Chapter 7: Strategic Sourcing

1. Chapter 7: Strategic Sourcing

2. 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 SupplyChain http://www.covisint.com/

3. 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 Retailer Customer First noticed regarding Pampers

4. 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.

5. 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.

6. Causes of the bullwhip effect • Order synchronization • Order batching • Trade promotions and forward buying • Reactive and over-reactive ordering • Shortage gaming

7. 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.

8. 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.

9. 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

10. 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.

11. 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.

12. 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.

13. Supply Chain Design Strategy Based on concepts developed by Marshall Fischer at Wharton (Penn) • 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

14. 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

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

16. 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

17. 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

18. 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 Industries with higher gross margins tend to have lower inventory turns Source: Bizstats.com

19. 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

20. 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