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

What is the bullwhip effect? Demand variability increases as you move up the supply chain from customers towards supply CustomerRetailerDistributorFactoryTier 1 SupplierEquipment First noticed regarding Pampers

Bullwhip effect in the US PC supply chain 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 Customers order on the same order cycle, e.g., first of the month, every Monday, etc. 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.

Order batching Retailers may be required to order in integer multiples of some batch size, e.g., case quantities, pallet quantities, full truck load, etc. The graph shows simulated daily consumer demand (solid line) and supplier demand (squares) when retailers order in batches of 15 units, i.e., every 15 th demand a retailer orders one batch from the supplier that contains 15 units.

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: One retailer’s buyTotal shipments and consumption

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? äIs this a signal of higher future demand or just random variation in current demand? äHedge 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: äRetailers submit orders for delivery in a future period. äSupplier produces. äIf 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: äOrders that have been submitted that are likely be canceled are called phantom orders.

Strategies to combat the bullwhip effect Information sharing: äCollaborative Planning, Forecasting and Replenishment (CPFR) Smooth the flow of products äCoordinate with retailers to spread deliveries evenly. äReduce minimum batch sizes. äSmaller and more frequent replenishments (EDI). Eliminate pathological incentives äEvery day low price äRestrict returns and order cancellations äOrder allocation based on past sales in case of shortages Vendor Managed Inventory (VMI): delegation of stocking decisions äUsed by Barilla, P&G/Wal-Mart and others.

Supply Chain Design Strategy Functional Products äStaples that people buy at retail outlets äPredictable demand and long life cycles äPhysical costs äStrategy: Minimize physical costs Innovative Products äLife cycle is just a few months (e.g. fashion clothes & computers) äDemand is unpredictable äMarket mediation costs (inventory & stockouts) äStrategy: Maximize responsiveness & flexibility Based on concepts developed by Marshall Fischer at Wharton (Penn)

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 äEfficient SC’s äRisk-Hedging SC’s äResponsive SC’s äAgile SC’s

Hau Lee’s SC Uncertainty Framework Demand Uncertainty Low (Functional products) High (Innovative products) Efficient SC Ex.: Grocery Responsive SC Ex.: Computers Risk-Hedging SC Ex.: Hydro-electric power Agile SC Ex.: Telecom Low (Stable Process) High (Evolving Process) Supply Uncertainty

Outsourcing Outsourcing is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers Reasons to Outsource äOrganizationally-driven äImprovement-driven äFinancially-driven ABC News Report on Outsourcing Part 2

Inventory Turnover Obtaining data äLook up inventory value on the balance sheet äLook up cost of goods sold (COGS) from earnings statement – not sales!! Common benchmark is inventory turns äInventory 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 $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 Retail Hardware stores: 3.5 Retail Nurseries & Garden Supply: 3.3 General Merchandise Stores: 4.7 Grocery Stores: 12.7 New & Used Car Dealers: 6.8 Gas stations & mini-marts: 39.3 Apparel &Accessories: 3.5 Furniture & home furnishings: 4.1 Drug Stores: 5.3 Liquor Stores: 6.6 Other Retail Stores: 4.3 Wholesale Groceries & related: 17.8 Vehicles & automotive: 6.9 Furniture & fixtures: 5.5 Sporting goods: 4.8 Drug store items: 8.5 Apparel & related: 5.5 Petroleum & related: 42.4 Alcoholic beverages: 8.5 Source: Bizstats.com Industries with higher gross margins tend to have lower inventory turns

Value Density Value density is defined as the value of an item per pound of weight äIt 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 äThe key to mass customization is effectively postponing the tasks of differentiating a product for a specific customer until the latest possible point in the supply- chain network