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

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

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

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 – The use of supply chain partners to provide products or services The sourcing decision defines responsibilities of operations and supply chain managers: Insourcing – determine required capacity and resources – determine appropriate manufacturing or service processes to use – determine information systems required – manage and coordinate operations Outsourcing – identify the most qualified suppliers – manage the buyer-supplier relationship Make-or-Buy Decision © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Advantages and Disadvantages of Insourcing High degree of control Ability to oversee the entire program Economies of scale and/or scope Disadvantages Required strategic flexibility Required high investment 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

Advantages and Disadvantages of Outsourcing High strategic flexibility Low investment risk Improved cash flow Access to state-of-the-art products and services 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 © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Factors Affecting the Decision to Insource or Outsource Favors Insourcing Favors Outsourcing Factor Environmental uncertainty low high Competition in the supplier market low high Ability to monitor supplier performance low high Relationship of product/service to high low buying firm’s core competencies © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

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

Insourcing and Outsourcing Costs Insourcing Outsourcing Direct material Direct labor Freight costs Variable overhead Price (from invoice) Supervision Administrative support Supplies Maintenance costs Equipment depreciation Utilities Building lease Fixed overhead Purchasing Receiving Quality control Direct costs Indirect costs Determining the actual cost of a product or service is a complicated task requiring both good judgment and the application of sound quantitative techniques. For example, how should design cost be assigned among current products and future products? Also, what is the impact of the expected time frame of the purchasing decision? © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Complexity or Risk Impact Portfolio Analysis High Bottleneck Critical Routine Leverage Complexity or Risk Impact Low Low High Value Potential © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

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

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

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

Routine Quadrant Many alternative products and services Many sources of supply Low value, small individual transactions Everyday use, unspecified items Anyone could buy it Strategy Simplify acquisition process Tactics Increase role of systems Reduce buying effort Actions Rationalize supplier base Automate requisitioning, e.g., EDI, credit cards 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

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 Cross sourcing has the advantage of providing for a backup supplier in case the primary supplier cannot provide the required volume. Dual sourcing is typically split 70% – 30% so that the dominant supplier will lose business if performance suffers. © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

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

Weighted-Point Evaluation System - II Summary Data for Alternative Suppliers Performance Dimension Aardvark Beverly Conan the Electronics Hills Inc. Electrician $4/unit $5/unit $2/unit 5% defects 1% defects 10% defects 95% on time 80% on time 60% on time Price Quality Delivery reliability © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Weighted-Point Evaluation System - III Criteria Weights WPrice = 0.3 WQuality = 0.4 WDelivery = 0.3 5 = excellent 4 = good 3 = average 2 = fair 1 = poor Scoring Scheme © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Weighted-Point Evaluation System - IV Performance Values for Alternative Suppliers Performance Dimension Price Quality Delivery reliability Aardvark Beverly Conan the Electronics Hills Inc. Electrician 4 3 5 1 2 © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

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

Trends in Supply Management Sustainable Supply* Supply Base Reduction Global Sourcing Supply Chain Disruptions Supply Chain Capacity Transportation Costs *Referred to as Environmentalism in the text. © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Case Study in Sourcing Decisions Pagoda.Com