Supply Chain Management

Lecture 24

Semester Outline
Thursday April 15 Tuesday April 20 Thursday April 22 Tuesday April 27 Thursday April 29 Chap 14 Chap 15 Simulation Game briefing Review, buffer Simulation Game

Outline
Today
Finish with Chapter 14
Sections 1, 2, 3, 4, 6, 7, 8, 9
Section 6 buyback and revenue sharing contracts only

Homework 5 due tomorrow Next week

Chapter 15
Sections 1, 2

Simulation game briefing

Summary
In-House or Outsource (make or buy)?
The decision to outsource is based on the growth in supply chain surplus provided by the third party and the increase in risk by using a third party

Summary
Buy if
Supplier has cost advantage, better quality
Supplier may have better technology and may aggregate orders

Insufficient capacity
Demand grows faster than anticipated

Lack of expertise
Supplier may hold the patent to a process or product

Make if
Control cost and quality
Easier to control cost and quality

Protect proprietary technology

Protect competitive advantage

Use existing idle capacity

Short term solution

Single Versus Multiple Suppliers

Reasons for favoring a single supplier
To establish a good relationship Less quality variability Lower cost (quantity discount) Transportation economies Need capacity Spread the risk of supply interruption Create competition Policy

Reasons for favoring multiple suppliers

Outsourcing Logistics
A third-party logistics (3PL) provider performs one or more of the logistics activities relating to the flow of product, information, and funds that could be performed by the firm itself
First party logistics provider (1PL)
Shipper, a firm that needs to have goods transported from A to B

Second party logistics provider (2PL)

Carrier, firm which actually owns the means of transportation

Third party logistics provider (3PL) (sometimes LSP)

Typically specialize in integrated operation, warehousing and transportation services that can be scaled and customized to customers needs

Services Provided by 3PLs

Service Category Transportation Basic Service Inbound, outbound by ship, truck, rail, air Some specific value added services Track/trace, mode conversion

Warehousing
Information technology Reverse logistics Other 3PL services

Storage, facilities management

Provide and maintain advanced information systems Handle reverse flows

Cross-dock, in-transit merge, inventory control

Transportation management systems, warehousing management Recycling, customer returns, repair/refurbish Customs brokering, hazardous material, order taking, consulting, port services, etc.

How has globalization impacted sourcing decisions?

Outsourcing Logistics
A fourth-party logistics (4PL) provider manages other 3PLs. Whereas a 3PL targets a function, a 4PL targets management of an entire process
Fourth party logistics provider (4PL)
A 4PL is an integrator that assembles the resources, capabilities, and technology of its own organization and other organizations to design, build and run comprehensive supply chain solutions Source: Accenture 4PL use 2PLs and/or 3PLs to supply service to customers, owning mostly computer systems/technology

Best Practice 4PL

Li & Fung
The firm aggregates demand across hundreds of customers, capacity across thousands of suppliers, and uses detailed information to match supply and demand in the most cost effective manner By sourcing appropriately Li & Fung gets around regional trade umbrellas such as the EU and NAFTA

How do 4PLs Add Value?

How do 4PLs add value to a firm managing its own logistics providers? The fundamental advantage that 4PLs may provide comes from greater visibility and coordination over a firms supply chain and improved handoffs between logistics providers

Sourcing Process
Supplier scoring and assessment
Process used to rate suppliers
Supplier scoring and assessment Supplier selection and contract negotiation

Supplier selection
Choose the appropriate supplier(s)

Design collaboration
Work together with supplier when designing components for the final product

Design collaboration

Procurement
Process of placing orders and receiving orders from supplier(s)
Procurement

Sourcing planning and analysis

Analyze spending across various suppliers, identify opportunities for decreasing cost

Sourcing planning and analysis

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

Procurement

Sourcing planning and analysis

Supplier scoring and assessment

Common fundamental mistake when choosing a supplier
Only focus on quoted price

Supplier performance should be compared on the basis of the suppliers impact on total cost

Factors besides purchase price that influence total cost

Replenishment lead times
Does it pay to select a more expensive supplier with a shorter lead time? If lead time grows, safety inventory grows proportionally to the square root of the replenishment lead time

On-time performance
Is a more reliable supplier worth the extra pennies? If variability of lead time grows, the required safety inventory at the firm grows

Factors besides purchase price that influence total cost

Supply flexibility
The less flexible a supplier is, the more lead-time variability it will display as order quantities change

Delivery frequency/lot size

Delivery frequency affects the transportation cost, lot size affects the cycle inventory holding cost

Supply quality
Quality affects unit price and lead time as follow-up orders may need to be fulfilled to replace defective products

Inbound transportation cost

Sourcing a product overseas may have lower product cost, but generally incurs a higher inbound transportation cost

Factors besides purchase price that influence total cost

Pricing terms
For example, quantity discounts (and the impact it has on cycle inventory)

Information coordination capability

Good coordination results in better planning and ultimately lower production, safety inventory, and transportation cost

Exchange rates, taxes, and duties

Important for global supply chains as it affects the unit price

Supplier viability
The likelihood that the supplier will be around to fulfill the promises it makes (uncertainty increases safety inventory)

Design collaboration capability

Can help reduce all cost, improve quality, and decrease time-tomarket

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

Procurement

Sourcing planning and analysis

Design Collaboration
50-70% of spending at a manufacturer is through procurement
Compared to only about 20% several decades ago

80% of the cost of a purchased part is fixed in the design phase Design collaboration with suppliers can result in reduced cost, improved quality, and decreased time to market

How Much Does it Cost to Make an iPad?

Com ponent Estim ated cost Display Module - 9.7" Diagonal, 262K Color TFT, IPS Technology, $65.00 1024 x 768 Pixels Touchscreen Assembly - 9.7" Diagonal, Capacitive, ITO Glass $30.00 on Glass, Painted All enclosure metals, plastics, PCB substrates, connectors, $32.50 etc. Battery - Li-Ion Polymer, 3.75V, 6600mAh $21.00 Microprocessor A4 Microprocessor Core Integrated w ith Graphics $19.50 Processing Unit w / PoP DRAM 2Gbit Mobile SDRAM - Package on Package (stacked on A4) $7.30 WLAN n + BT + FM Module (Featuring Broadcom) Touchscreeen Microcontroller Touchscreen Driver Multitouch Controller - Capacitive Pow er Management Integrated Circuit Pow er Management Integrated Circuit Other Electronic Components NAND Flash Box Contents Total Materials Manufacturing Retail Price $8.05 $2.30 $1.80 $1.40 $2.10 $1.25 $20.20 $29.50 $7.50 $250.60 $9.00 $499.00

Audio Codec - Ultra Low Pow er, Stereo, w / Headphone Amplifier $1.20

Source: iSuppli

Supply Chain Top 25, 2009

Design Collaboration
Design for logistics
Attempts to reduce transportation, handling, and inventory cost Coors redesigned glass bottle reduced transportation cost

Design for manufacturability

Attempts to design products for ease of manufacture (part commonality, designing symmetrical parts, designing parts to provide access for catalog parts)

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

Procurement

Sourcing planning and analysis

Contracts and Supply Chain Performance

Many shortcomings in supply chain performance occur because the buyer and supplier each try to optimize their own profits
Total supply chain profits might therefore be lower than if the supply chain coordinated actions to have a common objective of maximizing total supply chain profits Double marginalization results in suboptimal order quantity The supplier must share in some of the buyers demand uncertainty

A contract should be structured to increase the firms profits and supply chain profits

Contracts and Supply Chain Performance

Example
Consider a music store that sells compact discs. The supplier buys/manufactures compact discs at $1 per unit and sells them to the music store at $5 per unit. The retailer sells each disc to the end customer at $10. At this price demand is normally distributed, with a mean of 1,000 and a standard deviation of 300. The retailer has a margin of $5 per disc and can potentially lose $5 for each unsold disc
Manufacturer Distributor Retailer Customer

$1

$5

$10

Contracts and Supply Chain Performance

Retailer p = $10 c = $5 Supplier $5 $1

s = $0 CSL = (p-c)/(p-s) = 0.5

O* = F-1(CSL,,) =1,000 Expected profits = (see 12.3) = $3,803
Manufacturer Distributor

1,000*4 = $4,000

Total profit = 3,803 + 4,000 = $7,803

Retailer Customer

$1

$5

$10

Contracts and Supply Chain Performance

Supply Chain p = $10 c = $1

s = $0
CSL = (p-c)/(p-s) = 0.9 O* = F-1(CSL,,) =1,384 Expected profits = (see 12.3) = $8,474
Manufacturer Distributor Retailer

versus $7,803
Customer

$1

$10

Supplier Selection and Contracts

Contracts to increase product availability and supply chain profits
Buyback Contracts Revenue-Sharing Contracts Quantity Flexibility Contracts

Contracts to increase agent effort Contracts to induce performance improvement

Shared savings contract

Buyback Contracts
Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price Increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier

Impact of Buyback Contracts on Profitability

Wholesale Buyback Optimal Expected Price c Price b Order Size Returns $5 $0 1,000 120 $5 $2 1,096 174 $5 $3 1,170 223 $6 $0 924 86 $6 $2 1,000 120 $6 $4 1,129 195 $7 $0 843 57 $7 $4 1,000 120 $7 $6 1,202 247 Expected Expected Expected Profit Profit Profit Retailer Supplier SC $3,803 $4,000 $7,803 $4,090 $4,035 $8,125 $4,286 $4,009 $8,295 $2,841 $4,620 $7,461 $3,043 $4,761 $7,804 $3,346 $4,865 $8,211 $1,957 $5,056 $7,013 $2,282 $5,521 $7,803 $2,619 $5,732 $8,351

Buyback Contracts
Downsides that buyback contract results in
Surplus inventory for the supplier that must be disposed of, which increases supply chain costs Misleading for the supply chain as it reacts to (inflated) retail orders, not actual customer demand

Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers so that the supplier can keep the surplus

Revenue Sharing Contracts

The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold

Blockbuster (1998)
Blockbuster purchases a copy from a studio for $60 and rents for $3
Blockbuster must rent the tape at least 20 times before earning profit In 1998, 20% of surveyed customers reported that they could not rent the movie they wanted because the Blockbuster did not have that movie

In 1998, Blockbuster started revenue sharing with the major movie studios
Blockbuster pays the wholesale price of $9 per copy. Blockbuster shares (1-) =30-45% portion of the revenue with the movie studio

The impact of revenue sharing on Blockbuster was dramatic

Rentals increased by 75% in test markets due to higher video availability

Netflix
Blockbuster owns its DVDs Netflix has established revenue sharing contracts with most studios
DVDs are purchased at cost Netflix pays on average $1.40 to the studios each time their title is rent At end of contract Netflix acquires some percentages of the units for retention or sale, the remaining DVDs are destroyed or returned to the original studio

Impact of Revenue Sharing Contracts on Profitability

Wholesale Price c $1 $1 $1 $2 $2 $2 Revenue Expected Expected Expected Sharing Optimal Expected Profit Profit Profit Fraction f Order Size Returns Retailer Supplier SC 0.30 1,320 342 $5,526 $2,934 $8,460 0.45 1,273 302 $4,064 $4,367 $8,431 0.60 1,202 247 $2,619 $5,732 $8,351 0.30 1,170 223 $4,286 $4,009 $8,295 0.45 1,105 179 $2,881 $5,269 $8,150 0.60 1,000 120 $1,521 $6,282 $7,803

Contracts Advantages vs. Disadvantages

Advantages
Uncertainty reduction for retailer Relationship leveraging

Disadvantages
Supplier being blocked from selling to other retailers Retailer being blocked from buying from other suppliers

Sourcing Process

Supplier scoring and assessment

Supplier selection and contract negotiation

Design collaboration

Procurement

Sourcing planning and analysis

Procurement
Procurement transactions begin with the buyer placing the order and end with the buyer receiving and paying for the order
Goal is to enable orders to be placed and delivered on schedule at the lowest possible overall cost

Two main categories of purchased goods:

Direct materials: components used to make finished goods
Memory, hard drives, and CD drives are direct materials for a PC

Indirect materials: goods used to support the operations of a firm

PCs are indirect materials for a car manufacturer

Product Categorization by Value and Criticality

High Critical items
(i.e. components with long lead times)

Strategic items
(i.e. subsystems, electronics for an auto manufacturer) Ensure long term relationship

Criticality

Ensure availability

General items
(mostly indirect materials) Ensure low cost

Bulk purchase items

(small parts, packaging) Ensure low cost

Low Low

Value/Cost

High

Outsourcing at Darden
Darden Restaurants, owner of popular brands such as Olive Garden and Red Lobster, serves more than 300 million meals annually in over 1,700 restaurants across the US and Canada. To achieve competitive advantage via its supply chain, Darden must achieve excellence at each step. With purchases from 35 countries, and seafood products with a shelf life as short as 4 days, this is a complex and challenging task. Those 300 million meals annually mean 40 million pounds of shrimp and huge quantities of tilapia, swordfish, and other fresh purchases.

What are outsourcing opportunities in a restaurant?