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

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What is the bullwhip effect?

Demand variability increases as you move up the supply chain from customers towards supply

Customer

RetailerDistributorFactoryTier 1 SupplierEquipment

First noticed regarding Pampers

Bullwhip effect in the US PC supply chain

Semiconductor

1995 1996 1997 1998 1999 2000 2001

-40%

-20%

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80%

PC

SemiconductorEquipment

Changes indemand

Semiconductor

1995 1996 1997 1998 1999 2000 2001

-40%

-20%

0%

20%

40%

60%

80%

PC

SemiconductorEquipment

Changes indemand

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.

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Time (each period equals one day)

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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 15th demand a retailer orders one batch from the supplier that contains 15 units.

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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 buy

Time (weeks)

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Shipments

Consumption

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Total 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? Is this a signal of higher future demand or just random variation in

current demand? 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:

Retailers submit orders for delivery in a future period. Supplier produces. 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: Orders that have been submitted that are likely be canceled are called

phantom orders.

Strategies to combat the bullwhip effect Information sharing:

Collaborative Planning, Forecasting and Replenishment (CPFR)

Smooth the flow of products Coordinate with retailers to spread deliveries evenly. Reduce minimum batch sizes. Smaller and more frequent replenishments (EDI).

Eliminate pathological incentives Every day low price Restrict returns and order cancellations Order allocation based on past sales in case of shortages

Vendor Managed Inventory (VMI): delegation of stocking decisions Used by Barilla, P&G/Wal-Mart and others.

Supply Chain Design Strategy

Functional Products Staples that people buy at retail outlets Predictable demand and long life cycles Physical costs Strategy: Minimize physical costs

Innovative Products Life cycle is just a few months (e.g. fashion

clothes & computers) Demand is unpredictable Market mediation costs (inventory &

stockouts) Strategy: Maximize responsiveness &

flexibility

Based on concepts developed by Marshall Fischer at Wharton (Penn)

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 Efficient SC’s Risk-Hedging SC’s Responsive SC’s Agile 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

Organizationally-driven

Improvement-driven

Financially-driven

ABC News Report on Outsourcing Part 2

Inventory Turnover

Obtaining data

Look up inventory value on the balance sheet

Look up cost of goods sold (COGS) from earnings statement – not sales!!

Common benchmark is inventory turns

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

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.comSource: 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

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

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 supply-chain network