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.

Introduction
The sourcing decision Sourcing strategies Supplier evaluation Trends in supply management

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

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

Make-or-Buy Decision

Advantages and Disadvantages of Insourcing

Advantages Disadvantages
High degree of control Required strategic flexibility Ability to oversee the entire program Required high investment Economies of scale and/or scope Loss of access to superior products and services offered by potential suppliers

Advantages and Disadvantages of Outsourcing

Advantages
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

Factors Affecting the Decision to Insource or Outsource

Factor
Environmental uncertainty
Competition in the supplier market Ability to monitor supplier performance

Favors Insourcing
low
low low

Favors Outsourcing
high
high high

Relationship of product/service to buying firms core competencies

high

low

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

Insourcing and Outsourcing Costs

Insourcing Direct costs
Direct material Direct labor Freight costs Variable overhead Supervision Administrative support Supplies Maintenance costs Equipment depreciation Utilities Building lease Fixed overhead

Outsourcing
Price (from invoice) Freight costs

Indirect costs

Purchasing Receiving Quality control

Portfolio Analysis

High

Complexity or Risk Impact

Bottleneck

Critical

Routine
Low
Low

Leverage
High

Value Potential

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

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

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

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

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

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

Weighted-Point Evaluation System - II

Summary Data for Alternative Suppliers
Performance Dimension Aardvark Electronics Beverly Hills Inc. Conan the Electrician

Price

$4/unit

$5/unit

$2/unit

Quality
Delivery reliability

5% defects
95% on time

1% defects
80% on time

10% defects
60% on time

Weighted-Point Evaluation System - III

Score X Performance XY WY
Y 1 n

Criteria Weights WPrice = 0.3

Scoring Scheme 5 = excellent 4 = good

WQuality = 0.4
WDelivery = 0.3

3 = average
2 = fair 1 = poor

Weighted-Point Evaluation System - IV

Performance Values for Alternative Suppliers
Performance Dimension Aardvark Electronics Beverly Hills Inc. Conan the Electrician

Price

Quality
Delivery reliability

3
4

5
2

1
1

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

Trends in Supply Management

Sustainable Supply* Supply Base Reduction

Global Sourcing
Supply Chain Disruptions Supply Chain Capacity Transportation Costs

Case Study in Sourcing Decisions

Pagoda.Com