
$7
$0
843
57
$7
$4
1,000
120
$7
$6
1,202
247
Expected Expected Expected
Profit
Profit
Profit
Retailer
Supplier
SC
$3,803
$4,000
$7,803
$4,090
$4,035
$8,125
$4,286
$4,009
$8,295
$2,841
$4,620
$7,461
$3,043
$4,761
$7,804
$3,346
$4,865
$8,211
$1,957
$5,056
$7,013
$2,282
$5,521
$7,803
$2,619
$5,732
$8,351
Buyback Contracts
• Downsides that buyback contract results in
– Surplus inventory for the supplier that must be disposed of,
which increases supply chain costs
– Misleading for the supply chain as it reacts to (inflated) retail
orders, not actual customer demand
• Most effective for products with low variable cost, such
as music, software, books, magazines, and newspapers
so that the supplier can keep the surplus
Revenue Sharing Contracts
• The buyer pays a minimal amount for each unit
purchased from the supplier but shares a fraction of
the revenue for each unit sold
Blockbuster (1998)
• Blockbuster purchases a copy from a studio for $60 and
rents for $3
– Blockbuster must rent the tape at least 20 times before earning
profit
– In 1998, 20% of surveyed customers reported that they could not
rent the movie they wanted because the Blockbuster did not
have that movie
• In 1998, Blockbuster started revenue sharing with the
major movie studios
– Blockbuster pays the wholesale price of $9 per copy.
– Blockbuster shares (1-θ) =30-45% portion of the revenue with
the movie studio
• The impact of revenue sharing on Blockbuster was
dramatic
– Rentals increased by 75% in test markets due to higher video
availability
Netflix
• Blockbuster owns its DVDs
• Netflix has established revenue sharing contracts with
most studios
– DVDs are purchased at cost
– Netflix pays on average $1.40 to the studios each time their title
is rent
– At end of contract Netflix acquires some percentages of the units
for retention or sale, the remaining DVDs are destroyed or
returned to the original studio
Impact of Revenue Sharing Contracts
on Profitability
Wholesale
Price c
$1
$1
$1
$2
$2
$2
Revenue
Expected Expected Expected
Sharing
Optimal Expected
Profit
Profit
Profit
Fraction f Order Size Returns
Retailer
Supplier
SC
0.30
1,320
342
$5,526
$2,934
$8,460
0.45
1,273
302
$4,064
$4,367
$8,431
0.60
1,202
247
$2,619
$5,732
$8,351
0.30
1,170
223
$4,286
$4,009
$8,295
0.45
1,105
179
$2,881
$5,269
$8,150
0.60
1,000
120
$1,521
$6,282
$7,803
Contracts Advantages vs.
Disadvantages
• Advantages
– Uncertainty reduction for
retailer
– Relationship leveraging
• Disadvantages
– Supplier being blocked
from selling to other
retailers
– Retailer being blocked from
buying from other suppliers
Sourcing Process
Supplier
scoring
and
assessment
Supplier
selection
and
contract
negotiation
Design
collaboration
Procurement
Sourcing
planning
and
analysis
Procurement
• Procurement transactions begin with the buyer placing
the order and end with the buyer receiving and paying for
the order
– 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
• Memory, hard drives, and CD drives are direct materials for a PC
– Indirect materials: goods used to support the operations of a firm
• PCs are indirect materials for a car manufacturer
Product Categorization by Value
and Criticality
High
Strategic items
(i.e. components with
long lead times)
(i.e. subsystems, electronics
for an auto manufacturer)
Ensure availability
Ensure long term relationship
General items
Bulk purchase items
(mostly indirect materials)
(small parts, packaging)
Ensure low cost
Ensure low cost
Criticality
Critical items
Low
Low
Value/Cost
High
Outsourcing at Darden
Darden Restaurants, owner of popular brands such as Olive
Garden and Red Lobster, serves more than 300 million meals
annually in over 1,700 restaurants across the US and Canada. To
achieve competitive advantage via its supply chain, Darden must
achieve excellence at each step. With purchases from 35
countries, and seafood products with a shelf life as short as 4
days, this is a complex and challenging task. Those 300 million
meals annually mean 40 million pounds of shrimp and huge
quantities of tilapia, swordfish, and other fresh purchases.
What are outsourcing opportunities in a restaurant?